The changes to the lease accounting standards -- commonly referred to as FASB 13 -- are finally coming into effect for publicly traded companies as of December 15, 2018. Whether your company is privately held or publicly traded, these new standards will change how your leases get reflected on your balance sheet.
A Brief History of FASB 13
The original FASB standard dates back to late 1976 when the statement -- entitled Accounting for Leases -- was first issued. The original statement created two different types of leases -- capital leases and operating leases. Capital leases were treated similarly to a purchase in that they were on a company's balance sheet, while operating leases were kept off balance sheets, not affecting company's assets and liabilities. Because of the way that the standard was worded, just about every lease ended up being treated as an off-balance sheet operating lease.
Gradually, the accounting industry realized that this method of accounting didn't really capture the realities of long-term leases. In the aftermath of the 2002 passing of the Sarbanes-Oxley Act and in response to a 2005 report from the Securities and Exchange Commission, FASB began working on a new lease accounting standard in 2006. While this standard was controversial and took the better part of a decade to finalize, it was finally published as Accounting Standards Update (ASU) 2016-02, Leases—Topic 842 in late February of 2016, with its implementation delayed until December 15, 2018 for publicly traded companies.
What The New FASB 13 Means
Under the new standard, it is essentially impossible to treat any lease over 12 months as an operating lease. As such, the new normal will be the finance lease -- which is the updated name for a capital lease. To record the finance lease as a lessee, your company will create a balance sheet asset for the value of your right-of-use as the property and show a lease liability for the present value of the lease payments.
The accounting impacts of these changes are two fold. First, both the assets and liabilities shown on your balance sheet will grow. This could affect your company's financial ratios. Second, your rent payments will be treated as a mixture of interest and depreciation of the right-of-use asset. This means that they will no longer be part of your operating expenses and will be moved out of your company's EBITDA. The net result of this would be to keep your profit the same while increasing EBITDA.
What Do I Need To Do?
Since the new FASB standard contains look back provisions, you essentially have to be following it now to have historical data ready for the December 15, 2018 start date. Because becoming compliant requires, among other things, calculating the relative value of the right of use portion of your leases and selecting an appropriate discount rate for the present value calculating, this process will require the help of a market expect (like a commercial real estate broker) as well as an accounting team.
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