2019 will be a big year for the treatment and reporting of leases and the impacts to the lessee, lessor, and company at large are shaping up to be significant.
Origin of Change
In a news release by the Financial Accounting Standards Board (FASB), it was noted that these changes have been a long time coming and first began in 2006 with the teamwork of the FASB and International Accounting Standards Board (IASB).
Reason for Change
Given the far-reaching effects, the FASB Chair, Russell G. Golden was quoted in the FASB news release explaining what brought about the changes: “the new guidance responds to requests from investors and other financial statement users for a more faithful representation of an organization’s leasing activities. It ends what the U.S. Securities and Exchange Commission and other stakeholders have identified as one of the largest forms of off-balance sheet accounting.”
In their publication “IFRS 16: The leases standard is changing: Are you ready?,” PricewaterhouseCoopers explained the importance of leases to businesses and why, depending on the industry, they can be essential to operations: “leasing is an important and widely used financing solution. It enables companies to access and use property and equipment without incurring large cash outflows at the start.”
The importance of leases, therefore, directly correlates as to why these changes are consequential.
Before delving into the changes and impacting ramifications, Work US detailed the old method of treating leases and explained that the reason the changes were made was due to a quest for transparency: “under the current accounting standards, leases must be defined as either finance or operating leases. Operating leases are treated as expenses on our income statement, leaving the balance sheet unaffected. Finance leases…are treated as both assets and liabilities on the balance sheet.”
The deletion of the finance vs operating lease notation is the central change to the leasing standard and the basis for the impacting ramifications.
The FASB made clear in their news release that the “new ASU will require both types of leases to be recognized on the balance sheet” and “will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements.”
The significance of this cannot be understated as the effects will be felt by not only the parties to the lease but the accounting and IT departments of the company, as well.
Work US explained that due to the erasing of the finance and operating lease distinction, “all leases will be capitalized” and “trillions of dollars worth of leases are expected to be brought onto company books as a result.”
In their article “New leases standard-effective date and sweep issues,” EY published that the “IASB decided to require entities to apply the new leases standard for annual periods beginning on or after 1 January 2019.”
Work US further detailed that “public companies will be required to retrospectively apply the new standards to their 2017 and 2018 financial statements, with nonpublic companies expected to do the same for 2018 and 2019.”
EY included the following decisions as central to the changes:
- Lease modifications treated as a separate new lease;
- Reassessment of the discount rate for Floating interest rate leases;
- Costs associated with returning an underlying asset at the end of a lease;
- Short-term leases and leases of low-value assets in a business combination;
- Disclosure requirements for leases within the scope of IFRS 5.
These decisions are worth delving into further for any accountant and or accounting department to understand the true parameters of these changes and how the costs and finances of an entity will be truly affected.
For finance professionals that have just changed companies or are interviewing will new companies, studying the impact of these changes would serve you and the new/prospective company greatly.
Impacts and the way forward
PwC divulged that “the pervasive impact of these rules requires companies to transform their business processes in many areas, including finance and accounting, IT, procurement, tax, treasury, legal, operations, corporate real estate and HR.”
Street Fleet, a courier and logistics company, commented that “those in retail, distribution, agribusiness and logistics are expected to be most affected and should be aware of the potential consequences.” Once implemented, they are hoping for the financial transparency that the standard will require.
Work US suggested that given the likely increase of assets and liabilities for companies, short-term leases should be considered as well as ownership, when possible.
PwC put out the below list of ramifications and they are worth exploring:
- Financial ratios and performance metrics redefined;
- Stakeholder awareness and communication;
- Implementation can be cumbersome and costly;
- New IT systems and robust processes and controls needed;
- Benefits to lessees beyond compliance and new opportunities for lessors;
- Unexpected tax consequences may arise.
As January 1, 2019 is a little less than a year away, affected and interested parties should use the upcoming year to fully grasp the changes and the steps that need to be taken.
“Changes to lease accounting come 1 Jan 2019.” Street Fleet, 24 Jan. 2018. <http://www.streetfleet.com/au/news/changes-to-lease-accounting-come-1-jan-2019>
“Changes to leasehold accounting standards in 2019.” Work US, 24 Jan. 2018. <http://us-en.workunitedstates.regus.com/changes-to-leasehold-accounting-standards-in-2019/>
“FASB Issues New Guidance On Lease Accounting.” Financial Accounting Standards Board, 24 Jan. 2018. <www.fasb.org/jsp/FASB/FASBContent_C/NewsPage&cid=1176167901466>
“IFRS 16: The leases standard is changing: Are you ready?” PwC, 24 Jan. 2018. <http://www.pwc.com/au/assurance/ifrs/assets/ifrs16lease-brochure.pdf>
“New leases standard-effective date and sweep issues.” EY, 24 Jan. 2018. <www.ey.com/Publication/vwLUAssets/IFRS_Developments_Issue_114:_New_leases_standard_-_effective_date_and_sweep_issues/$FILE/Devel114-Leases-Oct2015.pdf>