The Joint Project on Lease Accounting has been completed and the final standards has been issued by the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”). The project, which has been ongoing for several years, has significant changes and will present both a challenge and an opportunity for Certified Public Accountant (“CPAs”).
Leases, currently classified as operating leases, allow the lessee to avoid recognizing the lease obligation as a liability on its financial statements and making expensive investments in fixed assets. The tentative conclusions reached by the FASB and the IASB would require that all leases, except certain narrowly defined short term leases, be recognized on lessee balance sheets as a Lease Liability with an offsetting Right to Use asset. The definition of a lease would become more complicated and many provisions in the lease would have to be identified and evaluated to determine whether there are accounting implications that must be addressed. With respect to expense recognition, the FASB and the IASB have tentatively reached different conclusions in this area. The FASB would classify leases into two types (A and B) with most equipment leases falling into Type A and most real estate leases falling into Type B. However, for many leases, judgment will have to be applied to ensure that the lease classification is appropriate. For Type A leases, expense recognition would be accelerated while for Type B leases, expense would be recognized basically on a straight line basis. The IASB would apply accelerated expense recognition to all leases. As one can see, lease accounting will become extremely more complicated for lessees. And remember, the proposed new lease accounting standard applies to all leases which fall under the definition of a lease in the proposed standard, both real estate and equipment leases.
The net effect of the new lease accounting standard will be a major increase in liabilities that must be recorded on the balance sheet of the lessees and a negative impact on debt to equity ratios. For many lessees that use debt financing vehicles which contain restrictive financial covenants, any increase in liabilities could present a particular challenge and may well require a waiver discussion with the lender. Certainly, lease versus purchase analyses will become more important and could result in a decrease in leasing activity. But it is difficult to envision any significant decrease in leasing for a number of reasons. Many companies are cash strapped and leasing presents a particularly advantageous form of financing for those organizations that want to minimize upfront cash outlays. Additionally, leasing allows companies the flexibility to relocate more easily to another location or to change to a more advantageous equipment type after the termination of the lease. Ownership of real estate and equipment may well inhibit this flexibility. To be sure leasing strategy may change. Shorter term leases will result in smaller liabilities that must be recorded. But there is a business trade off. Shorter term leases mean more frequent lease renegotiation risk and the possibility of increased leasing costs.
Presented below is a partial list of actions steps that should be considered immediately.
• The issues considered are more numerous and complex than under the current accounting standards and require a complete understanding of all of the terms of the lease. In addition, the reassessment requirements are much more rigorous. Remember that existing leases at the time of adoption will not be grandfathered. It is critical that the terms of each lease be documented clearly and consistently in a manner that allows for ready review.
• How will lease strategy change as a result of the new accounting standards, if at all? Leases consummated now may well have to be transitioned to the new accounting standard. No one wants the accounting implications to drive the economics of the organization but they will undoubtedly be a consideration. We mentioned these issues previously. Will lease versus buy decisions change? Will lease terms change? Longer lease terms will result in larger liability balances; however, shortening lease terms may not be in the best operational interests of the organization.
• Financial statement analytics will change dramatically. Lessees should consider the implications on among other things, debt covenant compliance, employee compensation plans, contractual agreements and other key legal documents. Determining the impact of the proposed changes on these critical financial metrics at an early date will allow for timely planning and discussions with interested parties. How should CPAs be preparing for this significant change in accounting treatment? There will be a challenge for CPAs in understanding and interpreting the provisions of the new standard. However, there will also be an opportunity to act as a trusted business advisor in assisting clients in the implementation of the new standard. Now is the time to start preparing for opportunities that may present themselves. We at iLeasePro believe that one of the opportunities is in the area of technology.
Surveys have shown that more than one half of the lessees surveyed maintain their leasing records on Excel spreadsheets. The more complicated calculations required under the proposed standard and the need to consider more carefully the exact terms of leases dictate that a more sophisticated approach to recordkeeping is required. Maintaining comprehensive lease records on one technology solution may also result in significant operating efficiencies for lessees. iLeasePro has been developed as a comprehensive lease management and accounting technology solution so that the user can achieve operating efficiency in addition to accounting compliance. Additionally, the iLeasePro operating model is designed to allow resellers/advisors to act as a consulting resource to assist clients in maintaining their lease portfolios.
We provide the technology solution and you provide the value added consulting services. Click here to learn more information about the iLeasePro Certified Partner Program
You should also download our latest whitepaper CPA Call to Action to help you better understand the opportunities available for you to add value for your clients regarding these upcoming lease accounting changes.