November 30, 2016
Don’t Procrastinate: The Impact of the New Lease Accounting Standard is Real
You can’t avoid it for much longer. The new lease accounting standard is around the corner and takes effect in 2019* for public companies and a year later for private companies. While it may seem like there’s plenty of time to prepare, don’t underestimate the level of effort it’s going to take your team. The new standard will have an impact far beyond accounting and disclosure and will require additional resources and effort – across multiple departments – to implement and manage.
While the new lease accounting standard doesn’t take effect until January 1, 2019, public companies will be required to restate the financials for all years presented to give effect to the new standard, as if it was adopted on January 1, 2017. Also, all leases in effect at the initial date of adoption will need to be accounted for in accordance with the new guidelines.
Here’s some information and important considerations to ensure your company is ready.
What do the changes to the lease accounting standards really mean?
There are several significant changes, the most notable of which is the new lessee accounting model. This includes changes to what is reported on many companies’ balance sheets for assets they use under leases in their businesses. Assets leased for more than one year will be recorded as a “Right-to-use asset,” and a corresponding liability will be recorded as a “Lease liability.” Companies will no longer be able to structure lease agreements to achieve off balance sheet accounting for leases that have a term of twelve months or longer.
As previously mentioned, the reporting changes must be applied retroactively, so companies will be required to perform calculations for the current period and for all comparative prior periods presented in their financial statements. This means that most public companies will need to consider the impact and apply the new guidance to leasing transactions beginning in 2017. In addition, there will be increased disclosure requirements in the new guidance.
There are also impacts on the income statement for companies leasing assets. The two categories of leases are “Finance” and “Operating,” and while both will be recorded on the balance sheet, the effects on the income statement will differ. For example, finance leases will be more front-end loaded for expense amortization and interest expense being recorded. Operating leases will be expensed on a straight-line basis and will be classified as operating expenses. Amortization and interest expense will be added back in EBITDA determinations.
How will the new lease standard impact company resource needs?
The changes in lease accounting will add considerable administrative burden. The data to calculate lease assets and liabilities will need to come from several sources in the organization. The calculation is complex and involves estimates and judgments from both finance and operational departments. Leases will need to be reviewed to determine if non-lease services are embedded in the agreement. For instance, if you lease a copier and the agreement includes a service component, the service component will need to be carved out and accounted for separately from the leased asset.
This also means that procedures and controls will need to be updated to provide for periodic reviews of estimates used in the calculations and to ensure lease data is captured going forward for new leases, renewals and amendments.
What are the impacts of the new lease standard to other areas of the business?
The new lease accounting standard goes beyond the finance department, so there is a lot to consider. Here are a few examples:
- Treasury: The increased leverage on the balance sheet will likely change certain financial ratios, such as the debt to equity ratio, so impacts on financial modeling and debt covenants must be considered.
- Legal: Future lease agreements will need to be closely reviewed and written to the new standard so they can be as advantageous as possible.
- IT: If you maintain or plan to maintain lease records electronically, it’s important to involve the IT team sooner than later.
- Tax: There will likely be added complexity to income tax accounting and other reporting requirements to consider.
- Procurement: The procurement and financial planning departments should reevaluate how to acquire assets going forward to achieve the best outcome, including lease vs buy decisions.
- Training/HR: To ensure a successful transition to the new lease standard, don’t overlook training about the new requirements that affect each department.
Why should companies get started now?
Getting started now can help save time, money and stress.
- Collecting, analyzing and centralizing the necessary lease data will take time and resources. For example, keep in mind that data on leases that have ended or will terminate before the effective date will also need to be gathered for the comparative reporting periods.
- Finding and implementing the right technology solution will also take considerable time and resources and involves coordination with individuals outside of accounting.
- Many of your resources involved in adopting this new standard are the same ones that need to focus on ongoing company needs, as well as other upcoming items such as implementing new revenue recognition guidance. Keep in mind that there will be considerable demand on your limited resources.
- Finally, companies need to understand the impact early to allow adequate time to communicate with outside stakeholders to manage their expectations. The impact on the balance sheet could catch lenders and investors off guard, so they should be notified in advance to address any covenant concerns.
What is the roadmap for success?
Here are some key steps that companies should follow in preparation for the new lease standard:
- Understand the accounting and financial reporting requirements.
- Form a cross-functional implementation team to evaluate the lease standard.
- Identify and inventory all company lease agreements. Start by asking yourself, “What is the universe of assets we use that we don’t own?” You may find non-traditional lease assets are now covered by the new standard.
- Assess the impact to the company’s financial statements, other reporting requirements and loan covenants.
- Communicate with management and advisors to make them aware of the impact on future financial reports.
- Identify improvements needed in financial reporting and internal control processes and systems to capture, account for and evaluate lease agreements.
- Consider early adoption at the same time as the new revenue recognition standard to best coordinate implementation efforts and resources.
* Technically, the new standards take effect for interim and annual periods beginning after December 15, 2018.
Time will quickly run out for companies that don’t start assessing and planning for the new lease accounting changes, so now’s the time to get started. Need help with creating and implementing a lease accounting roadmap? Contact Bridgepoint today.
You may also like:
Follow us on Twitter and LinkedIn for the latest insights on the new lease standard and other important topics.