How Proposed Lease Accounting Changes May Affect Your Company

The proposed guidance issued jointly by the Financial Accounting Standards Board and the International Accounting Standards Board would require that all leases, including those classified as operating leases, be recognized as both an asset and a liability on a company’s balance sheet. The proposed guidance, while not likely to take effect before 2014, will eliminate what some have considered a significant off - balance sheet transaction for many companies.

You read that right: your seven-year office lease would have to be recorded on your company’s balance sheet as both an asset and an obligation. This could potentially have a negative impact on the company’s return on assets and leverage ratios as well as other important performance metrics. The value of the asset and obligation are to be determined based upon a present value calculation.

This also means that the days of a painstaking lease review for compliance with the existing capitalization requirements could be a thing of the past for company controllers. However, the new source of lease accounting frustration will likely center around the lease terms and present value calculations.  One estimate puts over a trillion dollars in operating leases that would be recorded on company balance sheets if this guidance becomes effective as proposed. While no one is likely to argue against the added transparency of a significant company transaction, many question the idea of adding assets that are merely rented and the related obligations.

WHAT SHOULD I DO NOW?
It is not yet required for companies to start recording all their leases as an asset and obligation, but it is presumed inevitable.  Therefore, it is in your best interest to start evaluating the impact of this proposed accounting change.  If applicable, start having discussions with your banker to determine if loan covenants can be renegotiated or some flexibility added in order to accomodate the impact of the proposed guidance.  If you are contemplating a new lease, consider looking at the pro-forma impact that it might have on your financial statements.  The sooner you understand the impact this change will have on your business, the less burdensome this change will be.

James P. Kenney, CPA is a Member of the Firm at Wolf & Company, P.C. and can be reached at 617-428-5433 or jkenney@wolfandco.com.

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