Accounting Standards Update

Get ready for the new lease standard

A new accounting rule for reporting leases goes into effect in 2019 for public companies. Although private companies have been granted a one-year reprieve, no business should wait until the last minute to start the implementation process. Some recently revised guidance is intended to ease implementation. Here’s an overview of what’s changing.

Old rules, new rules

Under the existing rules, companies must record lease obligations on their balance sheets only if the arrangements are considered financing transactions. Few arrangements get recorded, because accounting rules give companies leeway to arrange the agreements in a way that they can be treated as simple rentals for financial reporting purposes. If an obligation isn’t recorded on a balance sheet, it makes a business look like it is less leveraged than it really is.

In 2016, the Financial Accounting Standards Board (FASB) issued a new standard that calls for major changes to current accounting practices for leases. In a nutshell, Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), will require companies to recognize on their balance sheets the assets and liabilities associated with rentals.

Most existing arrangements that currently are reported as leases will continue to be reported as leases under the new standard. In addition, the new definition is expected to encompass many more types of arrangements that aren’t reported as leases under current practice.

Revised guidance

Recently, the FASB revised two provisions to make the lease guidance easier to apply:

1. Modified retrospective approach. Upon adoption of the new lease accounting standard, companies may elect to present results using the current lease guidance for prior periods. This will allow management to focus on accounting for current and future transactions under the new rules — rather than looking backward at old leases.

2. Maintenance charges. On March 28, the FASB agreed to give lessors and property managers the option not to separately account for the fees for “common area maintenance” charges, such as security, elevator repairs and snow removal.

In addition, the FASB has provided a practical expedient to utilities, oil-and-gas companies and energy providers that hold rights-of-way to accommodate gas pipelines or electric wires. Under the revised guidance, companies that hold such land easements won’t have to sort through years of old contracts to determine whether they meet the definition of a lease. This practical expedient applies only to existing land easements, however.

Need help?

The lease standard is expected to add more than $1.25 trillion of operating lease obligations to public company balance sheets starting in 2018. How will it affect your business? Contact us to help answer this question and evaluate which of your contracts must be reported as lease obligations under the new rules.

© 2018

For-profit vs. not-for-profit: Compare and contrast financial reporting goals

As the term suggests, for-profit companies are driven primarily by one goal — to maximize profits for their owners. Nonprofits, on the other hand, are generally motivated by a charitable purpose. Here’s how their respective financial statements reflect this difference.

Reporting revenues and expenses

For-profits produce an income statement (also known as a profit and loss statement), listing their revenues, gains, expenses and losses to evaluate financial performance. They report mainly on profitability and increasing assets, which correlate with future dividends and return on investment to owners and shareholders.

By comparison, not-for-profit entities just want revenue to cover the costs of fulfilling their mission now and in the future. They often rely on grants and donations in addition to fees for service income. So they prepare a statement of activities, which lists all revenue less expenses, and classifies the impact on each net asset class.

Many nonprofits currently produce a statement of functional expenses. But a new accounting standard kicks in this year — Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities. It will require organizations to classify expenses by nature (meaning categories such as salaries and wages, rent, employee benefits and utilities) and function (mainly program services and supporting activities). This information will need to be expressed in a grid format that shows the amount of each natural category spent on each function.

Balance sheet considerations

For-profit companies prepare a balance sheet that lists the owner’s or shareholders’ equity, which is based on the company’s assets, liabilities and prior profits. The equity determines the value of a company’s common and preferred stock.

Nonprofits, which have no owners, prepare a statement of financial position. It also looks at assets, liabilities and prior earnings. The resulting net assets historically have been classified as 1) unrestricted, 2) temporarily restricted, or 3) permanently restricted, based on the presence of donor restrictions. Starting in 2018 for most not-for-profits, the new accounting standard will reduce these classes to two: 1) net assets without donor restrictions and 2) net assets with donor restrictions.

Footnote disclosures

Another key difference: Nonprofits tend to focus more on transparency than for-profit businesses do. Thus, their financial statements and footnotes include a lot of disclosures, such as about the nature and amount of donor-imposed restrictions on net assets. Starting in 2018, ASU No. 2016-14 will require more disclosures on the amount, purpose and type of board designations of net assets. Additional disclosures will be required to outline the availability and liquidity of assets to cover operations in the coming year.

Common denominator

Whether operating for a profit or not, all entities have a common need to produce timely financial statements that stakeholders can trust. Contact us for help reporting accurate financial results for your organization.

© 2018

Evaluating going concern issues

Financial statements are generally prepared under the assumption that the business will remain a “going concern.” That is, it’s expected to continue to generate a positive return on its assets and meet its obligations in the ordinary course of business. But sometimes conditions put that assumption into question.

Recently, the responsibility for making going concern assessments shifted from auditors to management. So, it’s important for you to identify the red flags that going concern issues exist.

Make the call

Under Accounting Standards Update No. 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, management is responsible for assessing whether there are conditions or events that raise “substantial doubt” about the company’s ability to continue as a going concern within one year after the date that the financial statements are issued — or available to be issued. (The alternate date prevents financial statements from being held for several months after year end to see if the company survives.)

When going concern issues arise, auditors may adjust balance sheet values to liquidation values, rather than historic costs. Footnotes also may report going concern issues. And the auditor’s opinion letter — which serves as a cover letter to the financial statements — may be downgraded to a qualified or adverse opinion. All of these changes forewarn lenders and investors that the company is experiencing financial distress.

Meet the threshold

When evaluating the going concern assumption, look for signs that your company’s long-term viability may be questionable, such as:

  • Recurring operating losses or working capital deficiencies,
  • Loan defaults and debt restructuring,
  • Denial of credit from suppliers,
  • Dividend arrearages,
  • Disposals of substantial assets,
  • Work stoppages and other labor difficulties,
  • Legal proceedings or legislation that jeopardizes ongoing operations,
  • Loss of a key franchise, license or patent,
  • Loss of a principal customer or supplier, and
  • An uninsured or underinsured catastrophe.

The existence of one or more of these conditions or events doesn’t automatically mean that there’s a going concern issue. Similarly, the absence of these conditions or events isn’t a guarantee that your company will meet its obligations over the next year.

Comply with the new guidance

Compliance with the new accounting standard starts with annual periods ending after December 15, 2016. So, managers of calendar-year entities will need to make the going concern assessment starting with their 2016 year-end financial statements. Contact us for more information about making going concern assessments and how it will affect your financial reporting.

© 2017