The days of using off-balance-sheet financing for capital purchases are over. As we explained recently on the blog, big changes are ahead for the financial statements of businesses, thanks to a long-awaited major accounting standard update that brings operating leases onto company balance sheets.
The Financial Accounting Standards Board (FASB) finalized the new accounting standard in late February 2016, with an effective date of January 1, 2020, for privately-held businesses. All lease agreements in effect on or after January 1, 2020, must record a liability for the present value of the lease payments with the offsetting side to a noncurrent asset. This means billions of dollars of these lease obligations will soon need to be included on balance sheets.
Even though this new accounting standard is not effective until 2020, this change from current practice impacts businesses today in several ways. Let’s take a look at what business owners should be doing now to prepare for the impact of these new accounting rules.
Review: Compile all current lease programs for equipment and any lease agreements for real property, with an eye toward both lease length and renewal periods. A lease with a longer timeframe means a greater liability will need to be recorded on financial statements. Taking the time now to calculate the approximate impact the new standard will have on your balance sheets can help you better prepare to absorb a potentially larger liability.
Think ahead: Establish a protocol for evaluating all future lease agreements. Make sure the process includes analysis of accounting treatment, financial statement impact and financing issues. The leases you sign today could be included in these new standards, and could impact loan covenants.
Communicate: Get in contact with your financing institutions to educate them on the impact this standard will have on your balance sheet and prospective financial reporting. Also, use this opportunity to understand the financial institution’s interpretation of the standard and the impact it may have on the financial institution’s lending practices. This will help you determine if your financial covenants will be negatively impacted by this change in accounting for leases.
RKL’s audit and accounting team has the expertise to help businesses with the action items listed above in preparation for the new standards. Businesses with questions about how this will affect their bottom lines should contact your RKL professional or one of our local offices.
Contributed by Keith L. Eldredge, CPA, CCIFP®, partner in RKL’s Audit Services Group. Keith is primarily responsible for serving the accounting and auditing needs of privately held construction and real estate clients.