Lease Changes and Ramifications

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.”

Lease Importance

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.

Old Method

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.”

Central Change

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.

Main Effect

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.”

Dates

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.”

Further changes

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.

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Sources:

“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>

GAAP Changes for 2018 and the Impact on Accounting and Finance Professionals

The 2018 financial reporting season will be an important one as it marks the beginning of the implementation of the new GAAP changes. All companies will be impacted by the GAAP (Generally Accepted Accounting Principles) changes, perhaps with public companies feeling it the most. Due to this, all current finance and accounting personnel in companies, (and people looking to secure jobs in these sectors), especially public companies, must be aware of the changes and understand their direct impact on a company’s financial projections.

Origin of Changes

As explained in FASB’s (Financial Accounting Standards Board) Release Notes of the Proposed U.S. GAAP Financial Reporting Taxonomy, the US GAAP is under the purview of The Financial Accounting Foundation (FAF) and the FASB. Each year there is an opportunity to be part of a public review of the GAAP during certain time frames and once it is in its final form, it is put to use by the US Securities and Exchange Commission (SEC).

Implementation Dates

Brett Cohen, Partner, and David Morgan, Senior Manager at PwC detail the varying dates of implementation based on company type. Because the GAAP changes will be so impactful and arduous to put into practice, an optional deferral date was given by the FASB. For public companies, “the proposed deferral would result in the new revenue standard being effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2017.” For nonpublic companies, the implementation would begin on December 15, 2018 and December 15, 2019 for “interim periods within fiscal years.”

The deferral date for public companies is already upon us and has presumably been top of mind for the last year within finance departments. For nonpublic companies, the upcoming year or two will be marked with trying to navigate these changes and doing the heavy lifting in terms of drafting a road map for finance and accounting employees moving forward.

Top New Standards

Denise Lugo of Bloomberg has listed and described the top new standards that will be affecting company’s financial statements:

  1. Revenue
  2. Employee Share-Based Payment Accounting
  3. Cash Flows
  4. Simplifying Measurement of Inventory
  5. Classifying Deferred Taxes.

Lugo explains that for #1: Revenue, it correlates to ASC 606 (Revenue from Contracts with Customers) and promises to be “one of the biggest overhauls in financial reporting” and should be taken seriously as it will go into effect in 2018. This standard “requires a five-step process for customer-contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards…companies are required to provide enhanced disclosures that focus on the nature, amount, timing and uncertainty of revenue and cash flows from contracts with customers.”

#2: Employee Share-Based Payment Accounting is described by Bloomberg as “making it easier to account for stock forfeitures-losses-because they can be accounted for when they occur instead of having to estimate them…it also liberalizes classification of stock compensation awards for tax withholdings and allows a company to withhold the maximum instead of limiting it to the minimum statutory rate.” This is important as the net income of companies may be affected.

The goal of #3: Cash Flows is to “provide clarity for companies on whether an item should be categorized as operating, financing or investing.” Lugo notes that this factor has not previously been included in GAAP.

Simplifying Measurement of Inventory, standard #4, changes “the measurement principle for inventory from lower of cost or market value to lower of cost and net realizable value.” This will affect companies that sell products and sometimes discontinue products.

The revision to #5: Classifying Deferred Taxes is in the interest of simplicity and efficiency as it “requires companies to classify all their deferred taxes as noncurrent instead of having to go through more complex calculations to determine what is going to happen within the year and what happens after that.”

Changing Taxonomy

In their Release Notes, the FASB compared changes to prior years, and from 2017 to 2018, there was a decrease in new elements and the definition changes and deprecated elements stayed relatively the same, though slightly increased.

The FASB noted that all the GAAP changes were done in the interest of stability and simplification.

The Way Forward: Two Methods

Bradley C. Brasser, Rory T. Hood, Joel T. May and W. Stuart Ogg of Jones Day discuss in detail for Lexology the ramifications and necessary considerations for companies as they grapple with their upcoming first financial reporting of 2018 Q1 under the new GAAP.

Brasser et. al. explains the two methods possible for financial disclosure reports:

  1. Full Retrospective Method: “involves recasting prior periods revenue and expenses to reflect the effects of the new standards;”
  2. Modified Retrospective Method: “will apply the new standard to all contracts entered into after the adoption date and involve an opening balance sheet adjustment for the period for prior contracts with remaining obligations.”

Whichever method is chosen, the earnings described in public companies’ annual and interim reports will be greatly impacted, as this Jones Day team has made clear.

Unsure Footing

Even though these changes have been in the works since 2014, many public companies are still very much in the process of studying the new standards as they relate to their financial bottom line and disclosure practices. The new GAAP will impact companies very differently depending on their size, financial state, etc.

This was seen in disclosure reports made over the summer, specifically with Microsoft and Apple. Lexology included both disclosure statements and Apple was brief and a bit vague regarding the implications of the new standards and Microsoft was more specific and divulging, making mention of specific numbers.

As time passes in 2018 and more public disclosure reports are released from public companies, it will become apparent which method of reporting was chosen and what challenges were faced in doing so.

Historic Changes

Companies, especially public companies that report financial earnings and disclosures, are being affected by “the most historic accounting changes to hit U.S. capital markets in decades,” explains Bloomberg’s Lugo. She highlighted that of the changes, what will be affected are “reporting of revenue streams, balance sheets and net income” and are “likely to roil earnings reports.”

What Employers and Employees Should Do

Also in Bloomberg, Neri Bukspan, a Partner with Ernst & Young in their Financial Accounting Advisory Services division, explained that “companies should also consider creating another, more robust, plain-English articulation to the market about what the changes are. The disclosure should include their effects on company results and comparability.”

It is important for companies to articulate these changes in layman’s terms and make correlations to their specific company since the changes are complex and far-reaching.

This is exactly what Annette Messler has and is doing for Friedman Williams. In leading the internal accounting team of Friedman Williams, Annette works closely with her tax accountants for updates and changes relating specifically to the accounting of our recruiting firm. As with her additional clients, when pertinent updates and or changes come along, she assesses the impacts and delivers what the effects will be to the affected client(s). While Annette doesn’t anticipate an impact for Friedman Williams directly, she explained that there is further research and conversations to be had in order to fully understand the scope of the new GAAP standards.

Adam Brown, BDO USA LLP’s Partner and National Director of Accounting told Bloomberg that “companies should talk to their investor relations team or mention the issue on analysts’ calls where the issue would be noticed so that it can be factored in.”

Keeping the key players in the loop regarding the financial health and reporting of a public company is essential, especially in this time of transition and change.

PwC published the article “New accounting guidance creates volatility in effective tax rates” in which they explain the crucial role corporate tax directors will play during the new GAAP implementation. PwC explains that “over the course of the next two years, companies will need to institute incremental processes to attempt to forecast the impact of stock option exercises…or income tax expense…or potential intercompany asset sales.”

Corporate tax directors play a large role in these forecasts and candidates looking to secure such a position need to educate themselves on how this role will be impacted by the implementation process of these new GAAP standards.

PwC went on to state that “companies with significant stock-based compensation programs will likely experience greater income tax expense volatility, as well as a meaningful impact on net income and earnings per share.”

Companies and those employees that work to design compensation packages should be mindful of this volatility as it affects the recipient as well as company financial forecasts.

Brasser et, al. of Jones Day explains in multiple instances of why it is imperative to involve all key employees in the process of implementing these standards.

They pointed out that the SEC has “publicly encouraged companies to provide transition disclosures to investors about the effects of the New GAAP.” This is largely due to the SEC viewing the new standards as being very impactful on disclosure issues and key stakeholders shouldn’t be surprised on how their company will be affected.

Furthermore, “…is the need to involve the audit committee in the process and to ensure that the SAB 74 disclosures are subject to effective internal control over financial reporting…” The SAB 74 (Staff Accounting Bulletin 74) disclosures reference the necessity of reporting how the new GAAP will affect the financial statements of the company.

The general main theme of the suggestions for employees and companies is to be proactive in informing the necessary people of the effects of the new GAAP standards so there are no surprises in how the company’s finances will be affected.

For people looking to elevate their careers within the accounting and financial sector, it would be wise and imperative to become educated on the new GAAP standards.

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Sources:

Brasser, Bradley C. et al. “Are You Ready For “New GAAP” Revenue Recognition? SEC Disclosure Considerations.” Jones Day, 16 Nov. 2017. <https://www.lexology.com/library/detail.aspx?g=6d8b670d-8cd5-47c4-84c1-5bd6a8d33143>

Cohen, Brett and Morgan, David. “FASB Proposes One Year Deferral of New Revenue Standard.” PwC, 16 Nov. 2017. <https://www.pwc.com/us/en/cfodirect/assets/pdf/in-brief/us-2015-09-fasb-proposes-deferral-new-revenue-standard.pdf>

Lugo, Denise. “New Accounting Rules Spell Big Changes for Public Companies.” Bloomberg BNA, 16 Nov. 2017. <https://www.bna.com/new-accounting-rules-n73014449900/>

Messler, Annette. Personal interview. 27 Nov. 2017.

“New Accounting Guidance Creates Volatility in Effective Tax Rates.” PwC, 16 Nov. 2017. <https://www.pwc.com/us/en/cfodirect/assets/pdf/in-the-loop/effective-tax-rates-volatility.pdf>

“Proposed U.S. GAAP Financial Reporting Taxonomy Release Notes.” Financial Accounting Standards Board, 16 Nov. 2017. <http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176169304602>