Six years after US accounting standard setters first sought comment on revising accounting for leases, the final standard arrived at the end of February, leaving companies with less than a year to prepare for bringing leases on balance sheet and working through the financial implications.
Additionally, multinational corporations (MNC) lessees will have to adapt to a different accounting standard in the US than in countries that instead abide by the standard finalized by the International Accounting Standards Board (IASB) a month before.
US publicly traded companies must present the new lease information in their 2019 financial statements—2020 for private companies. However, they will have to show the comparative effect on their balance sheets and income statements. Practically, that means calendar-year companies will have to have an opening balance-sheet calculation prepared by January 1, 2017.
“That’s the timeline risk companies face,” said Sean Torr, lease accounting services leader at Deloitte. “That means companies will have to have all their leases catalogued and the data available to do calculations by that date.”
Mr. Torr noted that the new lease accounting for lessors remains similar to the previous standards in both jurisdictions. However, he said, lessees’ requirement to bring most assets on their balance sheets will require them to develop systems to gather the data, do the necessary computations, and make sure the proper controls are in place—a major challenge for companies with large lease portfolios. He added that subsidiary accounting ledgers will likely be necessary to manage the addition of lease assets and liabilities to the balance sheet.
Meanwhile, corporate treasury must consider how the new lease accounting will affect key performance indicators and metrics, such as leverage ratios and the impact on debt covenants. “Thinking about those implications early and getting ahead of that is something treasury groups will want to contemplate,” Mr. Torr said.
He added that the different approaches taken by the Financial Accounting Standards Board (FASB) in the US and the IASB add another layer of operational complexity. The accounting standard setters’ approaches first diverged in early 2014, with FASB approving two options: operating leases that account for leases as straight line expenses, and finance leases, which have a front-loaded expense pattern. IASB instead opted to streamline the accounting and decided all leases must be accounted for as finance leases.
Mr. Torr explained that FASB’s dual model reflects leases with economically different “fact patterns.” Those fitting under the finance lease concept resemble acquisition financings and so the accounting reflects the interest component, similar to today’s accounting, while an operating lease is more akin to receiving an asset through a service, and so reflects more of a straight-line expense type pattern.
As a result of the expense pattern differences, US companies will have three line items on the income statement going forward. There will be the straight-line lease expense, formerly known as a rent expense, for operating leases; finance leases with the interest expense; and a depreciation component.
“So treasury thinking ahead about the company’s leasing activity and its impact on the financial statements in the context of those three new line items will be important,” Mr. Torr said.
He added that one benefit of the new accounting is that putting leases on the balance sheet will give companies more visibility and transparency into their leasing portfolios. Consequently, he added, treasury may end up reconsidering whether leasing or buying is more effective, as they consider transactions over the next three or so years, and how the new accounting could impact the company’s financing arrangements with lenders.
Mr. Torr said the extended period over which FASB and the IASB deliberated over the lease accounting has resulted in many companies getting a late start on preparations. Given the extent of longer-term changes to their systems, some companies may be thinking of a two-step approach, he said, where a temporary repository is created to collect data electronically in 2016, since implementing a longer-term solution may not be feasible by the start of next year.
“This will help other stakeholders—treasury executives, for example—to be able to run their metrics and pro formas, and to understand the impact,” Mr. Torr said.