Refinancing loans soon?
January 1, 2020 may seem a long way off, but if your company has significant operating leases, you may need to start preparing for that day now. Beginning with that calendar period, private business entities will be required to record the assets and liabilities for all operating leases that span more than 12 months on their balance sheets. Early adoption is permitted. If you are entering into any new long-term debt, consider the impact of lease accounting relating to financial covenants.
The Financial Accounting Standards Board (FASB) issued the Accounting Standards Update (ASU 2016-02) in February of 2016. This represents a major change in lease accounting – and a major challenge for you.
Why the New Standard?
Prior to the issuing of ASU 2016-02, businesses that created financial statements were critical of the way leasing transactions were recorded. They were not required to be included on the balance sheet, so there was no accounting of the, “…rights and obligations resulting from leases as assets and liabilities,” according to the FASB.
Finance vs Operating Leases
There have been no significant changes in the way expenses and cash flows are recognized and measured, and there is still a distinction between finance leases and operating leases. Each has its own reporting requirements for lessees, related to the way:
- Assets and liabilities are recorded,
- Interest and costs are recognized, and,
- Payments are classified.
- There have been minimal modifications in the accounting required of lessors.
Dealing with the Transition
Adding the lease-related assets and liabilities to your balance sheet may not sound that complicated. It is. You’ll face countless challenges as you try to comply with the rules put in place by ASU 2016-02, both during the transition period and beyond. For example, will you be able to:
- Manage any changes to the collection and maintenance of data?
- Modify IT processes so they can do the calculating required?
- Ensure that internal controls and other business processes can accommodate your changing needs?
- Determine how this will affect your income taxes?
There are other issues you’ll need to address, like determining whether to classify a business arrangement as a lease or a service.
While the deadline sounds far off, now is the time to start planning for what will be a complex combination of changes to your accounting process. We’d be happy to discuss the implications for your specific business and ensure that you’re ready for the new standards.