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How New Lease Guidance Could Impact Your Financing

Recent accounting guidance from the Financial Accounting Standards Board (FASB) has been released related to accounting for leases. While it’s not a topic that is likely to quicken anyone’s heartbeat, if you have leases for a vehicle fleet, facilities, warehouse, office space, or equipment those long term leases will need to be accounted for on your balance sheet. That activity of doing so will take some effort and may have a serious impact on business financing with debt covenants. Make sure you understand the issue so you can take action with plenty of time.

Leases Recorded on the Balance Sheet

While this may feel like a bookkeeping exercise, it’s more than that. Having to recognize the assets of the long term leases as well as the corresponding liabilities related to future payments means that your debt to equity ratio is going to change. If you have debt covenants that require a certain level of debt to equity, you could find yourself in violation of your financing debt covenants and your lender could call in the loan. For organizations that have just a few leases, you may not see such a stark increase but if you have a lot of equipment leases, multiple locations, or warehousing facilities, it would be in your best interest to start determining what the calculation will be ahead of the effective date.

Making the Calculation

The accounting work that will be needed to do this correctly is extensive. Once you know how many leases you have, the liability is calculated using the net present value of future lease payments with a corresponding right-of-use asset. The term of the lease to use is the non-cancellable period stated within the lease plus periods covered by an option to extend if you are reasonably certain you will exercise that option. This is something that has never been required for leases before and it needs to be done for each long term lease you have. The guidance does not require the calculation for leases under 12 months and given the level of effort, we would not recommend that you go through the process for a lease of such a short time period.

Effective Date

The effective date for the guidance is effective for public companies for fiscal years beginning after December 15, 2018 and one year later for privately held businesses.

Now that you understand how the new leasing guidance may impact your business, use the time between now and the effective date to develop your plan for how you will achieve compliance. If you want to speak with someone about your specific situation, give us a call!