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On Feb. 25, the Financial Accounting Standards Board released a new lease accounting standard considerably altering the way in which leases are accounted for on the balance sheet. While it doesn’t change the way in which a lease is drawn and financed, those companies looking to lease (your customers) now have to move forward and adopt it.
The idea behind the new rule is to provide a more accurate picture of a company’s financial health. Good news is it won’t impact the ability of these companies to acquire the necessary equipment to grow their businesses. Knowing how the new rule affects the future of your customers will give you the leg up on moving forward with future financial transactions.
Under the current accounting standards, businesses are able to classify leases as capital leases or operating leases. Capital leases are recognized on the balance sheet as both assets and liabilities, while operating leases are treated as operating expenses. Under the new rules, most leases will be capitalized.
“Historically, operating leases were just expensed for financial statement presentation purposes as paid, and an asset and a liability were never set up. Financing leases always required that an asset and a liability be shown from the start on the balance sheet because it was really a purchase,” said Greg Gremmer, CPA MBA.
While it was helpful for the business short-term, it wasn’t necessarily giving the most transparent overview of the businesses’ asset and credit risk.
“This rule makes a hybrid presentation rule which requires operating leases to be shown on the balance sheet and written off over the term of the lease. Instead of a purchased piece of equipment, the asset under an operating lease is ‘the right to use a piece of equipment’ because they are not actually acquiring a piece of equipment,” said Gremmer.
Businesses will be required to report all leases with terms of more than 12 months and all quantitative and qualitative information related to the lease transactions. Public companies must begin adhering to the new rule for the fiscal year beginning after December 15, 2018 – for most other companies the effective date is deferred a year, meaning most calendar – year private companies will be required to adopt the new standard in 2020.
According to an article highlighting this latest rule, and Gremmer, this new standard will mark the first time many businesses will recognize these operating leases on their balance sheet. That in return means that many of your customers might appear to be in different financial positions by the time this rule has been fully implemented. Because they have to report all operating leases, the amount of lease assets and liabilities will increase – and in return, upping their amount of debt owed on these obligations.
One key takeaway is that this new leasing standard might affect the way businesses consider their decisions to lease versus buy a particular piece of equipment. The way in which it affects the financial statement will be the determinant in how the business decides to move forward.
“Most new FASB’s way over-complicate things, but they try to cause financial presentation to be more reflective of reality, and I guess they feel this hidden operating lease obligation/liability needs to be shown to better accomplish that,” Gremmer concluded.
According to the Equipment Leasing and Finance Association Top 10 Equipment Acquisition Trends for 2016 report, the new rule still keeps the primary reasons to lease equipment unharmed – i.e. maintaining cash flow, preserving capital, obtaining supple financial solutions to avoiding uselessness. This new rule just forces a more authentic overview of its financial actuals.