For CFOs and small business owners, there are soon to be big changes regarding how leases appear on corporate financial statements. The new accounting rules aim for more transparency and will affect the balance sheets and profit and loss statements (P&L's) for any business that leases long-term office space.
The Financial Accounting Standards Board (FASB) created and drafted the new measures. Investopedia defines FASB as "a private, non-profit organization and standard-setting body, whose primary purpose is to establish and improve generally accepted accounting principles within the United States, with interest in the public good."
Believe it or not, the motivation for the upcoming changes goes back almost 15 years. Thanks to companies like Enron and WorldCom, CFOs can look forward to more accountability when reporting lease expenses. These companies collapsed, in part, due to concealed off-balance-sheet liabilities.
The main outcome of the new rules? The lease MUST go on the balance sheet, not just the P&L, as is current practice for most office or industrial leases. Soon, off-balance-sheet expenses will be a thing of the past.
A Brief Overview: Who Will FASB Rules Affect and When
- Public and private companies, including non-profits
- For public companies, the new standards take effect in 2019.
- For private companies and non-profits, the rules will apply starting in 2020.
- However, all businesses need to account for the changes starting ASAP. Records looking back two years from the start date above is also required.
The Fine Print: Other Effects of the New Office Lease Accounting Rules
Recording each year of every lease on the balance sheet seems stringent enough, but what if we told you your business must also begin recording future lease renewal options? That means for a 5-year lease with a 5-year renewal option, you will likely need to record a full 10 years of lease liability on the balance sheet. The new rules will impact businesses in a very real way. This especially means companies with capital reserve requirements such as insurance companies and banks.
Besides bigger and longer balance sheets, these effects include:
- A balance sheet liability that is higher than the value of the asset (at least at the transition point). This condition changes as the lease gets nears its expiration date. However, as high as 70% of companies will never experience an asset value greater than the liability value. This is because so many companies either extend their lease or move to a new space prior to the current property's lease expiration.
- Potentially limited borrowing power or increased need for capital reserves, caused by higher financial liability ratios.
- For international companies, a much larger (possibly up to 10% to 20% larger) liability ratio on the balance and P&L sheets for the transition year. The FASB is active in developing International Financial Reporting Standards (IFRS). They will require that statements from international companies include interest and amortization expenses occurring at the beginning of a lease.
Be Prepared for Upcoming Changes
These accounting changes will have potentially critical impacts on your company's financial statements, earnings, and valuation. There are ways to approach negotiations that take all of these new FASB changes into account. Start reviewing your situation now. Let us help you make strategic transactions that can reduce the impacts on your financial statements. If you have any questions about the changes, or for more information about how they may affect you, contact us today to schedule a consultation. firstname.lastname@example.org (512) 582-0150
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