Changes to Lease Accounting Standards Draw Near
Soon companies will be required to recognize operating lease assets and liabilities on the balance sheet.
For many years, there have been concerns raised stating that the current lease accounting model is inadequate, as it allows lessees to structure lease transactions to achieve off-balance sheet financing. Under current Generally Accepted Accounting Principles (GAAP), operating leases have effectively received off-balance sheet treatment, but the Financial Accounting Standards Board lease accounting standard that was issued in early 2016 has changed that.
The FASB’s Accounting Standards Update (ASU) will require lessees to recognize most leases on their balance sheets as leased liabilities with corresponding right-of-use assets. This change will affect a large number of companies, with the U.S. Securities and Exchange Commission (SEC) estimating that companies have approximately $2.3 trillion in operating lease commitments.
The primary standard for lease accounting is Statement of Financial Accounting Standards No. 13 (FAS 13, ASC 842 under FASB’s new coding structure). As part of the new lease accounting standard, FASB retained the FAS 13 (ASC 842) framework for lease classification.
The lessee’s expense accounting is identical to their historical accounting for a Penske operating lease on the income statement. The balance sheet will now include a right-of-use asset and a lease liability, and Penske will provide customers with a right-of-use calculation.
Additionally, although companies will record an operating lease liability on the balance sheet, it will not be classified as debt, which is great news for U.S. companies because debt metrics remain unaffected.
- Originally issued in November 1976
- They are one of approximately 168 accounting standards issued by FASB
- They establish standards of financial accounting and reporting for leases by lessees and lessors
- For lessees, a lease is a financing transaction called a capital lease if it meets any one of four specified criteria; if not, it is an operating lease which is treated as a current operating expense (such as rental property)
- The new changes announced in February 2016 mean operating leases will no longer be offbalance sheet for Penske’s customers
- The new standards are effective beginning with 2019 financial statements for public companies and 2020 financial statements for private companies
- Early adoption is allowed
The Benefits of Leases
Operating lease benefits are still in play. Penske believes customers will benefit from an operating lease for all of the traditional reasons, including no residual risk, no obsolescence risk, improved cash flow, budget certainty, and the reduction of risk and volatility.
For GAAP purposes, the lease liability is not considered debt. There will be no impact on debt ratios or loan covenants, and feedback from bankers and rating agencies will not impact a company’s credit or rating.
Increased Transparency
The FASB said the new guidance is intended to improve the financial reporting of leasing transactions and will provide better alignment with international accounting standards.
"The new standard ends one of the largest forms of off-balance sheet accounting and requires more disclosures related to leasing transactions," said FASB Chair Russell Golden.
FASB said the changes were in response to requests from investors and other financial statement users for a more accurate representation of an organization’s leasing activities. They should provide better visibility of operating leases that are not currently on the balance sheet and provide investors across the globe with more transparent, comparable information about lease obligations held by companies.
Compliance Deadlines
The FASB’s ASU 2016-02, Leases, said that for public companies, the new guidance will take effect with their 2019 financial statements; for private companies, with their 2020 financial statements. Early adoption will be permitted for all entities.
In preparation for the new lease accounting standard, companies should begin reviewing their current processes and seek guidance on the application of the FASB rules from their accounting professionals. The experts at Penske Truck Leasing are here to help.
The balance sheet will now include a right-of-use asset and a lease liability, and Penske will provide customers with a right-of-use calculation. For a full-service lease, the ROU amount is calculated as:
- The Present Value (PV) of Penske’s net fixed lease charge for each vehicle during the lease term
- PV is calculated using the customer’s borrowing rate
- If not available, estimated borrowing cost is substituted
- The net fixed-lease charge equals Penske’s Schedule ‘A’ Fixed-Lease Charge, minus prepaid and service-related costs (maintenance, licenses, personal property taxes, subs, overheads, washes, etc.)
- The remaining amount is approximately equal to the depreciation and interest portions of the fixed-lease payment
- This is the same value (i.e., minimum lease payment) used for the FASB 13 90 percent test
- ROU asset and ROU liability are reduced each month on the customer’s balance sheet
November 2018