FASB Proceeds with Final Standard on Leases

On November 11, 2015, the Financial Accounting Standards Board (FASB), the organization that sets accounting standards and rules for all public and privately held companies, voted to proceed with a new leases accounting standard, “Leases (Topic 842) – A revision of the 2010 Proposed FASB Accounting Standards Update, Leases (Topic 840)”.  The new standard requires companies and other organizations to include lease obligations on their balance sheets and will be effective for calendar year 2020 financial statements (for private companies), with early implementation permitted once the final standard is issued, which is expected in early 2016.  We would not recommend early adoption of this standard.

The new lease standard primarily stems from the FASB’s desire to converge its leasing standard with that of the International Accounting Standards Board, which has a similar standard as the one voted on by the FASB, as well as the FASB’s desire to respond to criticism that current lease accounting does not address the full economics of lease transactions.

Leases provide a means of gaining access to assets and a form of financing the use of those assets that reduces the exposure of asset ownership.  But for most leases, under current accounting guidance, the future lease obligations do not appear in an organization’s financial statements (balance sheet), rather the future lease obligations are listed in the notes that accompany the financial statements.  The FASB, financial statement users, investors and even the U.S. Security and Exchange Commission (SEC), which issued a report on off-balance sheet activities in 2005 recommending changes be made to the existing lease standards, sought greater transparency over leasing obligations.

The FASB’s new leases standard seeks to achieve this by presenting the discounted amount of future lease obligations on the balance sheet as a lease liability, with an offsetting asset on the balance sheet representing the organization’s right to use the leased asset.  The lease liability is reduced as payments are made under the lease, a portion of the payments representing interest expense (similar to debt payments), while the “right-of-use” asset is expensed over the lease term.  The process of recording these lease costs varies depending on whether the lease is for property (i.e. buildings, etc.) or assets other than property (i.e. equipment, vehicles, etc.).

The good news is this method of accounting only applies to those leases with a term greater than twelve months.

KatzAbosch will provide additional summaries once the final lease standard is published.  For now, we recommend performing a review of current lease agreements to determine the financial impact of the new standard as well as a review of current debt covenants, as the addition of a lease liability on the balance sheet may expose the need to have debt covenants redrafted (particularly financial debt covenants).

We would gladly be able to assist with any of these issues.  Please direct questions related to this topic to Claudia Wolter, CPA, CCIFP, CCA at cwolter@katzabosch.com or Tim Redmond, CPA at tredmond@katzabosch.com.

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