Impacts of New Lease Accounting Standards on Private Companies
In our last blog, we detailed specific applications of ASC 842 for private companies and explained what constitutes a lease. In this blog, we’ll examine the impacts of these standards.
Areas Where Your Business Could Be Impacted:
Balance sheet: Any new lease accounting system your company decides to adopt must also address taxes. Keep in mind, new assets that are recognized for operating leases will change your company’s book/tax difference computations.
IT and Operations: Companies may need new systems and controls to deal with current and future agreements—under the new lease standards, preexisting leases aren’t grandfathered, so they could likely migrate to the balance sheet.
Regulatory compliance: Regulated companies, including real estate brokerages, banks and insurance companies, may be subject to different regulatory calculations for new assets and liabilities on the balance sheet.
People in Your Organization Who are Impacted by New Lease Standards Under ASC 842
- Real Estate
Implications, Questions and Recommendations
Ensure that leases and related lease expense are properly disclosed. During the transition, entities should examine their process to identify lease arrangements and ensure that leases and related lease expense are properly disclosed in the notes to the financial statements. To the extent leases are recognized as lease assets and liabilities that were not previously disclosed, users of financial statements may be surprised.
Leverage ratio covenants could be impacted. Absent future change, leverage ratios based on current GAAP could be impacted upon the adoption of the new lease standards since liabilities will be increased under most definitions of liabilities in debt agreements. This could also impact:
- Debt to equity ratios
- Interest coverage ratios
- Return on assets
- Current ratios
Related party leases. The new lease standard makes a significant change in accounting for related party leases by shifting from substance-based criteria in current GAAP to accounting for related party leases based on their legally enforceable terms.
Non-lease components. New processes and procedures will be necessary for segregating lease and non-lease components.
Taxes and insurance. Leases which embed payments for taxes and insurance in the fixed lease payment may wish to consider revising the lease to make these variable (pass-through); otherwise the payments for taxes and insurance may need to be capitalized.
Consider EBITDA. EBITDA typically has included rent expense. Will all components of lease expense be included in EBITDA? That remains to be seen.
Cost-plus contracts. For cost-plus contracts that are common in construction, defense and health care industries, is lease expense a reimbursable cost under the new lease standards? Again, that remains to be seen.
Think through lease vs. buy decisions. It’s imperative for companies to assess the lease versus buy decision under the new standards.
Tracking lease assets. Will companies be able to track operating leases via journal entry, or will asset tracking software be needed?
The future of leasing. Will leasing arrangements evolve into service contracts? Additionally, will greater amounts of lease consideration become variable?