There’s been lots of back and forth about the merits and drawbacks of off-balance sheet accounting, but no matter which side of the argument you’re on, a new standard for lease accounting has been established and it will affect your business. As demands for transparency in financial reporting rise, all leases—from office equipment to warehouses to manufacturing equipment—will need to be presented on your company balance sheet. Organizations that were previously expensing all lease payments through operations under the historical lease accounting treatment will see a significant change in their financial statements.
Here’s what you need to know about how these new lease accounting practices will apply to your business.
What does this mean for your company?
The new standard essentially requires all leases to receive similar treatment to what were formerly called “capital leases,” specifying that property under lease now must be recorded as an asset. The related leasing obligation is then recorded and accounted for in a manner that closely mirrors a mortgage. Capital leases are now known as “financing leases,” with similar accounting to that from days of old. Leases that were formerly expensed as operating leases will now result in a capitalized asset—along with a corresponding liability.
Accounting and disclosures challenges
The new standard presents changes to wording and underlying definitions as well as practical changes that can complicate accounting and disclosures.
First, you’ll have to identify all leases. Some will be easy to spot, since the title on the top of the document will be clearly marked. However, the new standard also applies to certain leases that may be embedded within other contracts for services. Depending on the size and scope of your business, combing through all service agreements can take time, so it’s best to get on top of this task right away. Even though you may consider this an easy step, ask for help from your CPA firm. They will be able to provide guidance that addresses any specific issues with the leases.
Next, you’ll need to identify a number of variables related to each lease/classes of leases, some of which can be difficult to ascertain. These variables include: the lease term, what is included in payments, and the underlying interest rate. Additionally, whether a lease is classified as a financing lease or operating lease can actually shift over time, based on changes in circumstance. This classification adjustment also applies to overall accounting and disclosure when significant events occur, such as renewal or early termination.
The time for review is now
If you haven’t begun to review your lease holdings, you’re not alone. Early indicators suggest that many companies have not yet started preparation to implement this new standard, even though it is effective if your year-end is after December 15, 2018 (for public companies). For private companies, implementation of the new standard can begin for your 2020 calendar year if your fiscal is on the calendar year. In either case, the transition to this new standard will require you to calculate the effects on a retrospective basis for at least one year prior to implementation.
Reach out to your CPA firm to start digging into this ASAP. With such a large volume of data to collect and analyze, the sooner you begin, the better.