Companies Prep for FASB’s New Take on Leases

Still knee-deep in preparing for the massive new revenue recognition standard, public companies have plenty of reason to start revving up now for another major accounting change on the horizon—the new leasing standard.

The Financial Accounting Standards Board says it will issue its long-awaited final package on how to account for leases in the first quarter of 2016, soon after the International Accounting Standards Board has already issued its final rule. Both standards require all companies to add trillions of dollars in off-balance-sheet lease holdings to corporate balance sheets, although the two boards chose different avenues for reflecting the cost of lease obligations in the income statement.

FASB and the IASB agree that every company should reflect a right-of-use asset and liability on the balance sheet for all leases, except for the shortest-term leases that come and go during any given financial statement period. The IASB is requiring a single model for leases, where the transaction is treated like the financed purchase of an asset. FASB is retaining the two-model approach in current GAAP, but removing the bright lines used to classify leases and replacing it with more principles-based guidance on how to distinguish between operating and finance leases.

Don’t wait for the final rules to get ready, FASB advises. “As soon as possible—even prior to the issuance of the new leases standard—preparers should consider creating a transition timeline and action plan,” FASB wrote recently. “Early action is key to a successful transition.” The standard takes effect for public companies in 2019, a year after companies are required to adopt the new revenue recognition standard.

“The standard is pretty pervasive,” says Diana Gilbert, a senior consultant with RoseRyan. “We hear companies say the revenue standard is not going to change what they are doing, or the change will be minor, but very few are going to come to the same conclusion with the leasing standard. Anytime you bring something on the balance sheet, it has an effect.”

“We hear companies say the revenue standard is not going to change what they are doing, or the change will be minor, but very few are going to come to the same conclusion with the leasing standard. Anytime you bring something on the balance sheet, it has an effect.”

Diana Gilbert, Senior Consultant, RoseRyan

Chad Soares, a partner with PwC, says experts are renewing advice they’ve been offering for several years as FASB was developing the standard. “At the risk of sounding like a broken record, it’s the same advice we’ve been giving since 2009 and 2010,” he says. “Get your arms around your lease arrangements. For a lot of companies this is going to be a fairly significant change.”

Companies can and should form a project team and determine a method by which they will inventory, organize, and gather data from lease contracts, says Sean Torr, a director with Deloitte Advisory. “What does the lease landscape look like?” he asks. “You need to develop a plan to get all lease information into an electronic system. The culmination of an initial assessment will lead to a roadmap to adoption. That detailed, granular plan and roadmap is what companies need at the moment.”

Companies will need a method not only to gather lease information but also to continually update it, says Hal Hunt, a shareholder with audit firm Mayer Hoffman McCann. “You will need to continually reassess whether the purchase or renewal options are to be invoked,” he says. Companies will want to reach out to their vendors for software or other enterprise resource planning systems, he says, to determine where they can help.

JUST THE FACTS

Below is a fact sheet put out by the IASB on its new leasing standard.
The Changes

IFRS 16 Leases was issued on 13 January 2016. It replaces IAS 17 Leases.

The new Standard is effective 1 January 2019. Early application is permitted (as long as the recently issued revenue Standard, IFRS 15 Revenue from Contracts with Customers is also applied).

The biggest change introduced by the new Standard is that leases will be brought onto companies’ balance sheets, increasing the visibility of their assets and liabilities.

IFRS 16 removes the classification of leases as either operating leases or finance leases (for the lessee—the lease customer), treating all leases as finance leases.

Short-term leases (less than 12 months) and leases of low-value assets (such as personal computers) are exempt from the requirements. 
The Benefits

More faithful representation of a company's assets and liabilities 

Increased transparency

Improved comparability between companies that lease and companies that borrow to buy assets

Removes the need for most investors, credit rating agencies, and others to make adjustments (analysis shows that common-practice adjustments often over-estimate, but sometimes under-estimate, the value of off balance sheet leases)
The Numbers

US$3.3 trillion: listed companies around the world currently have around US$3.3 trillion of lease commitments (future payments).

Over 85 percent: of those commitments do not appear on the company’s balance sheet.

US$1.25 trillion: in 2005, the U.S. Securities and Exchange Commission estimated that U.S. public companies had approximately U.S.$1.25 trillion of lease commitments off balance sheet.

1 in 2: almost half of listed companies using IFRS or U.S. GAAP will be affected by the lease accounting changes.

66 times value of debt: analysis of some retailers that have gone into reorganization/liquidation shows that the value of off balance sheet leases was almost 66 times the value of on balance sheet debt.

1,700: the IASB has received over 1,700 comment letters on its consultations during the standard-setting process (one Discussion Paper, two Exposure Drafts).
Source: IASB

Another good reason to inventory leases soon, aside from preparing for the accounting, is to consider whether a company could benefit from renegotiating leases even before the standard takes effect, says Kimber Bascom, a partner and global IFRS leasing standards leader for KPMG. “Anytime numbers are going to go on the balance sheet, companies are sensitive to that,” he says. Renegotiating lease terms “is something companies will be able to do to manage the extent of the impact to the balance sheet.”

Where companies have leases denominated in foreign currency, they will also want time to consider changing hedging strategies, says Jeffrey Ellis, senior managing director at FTI Consulting. The new standards will require foreign exchange effects to be adjusted continuously over the life of the lease, he says. “Those changes will go through profit and loss, so that’s volatility you’ve not had to recognize to this point,” he says.

New systems solutions are almost a certainty for companies that have large, complicated lease portfolios, says Soares, but the inventory and assessment process are critical to determine exactly what a given company will need to comply with the new standard. “Some companies are absolutely adamant that they’ve got enough complexity and volume that they are going to have to digitize this,” he says.

Companies that file financial statements under both U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards are especially likely to need a new system solution of some kind, says Soares, because the calculations will be different under the U.S. and international rules. “I’m not sure those companies will have a choice,” he says.

For smaller companies with a smaller portfolio of leases, however, “they might decide brute force is the way to go,” says Soares. “The size and complexity of the population of leases is going to be the big driver.”

Another reason to inventory leases and assess impact early is to determine if a company might want to adopt the standard early, says Scott Lehman. The new standard allows companies to adopt immediately under a modified retrospective approach, where they can present historical periods with cumulative-effect adjustments that are easier to perform than full calculations. “Some may want get a head start so they are not adopting all these major new standards at once,” he says.

Peter Bible, a partner and chief risk officer at audit firm EisnerAmper, says companies also need early planning so they can begin to prepare regular readers of their financial statements about the change that is coming in the corporate balance sheet.

“What you really have to get your head around is the messaging, especially for companies that are heavy lease users,” says Bible. “Think about the Street, commercial banks, analysts, investors, credit rating agencies, earnings calls. You have to give them a sense of the size of this thing. The sheer size of the numbers may even come as a shock to the C-suite.”