This week we have guest blogger, Jim Giroux, CPA (Inactive), Senior Director of Business Development for Brilliant™ Management Resources, taking over for A Brilliant™ Blog – Check In With Jim to discuss key details finance leaders need to know once the new Lease Accounting Standards go into effect.
After nearly 10 years of discussion, a joint effort between the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB)—the governing bodies responsible for setting accounting standards for publically-traded companies—is on the verge of enforcing its new guidelines surrounding lease accounting.
Although the project was a convergent effort, there are several differences that accounting and finance leaders should be aware of between the FASB and IASB standards. For instance, accounting and finance leaders in the U.S. may have a different, more positive, view on the standards versus their European counterparts, as the IFRS standard includes all leases of assets (not just PP&E), which could include leases of intangible assets, inventory, assets under construction and more.
Further, following the Enron bankruptcy, the SEC (U.S. Securities and Exchange Commission) identified leases as an accounting issue that needed to be reviewed. The objective was to address the accounting for off-balance sheet financing of operating leases. The FASB’s new standard, ASU 2016-02, requires that all leases not of a short duration (i.e. 12 months or less) be reported on the balance sheet.
The implementation of this standard will go into effect beginning on Jan. 1, 2019 for public businesses, and on Jan. 1, 2020 for private companies and all other entities.
I recently came across a CFO.com e-book that does a nice job of guiding you through the technical details of this information. After review, I thought I’d include a few of their key points, along with some of my own accounting and finance expertise, to help you understand exactly how accounting, finance, and even information technology individuals, will be impacted. In fact, implementation of this standard could prove to be more daunting than first realized. So, it’s important to stay up to date on all of the information.
Take a look at the 5 Need-to-Knows About the Changes with Lease Accounting below:
1. Data Collection
Many, if not most, entities affected have multiple locations and these may be decentralized as to its records for operating leases. These firms likely have lease information within Excel spreadsheets that will need to be centralized at the corporate level for reporting purposes. These spreadsheets will also need to be enhanced as new information needed includes the incremental borrowing rate, the assets estimated useful life, the fair value of the asset, and any judgements and assumptions that were made to onboard the asset to the balance sheet. Experts feel multi-national companies will find data collection particularly challenging in gathering the required information if for no other reason than the lease is likely in the local foreign language.
2. Debt Covenants
Since the reporting requirements do require the liability to be placed on the balance sheet, companies will need to review their debt covenants to determine if the increased leverage will cause a debt violation. Since the reporting requirement is to show the operating lease liabilities outside of traditional debt, it is possible (hopefully) that the entities’ debt covenants are written in a way that they are able to separate these additional liabilities from the covenants and that there will be no effect. However, businesses will clearly want to review their covenants and have a specific discussion with their lenders earlier rather than later. Firms with a large amount of leverage available in their debt covenants may also make a business decision to purchase the assets with financing rather than continue to book operating leases; thus it is a good time to review your company’s lease/buy policy.
3. Internal Controls and Business Processes
Businesses should expect a deep review of their associated controls and internal processes, and their effectiveness in approving and onboarding each lease into its financial statements. Therefore, firms should examine their internal controls and adjust as needed. A shared service model may be appropriate i.e. where all leases need the approval of the Treasury department so that solid assumptions on interest rates can be determined up front (or actual rates agreed too), and the Treasury department is required to provide the lease accounting area with all copies and relevant dates needed to properly account for, and report the new leases per the Accounting Standards Update (ASU).
4. Information Systems
Smaller firms, or businesses with a limited amount of leases, will be able to continue with enhanced Excel spreadsheets. Larger companies and multi-national firms should be considering a lease operating or accounting package if they do not already have one. There are a number of systems available for purchase in the market that have already altered their software to accommodate these new reporting requirements. Please note the differences between the IFRS (International Financial Reporting Standards) and GAAP (Generally Accepted Accounting Principles) standards when analyzing these systems for your company.
5. Income Taxes
Companies will need to continue to determine the tax classification of a lease, and it’s possible that there will be differences between book and tax handling. One of the potential shifts in tax due to this ASU could be the result of the state apportionment formula. With these assets now on the books, there could be a state income tax shift as well as franchise taxes now payable.
Final note: Big 4 CPA firms, large CPA firms, CCH, IBM etc. have written extensive detailed papers on the effects of this ASU as a great start for understanding and applying the effects to your firm. A recent study was performed by E&Y and CBRE to understand where businesses are with regards to several of these issues affected by the standard, along with questions to determine what work has been performed in this area by their Accounting departments. A full 70 percent of companies surveyed suggested that they plan to start working on this standard in 2016 which is a significantly quicker start than past performances of those working toward implementing new standards. That being said, only 29 percent of the firms have actually started any work.
Should your business need of any help gathering of this data or need support with implementing a new software package for your firm’s leases, Brilliant™ is just a phone call away! Call 312.582.1800 or email [email protected] and mention this blog.
What are your thoughts on the new lease accounting standards? Comment below and let us know!