By Michael D. Koppel, CPA, PFS, CITP, MBA
Retired Partner at Gray, Gray & Gray, LLP
Millions of companies across the U.S. that lease equipment or vehicles in the course of doing business will soon need to adjust how they report lease activity on their financial statements. The Financial Standards Accounting Board (FASB) has updated its lease accounting stipulations, which apply to both capital and operating leases, and comply with Generally Accepted Accounting Principles (GAAP).
The new standard will require businesses to record and recognize the assets and liabilities of all leases (both capital and operating) with terms longer than 12 months.
Right now, operating lease obligations are “disclosed” in a company’s financial statements, but not recorded, and are thus omitted from the balance sheet. This results in under reporting of total obligations and affects the analysis of a company’s financial health used by investors and rating firms.
Most of the burden of the new FASB standard will be borne by the lessee, who will now have to be much more meticulous in how they classify and report lease activity. For example, principal payments and interest payments must now be recorded separately on financial statements.
The upshot of the detailed reporting of operating leases is likely to be that a company’s financial ratios will appear weaker. This could lead to lenders raising borrowing costs, which, in turn, could lead to companies deciding that purchasing may become a better option than leasing. The new reporting requirements will also necessitate changes to internal controls in order to gather more detailed data than is currently being collected.
For lessors, the impact of the new FASB regulations won’t be as dramatic. They may be required to reclassify certain lease payments as liabilities if the collection of the payments is uncertain. The additional reporting required of lessees could also affect lease negotiations. For example, lessees may seek lease terms of no longer than 12 months in order to reduce the impact on their balance sheets.
While the new FASB lease reporting standards won’t go into effect for public companies until after December 15, 2018, or for private companies that follow Generally Accepted Accounting Principles (GAAP) until a year later, you should begin laying the groundwork for the changes now.
However, this is also an opportunity for you to assess the method by which you are reporting activity. The new complexities in the requirements for lease reporting could lead many companies to consider reporting on a tax basis (mirroring your tax return) instead of reporting to GAAP standards.
For additional information on the new FASB lease reporting standards, please contact Gray, Gray & Gray at (781) 407-0300.