Everything You Need To Know About The New FASB Leasing Standards
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After long debate, the Financial Accounting Standards Board’s new leasing standards were ratified and will go into effect for fiscal years beginning after Dec. 15, 2018, for public companies and Dec. 15, 2019, for private companies—with the option, of course, for early adoption.
While Berdon LLP real estate audit partner Seth Molod, CPA acknowledges that these dates seem far off, they may be closer than you think, especially when you consider the reporting required under the new standards.
The new standards require companies to bring all lease assets and liabilities onto their balance sheets—considerably more info than in years past—which may require new systems and internal controls. Simply put, Seth believes, the changes could have a massive impact on lease negotiations with current and prospective lessees, and that’s why Bisnow sat down with him to get some insight.
Bringing It All To Light
Seth says businesses with capital or finance leases should know they’re in the clear, as all of their leases are already on their balance sheets and will be accounted for in a similar fashion. It’s businesses that have entered into operating leases and have liabilities not on the balance sheet that will have their worlds changed, as they’ll now be forced to record liabilities, rather than disclose them in the footnotes of their financial statements.
“Previously, there was a lot of incentive for companies to structure leases in a way that met the definition of an operating lease in order to avoid recording them on their balance sheets,” Seth tells Bisnow. “Structuring in this way resulted in better financial ratios and perhaps an enhanced borrowing ability."
Financial engineering of leases was a common practice to ensure more favorable balance sheet presentation, he continues, but the new rules blow that out of the water, and there’s a “huge question mark” in the credit community as to how to look at the potentially trillions of dollars that’ll appear on companies’ balance sheets and whether or not to reevaluate companies’ credit under a different model.
Seth says some companies will be putting hundreds of millions of dollars of debt onto their balance sheets that was never there before, which means that the traditional debt-to-equity and debt service coverage ratios that appear in credit loan agreements will have to be reworked.
But the financial position of these companies, Seth insists, is not changing. And it’s yet to be seen if Wall Street, the rating agencies or the lending community will dramatically change their views of companies based on the new standards.
However, companies with massive amounts of properties not on their balance sheets—including large retailers with thousands of operating leases—will face a huge implementation challenge as this information will need to be aggregated in new ways for recording and presentation in their financial statements.
But Seth says with every new standard, there are ways to financially engineer leases to minimize liability. Those who write shorter-term leases or leases with less fixed rent and more contingent rent may achieve the result of lower liabilities recorded. As such, companies that have leases coming up for renewal in the next few years may want to seriously consider how to structure them in order to avoid huge headaches in the future.
Multinational businesses should note that US GAAP will have a dual model—a finance lease and an operating lease—as opposed to International Financial Reporting Standards (IFRS), which is all finance lease-based. In a similar fashion to previous standards, finance leases generally recognize more costs upfront during the term of the lease than do operating leases.
“Operating in this new environment will present some challenges for businesses in choosing systems that can accommodate what amounts to a dual world,” Seth wrote in a Berdon media blast. “Businesses are advised to get a jump on the new standard and consider producing comparative financial statements during the transition to the effective date.”
Equipment Leases And Consolidating Vendors
One of the biggest changes to the leasing standards will be a greater disclosure about “leases embedded in service and other agreements, which convey the right to use property, plant, or equipment.”
What this means, Seth says, is that many companies will have to bifurcate the lease element of these agreements and recognize them separately from the service element. Conversely, leases that have service elements embedded will also have to be bifurcated and may result in reporting changes. In addition, much greater disclosure of the underlying nature of the agreements will be required.
Additionally, many businesses may revisit a lease vs. buy analysis, as buying an asset may be more attractive because the liability will have to be recorded on the balance sheet regardless.
The new standard may also drive businesses to consolidate the number of vendors they lease from in order to simplify the process of tracking leases and lower the overall cost of compliance. Some businesses, Seth says, can have a multitude of leasing vendors, when it may be simpler (and just as effective) to use only a few.
The Solution Lies In Technology
One of the biggest solutions that Seth recommends is technologies that can reduce and simplify the potential compliance costs. Many businesses—particularly middle market companies—don't have an advanced calculation system for leases, and they’ll need to spend time and money finding “the most economic and efficient tech solution” to keep their lease info updated, accurate and complete.
These technologies not only house all of your leases in one central location, but can help calculate the liabilities from year to year and affect your financial statements.
Still, Seth admits that the impact of these changes is yet to be determined. The reaction of the credit community, Wall Street and the rating agencies will likely drive corporate behavior. Similarly, vendors, landlords and other lessors will have to react to their customers’ behavior and adjust accordingly.
But by approaching it early and truly looking at all the financial solutions possible, companies could be well-prepared for a smooth, smart transition by the time the effective date rolls around.
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