The FASB has issued new lease rules and in order to help us prepare I’ve gathered some facts about the change
The FASB implemented a new standard that changes the way leases are accounted for. In accounting leases are grouped into one of two categories operating and capital as described in ASC . Operating leases are the simplest to account for and were treated as an current period expense (i.e. rent expense) which was only reflected on the income statement in addition it was disclosed in the notes to the financial statements. Capital leases, or leases that met certain criteria and were more akin to financing arrangements, were a bit more complex and are recorded as an Asset & Liability on the balance sheet.
Under the new standard all leases greater than one year will be capitalized on the balance sheet. This will add potentially trillions of liabilities to American companies. The new standard classifies leases as Type A or Type B. Type A are financing type leases, similar to the capital leases of the old standard, and type B are similar to operating leases. While both will now be on the balance sheet as a right-of-use asset and lease liability, the main difference is how these effect the income statement. Type B will be recognized as a single straight line amortization of the liability while Type A will require amortization of the right-of-use, interest on lease liability as well as impairment on the asset. It’s important to note that the IASB standard treats all leases as a Type A.
This change was made to improve the transparency of balance sheet. Operating leases are not reflected on the balance sheet. However these leases often carry long term considerations and obligations which affect the credit worthiness of the company. The intention is to reduce the use of off balance sheet financing and increase the usefulness of the balance sheet to reflect the true liabilities of the firm.
When does the change take place and how to prepare?
The change takes effect on 12/15/18 for public companies and 12/15/19 for private firms, however you can implement it earlier if you are ready. To get ready it’s best to update your firms lease inventories. Get a handle on all of the existing lease obligations. It will be advisable to invest in a system for managing leases and identifying new internal controls with the asset acquisition process.
For accounting providers we have an opportunity to help clients navigate the new standards. For the more technical minded we can design systems to store and analyze these contracts and assist in recognizing the asset, liability and expenses these generate. Since virtually every firm has these obligations there are many opportunities available.
Lease accounting is undergoing a major change in the way these assets are treated. The FASB’s new standard will increase transparency for investors. Although it presents many new challenges for our firms we must work hard to advise them and help them navigate the changing financial landscape.