The Financial Accounting Standards Board (FASB) functions as an independent and not-for-profit organization that establishes financial accounting and reporting standards for all organizations that follow Generally Accepted Accounting Principles (GAAP). After nearly 10 years in the making, FASB announced its most recent standards update in February 2016:
ASU 2016-02, Leases (Topic 842)
Intended to address some of the most common criticisms of the current accounting and reporting rules, the most recent amendments focus on transparency. In the aftermath of the SEC’s 2005 report on off-balance-sheet activities, which recommended changes be made to lease agreement regulations, the FASB and the International Accounting Standards Board (IASB) developed and published a joint guidance that, in the words of FASB Chair Russell G. Golden, “responds to requests from investors and other financial statement users for a more faithful representation of an organization’s leasing activities.”
Under current FASB regulations, companies are required to disclose lease commitments within the footnotes of their financial statements. With 2016’s proposed mandate, companies must now include their lease obligations on their balance sheet.
Since many large multinationals choose to strategically lease their equipment rather than purchase it (i.e. office buildings, warehouses, retails stores, manufacturing plants, trucks, computers, etc.), many of today’s largest multinationals are getting an early start on preparation. This point was recently highlighted in a 2016 LeaseAccelerator report titled “Who is Most Impacted by the New Lease Accounting Standards.” Using the most up-to-date 10-K filings and available SEC data, LeaseAccelerator compiled a list of the 500 largest US publicly traded companies, and ranked them according to their off-balance-sheet leasing obligations. It was estimated by LeaseAccelerator that Fortune 500 companies (i.e. Wal-Mart Stores Inc., McDonald’s Corp., FedEx Corp., etc.) have around $3.3 trillion in current leasing commitments. Of this $3.3 trillion, it was further estimated that an astonishing 85 percent fails to appear on balance sheets.
We have compiled the top five most significant issues that companies should be considering regarding the FASB’s new lease accounting standards.
1) Impact on the balance sheet
The impact will only be significant on companies that lease many tangible assets. The prior GAAP standard only required balance sheet recognition for capital leases. The new standard, one that KPMG has called a “new era” in accounting, states that asset leases that are high-value (i.e. $5,000 or more) or long-term (more than 12 months) must now be recorded on the balance sheet rather than as footnotes.
2) Foreign lease agreements
Balance sheets must now recognize properties outside of the United States. A critical point of observation is that lease agreements are typically drafted in the language of the lease jurisdiction, which may not be English. Having a way to overcome this language barrier should be a top compliance priority as lease agreement translations can be unnecessarily expensive and cause unnecessary time delays for accountants if not handled by specialized translation experts that can handle the volume and complexity.
3) Administrative burden
For lessees, balance sheets must recognize virtually all leases. If lease agreement management is decentralized, the increase in administrative burden to collect, manage, analyze and report additional lease data may require a rethink of how lease agreements are managed, who will manage them, and what technological changes may be required to cost-effectively meet the new compliance standard. According to Sean Egan, Managing Partner for iLease Management, “Many companies that now use spreadsheets to track lease details and perform accounting calculations will find it much more challenging to continue this practice. Bringing together all the elements of lease analysis, lease management, lease accounting and Burg’s translation capabilities will allow global organizations the ability to comply with these changes while enhancing organizational efficiency.” Determining the number, page count, and language of lease agreements may be a good first step in the process of evaluating the administrative burden.
4) Cost of compliance
The cost will depend on the size of the company, but according to the Equipment Leasing & Finance Foundation, implementation costs are the top outstanding concern. They are viewed as a significant financial burden requiring new processes, information technology infrastructure, and additional personnel. Estimates have ranged in the millions of dollars. Early preparation and implementation could significantly reduce costs.
5) Effective date
The standard is effective for interim and annual reporting periods beginning after December 15, 2018, 2019 or 2020 depending on the type of company and timing of its fiscal year. Although this may initially appear to be far into the future for most large companies, the SEC requirement for comparable financial data (in order to compare the before and after effects of the regulations) means that data from 2017 may also be required. As a result, the time to respond to the new lease accounting changes is now.
The new standard could bring drastic changes to a company’s balance sheet, approach to lease agreement management, technological infrastructure, and administrative operations. To minimize costs, start early and consult professionals regarding lease abstracting that complies with the new standard, what level of impact to expect, who will collect the new data, how will they handle non-English lease agreements, and what technology solutions exist to cost-effectively manage lease agreements.