Marking another milestone in accounting history, the Financial Accounting Standards Board has published its final standard requiring public companies to bring assets and liabilities associated with leasing on to corporate balance sheets in 2019.
FASB’s Accounting Standards Update 2016-02 requires all companies that lease any kind of asset -- from real estate to heavy equipment to office copiers -- to recognize leased property as an asset they have a right to use and a liability that they must settle over time. “The new guidance responds to requests from investors and other financial statement users for a more faithful representation of an organization’s leasing activities,” said Russ Golden, FASB chair, in a statement. “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, while requiring more disclosures related to leasing transactions.”
FASB’s standard, a decade in the making, follows a similar but not identical standard issued by the International Accounting Standards Board in January. Both standards require companies to bring lease assets and liabilities on to corporate balance sheets, but they differ in terms of how they will be reflected in the income statement. FASB’s model retains the essence of today’s two-lease model, where some leases will be recognized like in the income statement like the financed purchase of an asset and others more like a straight-line rental agreement.
The new standard also will require disclosures that are intended to help help financial statement users understand the amount, timing, and uncertainty of cash flows arising from leases. Those disclosures include both qualitative and quantitative information, providing additional insight into the amounts recorded in the financial statements, FASB says.
The standard is focused largely on new accounting for entities that lease property, but it also contains some targeted improvements for lessors that are meant to align lessee and lessor accounting and align lease accounting with the new revenue recognition model issued in 2014.
The United States has operated under the existing accounting rules for leasing since the 1970s, says Sean Torr, a director at Deloitte & Touche. “Leasing touches most organizations, so this change, which a is significant change to financial statements, will be impacting most organizations,” he says.
While the standard is not effective until 2019, Torr says companies should begin preparing now, if they haven’t already. Companies will be required to present three years worth of data as if the standard had already been in effect, so 2017 results will need to reflect the new rules. “That basically means you have to create an opening balance sheet as of Jan. 1, 2017, for calendar year public companies,” he says. “You measure that in months, not years.”
Companies need to be ready by that date with a complete inventory of all leased assets and with calculations performed under the new standard so the new opening balance sheet can be created, he says. “Lease portfolios will continue to be modified, so keeping that information current will be important,” he says.
Depending on the size and complexity of the lease portfolio, that might necessitate new systems. “The lead time to change systems, especially considering the opening balance sheet requirement for 2017, would be something companies should be evaluating as soon as they possibly can,” Torr says.
Critics of both the U.S. and international rules worry about the leverage that will be added to corporate balance sheets, but Torr believes analysts and other users of financial statements will not be shocked by the numbers. “They have over the years developed their own models that help them think through the implications of these types of financing arrangements, so the standards will give them a greater level of precision and transparency around the lease portfolio,” he says.