On November 11, the Financial Accounting Standards Board (FASB) voted to begin the process of issuing new rules governing the accounting for leases. The final standard is expected to be published in January 2016. The FASB has set the effective date for the new lease rules as 2020 for calendar year-end private companies. Ironically, the approval comes almost 39 years to the day of when Financial Accounting Standard (FAS) No. 13 (the last major lease standard) was issued back in November 1976.
As we have been hearing for years now, these new rules will require all long-term leases to be capitalized on companies’ balance sheets. Gone will be the old FAS 13 rules that required capitalization of only certain "capital" leases. Instead, capital and most operating leases will, in effect, be capitalized now. Some estimates are that over $2 trillion of new lease liabilities will be recorded as a result of these new rules.
A very understandable reaction would be to worry about how this affects your financial statements and how your external stakeholders will perceive those changes. Given the sheer number of organizations that these new rules will impact, all financial statement users, other than perhaps "casual" users, will have to adjust their understanding and expectations regarding financial statement metrics impacted by these changes. To be sure, we will all need to manage the expectations of our external stakeholders between now and 2020.
For now, however, companies should hold off, if possible, on agreeing to any long-term financial performance metrics until they have "modeled out" the impact of the new rules on those metrics. Alternatively, agreements could be structured to "carve out" the impact of these new rules. Finally, we recommend that during 2016 you begin the process of modeling the impact of the new rules on your financial statements.
We will be covering the provisions of the new standard in more depth in the next issue of our Accounting Wire newsletter (click here to sign up if you are not already receiving). Some of the key provisions of the new rules are as follows:
- All leases greater than 12 months will be capitalized using a present value model. An election will be available for private companies to use a risk-free rate to simplify the calculation of the present value of the lease.
- Leases will be categorized into two types. Both Type A and Type B leases will be capitalized in the same fashion. Type A leases are most easily thought of as the current capital leases, and Type B leases are similar to the current operating leases. However, the precise definitions of Type A and Type B leases vary somewhat from the current capital/operating lease definitions.
- The income impact between Type A and Type B leases will be different. Overall expense (amortization and interest) for Type A leases will be higher at the start of the lease and lower at the end. Type B leases will have level expense throughout the term of the lease.
The good news is that with a 2020 effective date, we should all have ample time to prepare for the new rules and how they will impact us. Contact Dan Szidon or your Wipfli relationship executive if you have questions or concerns.