After a long journey, the new leases accounting standard has been issued by both the International Accounting Standards Board ("IASB") in January 2016 and the Financial Accounting Standards Board (“FASB”) in February 2016.
What Are the Headlines?
• The liability for virtually all leases must be recognized on the balance sheet of the lessee at the discounted present value of future lease payments with an offsetting right of use asset.
• The FASB decided that for public business entities, the final leases standard will be effective for fiscal years beginning after December 31, 2018 (essentially January 1, 2019) and for nonpublic business entities, the effective date would be for fiscal years beginning after December 15, 2019 (essentially January 1, 2020).
• For lessees that report using FASB accounting standards, the pattern of expense recognition will generally stay the same. For those lessees reporting using IFRS standards, the pattern of expense recognition will change significantly. However, for all lessees, the new accounting model will require more sophisticated financial calculations and will mandate more monitoring and tracking of lease details.
One might look at the effective dates noted above and say that there are many years left to deal with the very complicated transition issues involved but the reality is that preparations should start immediately. Now is the time to organize a Transition Team within your organization. It will take a significant time commitment to compile the necessary documentation and complete all the steps that are necessary to implement this change in accounting. Additionally, it is critically important to estimate the preliminary financial effect of adopting the new leases standard based upon the inventory of existing leases and share that information with senior management.
Corporate Strategy Considerations
Significant changes in accounting such as this can cause a change in corporate strategy.
• Is it better to buy rather than lease? The major attraction of the current operating lease model will no longer be in place. Whether one leases or buys, the obligations must be recognized on the balance along with a corresponding asset.
• The longer the lease term the greater is the financial obligation that must be recognized on the balance sheet. Is it better to enter into shorter term leases in order to have a smaller liability on the balance sheet?
• There are more significant accounting implications to option clauses and variable lease payments under the provisions of the new standard. Does the company change its leasing strategy in these areas?
Financial Impact on Lessees
• Credit Suisse estimated that off-balance sheet liability just for S&P companies is at least $549 Billion (Deloitte Survey)
• Debt to equity ratios, existing debt covenants and various contractual agreements may be impacted
• For certain leases, the pattern of expense recognition may be dramatically accelerated
• Financial statement disclosure will greatly expand
• Costs of implementation will be significant
Operational Impact on Lessees
• Accounting for existing leases will have to be revised upon transition
• Existing leases will likely require abstracting of lease details
• Complexity of lease calculations will increase as more variables will have to be considered
• Data will require aggregation from various sources not currently considered
• More estimates and judgments will be required which will entail tighter auditing and tracking
• There will be an ongoing need to review and possibly reassess and revise initial estimates
Our view is that leasing will continue to remain an attractive financing alternative for most companies that currently use this strategy. Equipment leasing provides the lessees with the flexibility to determine the term of the equipment usage without having to deal with many of the obsolescence issues associated with owning equipment. And for many smaller companies it is much easier to obtain lease financing as opposed to bank financing for equipment purchases. Real estate leasing should also continue to be an attractive alternative for most companies that do not want to have the administrative burden of owning real estate. We believe that companies will pay close attention to structure the terms of their lease obligations in order to mitigate the impact of the liabilities that must be recognized on the balance sheet. But even in these cases, if a company has a leased location that is important to its business, the company will want to have control of that location for an appropriate period of time.
We at iLease Management LLC believe that the lease technology solution that is selected is a critical element of the transition to the new accounting model. Many companies that now use spreadsheets to track lease details and perform accounting calculations will find it much more challenging to continue this practice. Bringing together all the elements of Lease Analysis, Lease Management and Lease Accounting in one technology solution allows an organization to capture efficiencies that should be a byproduct of new technology adoption. That is why we developed our lease technology solution, iLeasePro.