Considering a New Lease? Factor in New FASB Leasing Accounting Standard

Most businesses and not-for-profits for whom we provide audit services have leasing arrangements that go beyond 12-month terms. They are entered into for things like office space, equipment and other operating assets for which the lessee never intends to gain ownership. In the past, these so-called “operating leases” weren’t listed on balance sheets as either assets or liabilities. Under new Financial Accounting Standards Board (FASB) guidelines going into effect, however, companies must now report most of these leases on their balance sheets.

The goal of FASB with the new lease accounting standard is to capture the true assets and liabilities of operating leases that extend beyond 12 months, which could represent billions of dollars in unreported “right-of-use” assets and liabilities. In the past, the majority of operating leases were generally reported by lessees as rent expense on income statements and in significant disclosures to the financial statements. Now under certain criteria lessees will need to report operating leases as right-of-use assets and lease liabilities on the balance sheet.

For public companies and some not-for-profits and employee benefit plans, the standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other organizations, the standard is effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020. Early application is permitted.

Aside from these deadlines, planning for the new standard should begin soon for several reasons.

  1. Some leases that fit the standard may be embedded in service contracts.

A service contract may be considered an operating lease since under the new FASB standard (a) you can identify a tangible asset and (b) the lessee has significant control over the asset’s use during the term of the contract. Companies will need to take an inventory of all operating leases that fit the new standard, including those embedded in contracts. Contracts that have non-lease components will require specific calculations to determine the asset amount to record.

  1. The new standards could require assessment of lease-buy decisions and debt covenant compliance.

Without the benefit of off-balance-sheet financing, companies will need to pay attention to how reporting the assets and liabilities of operating leases in the future could impact debt covenants tied to other existing financing. In some cases and if possible, purchasing the asset may make more sense than leasing.

  1. New leasing arrangements or existing lease modifications should be considered carefully for future reporting on the balance sheet.

If an operating lease is coming to the end of its term or your company is considering a new leasing arrangement, it should be assessed according to the new standard and how that may affect the balance sheet. Existing leases will need to be reassessed more frequently for asset and liability considerations than simply when the lease is modified or renewed.

As you review the new FASB lease accounting standard and have questions about how it could affect your balance sheet or financial statements — whether you are a lessor or lessee — talk to the audit team at Schmidt Westergard for guidance and planning. The new standard could also impact tax calculations for local and state or transfer pricing, for example, based on newly recognized assets. We can address those questions, too.