Beginning this year, public companies are required to change the way they report leases longer than 12 months on their balance sheets, a move intended to improve financial transparency. But it also might create headaches for some businesses.
Privately owned companies will have to follow the new requirements by 2021.
The changes were developed by the Financial Accounting Standards Board, a nonprofit standard-setting board that establishes generally accepted accounting principles in the United States.
The new GAAP standards require companies, nonprofits and other business entities that lease assets, including office space and equipment, to recognize on their balance sheets the assets and liabilities created by leases longer than a single year.
Previous GAAP required only capital leases to be recognized on the balance sheet, but the new standards also require operating leases to be recognized. Thus, those leases are now recognized as current assets and liabilities, rather than noncurrent assets and liabilities.
The new disclosures, the FASB said, will help investors and others better understand the amount, timing and uncertainty of cash flows arising from a business’s leases.
The new standards improve “financial statement transparency” and comparability among companies, according to Rhode Island accounting experts.
“Ultimately the standard will provide investors, bankers and owners with a more transparent view of the company financial picture,” said James Queenan, partner and director of audit and assurance at the Warwick accounting firm of DiSanto, Priest & Co.
“It will also offer a fresh look, and a potential redesign, of the lease-versus-buy analysis,” Queenan said.
‘There’s a lot of calculation involved. There’s a lot more accounting required for it.’
CLAIRE IACOBUCCI, Kahn, Litwin, Renza & Co. partner and director of audit services
Claire Iacobucci, partner and director of audit services at Providence accounting firm Kahn, Litwin, Renza & Co. Ltd., acknowledged the impact to balance sheets could influence myriad decisions about investments, borrowing, and mergers and acquisitions for businesses and nonprofits across a range of industries.
Iacobucci said it also involves more accounting work.
“It is tedious. There’s a lot of calculation involved,” she said. “There’s a lot more accounting required for it.”
Under previous GAAP, Iacobucci explained, business entities had two options: The first reporting option is known as a capital lease, which is capitalized on the balance sheet.
The second reporting option is an operating lease, which previously was recorded on the income statement and disclosed in the notes of the financial statements.
The new standards, Iacobucci noted, require all leases to be recorded on the balance sheet as a “right-of-use” asset and as a lease liability, though there are exceptions for leases of 12 months or less or if the agreement does not meet the definition of a lease.
Queenan concurred. Prior to the new standard, “most leasing activity was reported as off-balance sheet items in the footnotes to the financial statements,” he said. “Lessees will now need to recognize on the balance sheet a right-of-use asset and a lease liability upon the inception of the lease.”
For some businesses, the ability to collect the data necessary to comply with the new standards may be a challenge.
“Many large companies may lack centralized lease information, and some may have no information at all related to small leases for office equipment,” Queenan explained.
The lease accounting changes will affect virtually all industries. However, the impact will depend on the extent of each company’s use of leases – something the health care industry relies heavily upon, according to the national accounting firm of Citrin Cooperman & Co. LLP, which has an office in Providence.
“For example, in the health care industry, hospital systems and large multi-physician practices have numerous locations through real estate leases,” Citrin Cooperman noted in an analysis of the new standards.
“These organizations will see the greatest impact of these new standards,” the firm wrote.
For such entities, the firm advised, they should carefully analyze the implications of the new lease standards to key performance metrics, debt covenants, taxes and internal operations.
“The key performance metrics that are expected to be affected by these changes are the leverage ratio [debt compared with equity], current ratio [current assets compared with current liabilities] and debt-to-earnings before income taxes, depreciation and amortization due to the new standards adding liabilities to the books,” the firm wrote.
“Since lessees are adding the right-of-use assets to the balance sheets, it could also impact book-to-tax differences, state apportionment calculations and personal property taxes,” the firm added.
“From an operations perspective, companies will need to consider the impact of lease-versus-buy decisions, because companies no longer have the benefit of an off-balance sheet financing option,” the firm wrote.
Scott Blake is a PBN staff writer. Contact him at Blake@PBN.com.
