Changes to Lease Accounting Proving to Be More Complex Than Anticipated

The deadline to implement major changes in the way leases are treated for accounting purposes may appear to be well in the future:  late 2019 for publicly traded companies, and January 1, 2020 for privately held companies and non-profits. But accounting professionals are discovering that the work necessary to make the transition is significantly more complicated than anticipated.

The new standards, which apply to all companies (public, private and non-profits) that issue a financial statement in accordance with Generally Accepted Accounting Principles (GAAP) and have leasing transactions, will require leased assets to be recognized on the organization’s balance sheet.

This may have a significant impact on bank loans, as adding operating leases – which appear as debt – to the balance sheet may affect loan covenants by changing the amount of debt you are carrying. As a result, your business could slide into default on your loans without realizing it. The solution is likely to be a renegotiation of loan covenant terms, or a waiver or change in your lease agreement.

Depending on your company’s facts and circumstances, early adoption might be recommended.  However, this is proving particularly challenging for smaller organizations who may not have the staff or resources necessary to wade through the requirements – requirements that are being implemented to enhance the transparency of a company’s balance sheet, giving financial statement users a better understanding of actual obligations.

In the August 3 issue of the Journal of Accountancy, author Ken Tysiac, writes, “Maybe they have a limited accounting staff, and they are so busy with another heavy FASB implementation—revenue recognition—that they don’t realize that they don’t know where some of their lease contracts are. Perhaps they use spreadsheets for their fixed-asset accounting and don’t know that they will need to consider modifying their software to perform this accounting. And maybe they haven’t considered the effect that new liabilities on their balance sheets will have on their debt covenants with lenders.”

Where does this leave your organization? If you have been putting off the start of the process to modify your reporting to comply with the new standards, it is imperative that you accelerate the project. The simple task of identifying, categorizing, and organizing multiple types of leases into a more detailed accounting database is certain to require a considerable time and effort. Leases for real estate, equipment, vehicles – all must be included in the transition.

Your current accounting system may not be up to the new requirement of reporting leases on the balance sheet. Some modifications may be necessary, or you may wish to take this opportunity to upgrade to a newer, more comprehensive accounting software system.

All this will place demands on the time and attention of your internal accounting team and outside accounting firm. Quoting Cathy Clarke, a member of the AICPA Financial Reporting Executive Committee, Tysiac writes, “Smaller organizations that use a third-party bookkeeper need to make sure there is a clear understanding with the contractor about who is responsible for implementing the standard.”

Gray, Gray & Gray has been monitoring and reporting on the new lease accounting requirements, and we have a solid grasp on the updated rules and process necessary to comply with them. If you have any questions about your own company’s needs for this transition, please contact us at (781) 407-0300. You can also visit the Financial Accounting Standards Board (FASB) website for additional information.

To view a summary of the new standards, please click here.

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