The effective date of the new lease accounting standard, Accounting Standard Update (ASU) No. 2016-02, Leases (Topic 842), is quickly approaching with an effective date for fiscal years ending after Dec. 15, 2018 and Dec. 15, 2019 for public and non-public companies respectively. ASU 2016-02 is the first major change in lease accounting in over 30 years following the issuance of Statement of Financial Accounting Standards (SFAS) No. 13 in 1976 . Working towards convergence with International Financial Reporting Standards (IFRS) and generally accepted accounting principles (GAAP), and greater transparency are a couple of the major driving forces behind the new standard. Greater transparency is accomplished by providing financial statement users with more information on an entity's leasing activity operating leases longer than 12 months (formerly were off the balance sheet) are now required to be included as a right of use asset and liability on the balance sheet and additional disclosures are required. Overall, the lessor accounting has substantially remained unchanged.
Under both new and old GAAP the basic subject of a lease is defined as the lease of property, plant and equipment (land and depreciable assets), excluding leases of intangible assets, of rights to explore for; or use of non-regenerative sources such as oil and gas, of biological assets, of inventory, and of assets under construction. Subleases also fall under the new lease guidance.
Some of the economic impacts of this new lease standard are the effects it has on the calculation of debt covenants to obtain and maintain financing. Companies will want to discuss these issues with their bank and do an economic analysis of how this affects the calculation of the key ratios in keeping in compliance with these covenants. Another area of concern is with taxes. Tax issues will certainly play out in states where property apportionment factors are used in allocating taxable business income. Transfer pricing between related parties will also be an area of concern, as it relates to the apportionment of business income between various tax jurisdictions.
Accounting for the operating leases in excess of a year, requires the lessee to record a right of use asset and lease liability measurement. If a company has a portfolio of leases that are similar in nature they may choose to account for the leases as one lease, as long as doing so would not differ materially had the leases been accounted for individually. When accounting for a portfolio of leases, estimates and assumptions should be used documenting the size and composition of the portfolio.
According to a recent study by PwC and CBRE Group, of 600 financial executives surveyed, approximately 25 percent have not begun the lease implementation process, over 50 percent were considering the economic impacts of the changes, and only 25 percent had begun implementation. Of the 25 percent beginning the implementation process, 50 percent said the difficulty of implementation exceeded their initial expectations. The sweeping changes that will result affect almost all companies. The survey also indicated that many of the companies expect to implement a lease management system or modify their current ERP system to assist with compliance. The biggest hurdles that management faces is in data collection and having proper systems in operation. When the lease standard is applied, an entity is required to take the modified retrospective approach which retroactively applies the standard to all comparative years presented in the financial statements as if the standard had been in effect during those years.
To further discuss the impacts of the new lease standard, contact your local UHY LLP professional.