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.
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.
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.