UPDATE as of June 2020: The FASB made the decision to defer the effective date of the new lease accounting rules for private companies by another year due to companies having to put resources towards impacts of COVID-19 and not being able to focus on their adoption. Therefore, a private company using calendar year financial statements will need to follow the new lease accounting standard for calendar year 2022, rather than by the previously stated calendar year 2021.
The Financial Accounting Standard Board (“FASB”) issued a new lease accounting standard in February 2016 in an effort to improve transparency of “off-balance sheet” obligations. The new lease accounting standard is also commonly known as “Topic 842.” Just recently, FASB has issued updated guidance delaying the effective date of the new lease accounting standard for private companies.
Prior to release of the updated guidance, the new lease accounting standard would have been effective for private companies using calendar year financial statements in January 2020; however, private companies will now have an additional year to prepare for the adoption of the new lease accounting standard. A private company using calendar year financial statements will need to follow the new lease accounting standard for calendar year 2021. Companies should not delay their adoption and implementation planning efforts. Companies should also consider consulting with their auditors regarding how the new lease accounting standard will impact their financial statements. They should also consider consulting with their technology and software providers regarding changes to support the new standard.
What is Topic 842?
The new lease accounting standard and updates only apply to companies that prepare their financial statements in accordance with U.S. Generally Accepted Accounting Principles (U.S. GAAP). These changes do not impact the tax treatment of leases or the economic benefits of using leasing as a source of financing. A summary of the FASB lease accounting changes can be found here. Please feel free to reach out to a GreatAmerica sales representative if you have any questions.
Who is Impacted by FASB Updates?
This update impacts the financial reporting of leases for companies that are required to follow U.S. GAAP accounting standards. Examples of companies following U.S. GAAP include, without limitation:
- Public companies
- Regulated industries
- Larger private companies with external shareholders and/or banking relationships that require audited financials
What Exactly Is Changing?
The biggest change as a result of the new lease accounting standard will be that lessees will need to recognize operating leases on their balance sheets. This was not a requirement under legacy guidance. Although operating leases will be reported on-balance sheet, the lease liability is intended to be classified as an operating liability, rather than debt. Lessees should consult with their lenders to determine any potential impacts on their credit lines and covenants.
The FASB did retain a dual lease classification model. The new lease accounting standard maintains the concept of a finance lease (formerly a capital lease) and an operating lease. There were minor changes made to the lease classification criteria, primarily to remove the “bright lines” that exist in the current standard. A summary of the changes to the lease classification criteria are detailed in the table below.
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Setting the Record Straight on Lease Accounting “Myths” . . .
With these changes, it’s possible you may get some questions from your customers. There may also be misconceptions or misinterpretations about what this truly means for them. In the spirit of being proactive, let’s address some of the misconceptions you may encounter.
Myth #1: “The lease payment has always been an operating expense – not anymore”
Truth: The perception of an “operating expense” may be the result of the end-user/lessee considering the expense to be immaterial within their overall expenditures and/or the value of the contract in place is for service/consumables, although there was a contract signed including the use of equipment. It is important to understand whether the customer is referring to operating expense for tax or book accounting purposes. If it is for tax accounting purposes, Topic 842 has no impact on tax accounting. U.S. GAAP accounting lease classification can only be determined by the terms of the contract as described in the chart above.
Myth #2: “Leasing is no longer of any value to businesses”
Truth: Leasing equipment for use still has significant benefits including the preservation of cash and convenience of implementation. Those contracts that include the provision of equipment use and service or consumable items will continue to provide the “all-in-one solution” that businesses often prefer over purchasing equipment and separately contracting for service.
Businesses that Lease Assets Will Still Enjoy these Benefits:
- Convenience
- 100% financing
- Preservation of cash and/or financing lines
- Easy budgeting
- End of lease options
- Seamless upgrades to new technology
- Single invoice solution (i.e., lease + service/consumables)
Myth #3: “This new change will impact my tax reporting”
Truth: The new changes from FASB are intended to bridge the gap between international and U.S. GAAP accounting standards and specifically the treatment of lease contracts in financial reporting such as off-balance sheet obligations. The goal is to create better visibility for investors, shareholders and financial institutions. Tax treatment for leases has been, and will continue to be, guided by separate regulation.
Myth #4: “Bundled contracts won’t be allowed under the new rules”
Truth: Bundled contracts will continue to be allowed. No specific rules define the ability to, or place restrictions on, documenting a contract with service included on the equipment. Contracts that include a single payment for equipment and supplies will continue to be accepted and the end-user will be the one responsible for determining the appropriate accounting treatment.
How Will Your Customers React? And What Can You Do About It?
Depending on the profile of your customer base, you likely won’t receive many, if any, FASB Topic 842 related questions. However, it’s possible your customers may ask for a cash price. If you encounter this question, be sure you find out why they are asking it, as it could be due to lease accounting changes, tax reporting changes, or other reasons. Once you know the reason the customer is asking, you can provide the right solution to address their needs and concerns.
Your solutions deliver value and the customer’s business decision to lease should not be based on accounting guidance. While the customers are responsible for making the determination and conclusions on their lease contract, they may ask you for help. You need to determine your approach to adequately address the customer’s questions. Should your customers have questions, GreatAmerica has a number of subject matter experts on staff who would be willing to help answer any questions. As always, we encourage you and your customers to also consult your own accounting advisors.
Want to learn more? Download our FASB Flyer!
This article is for informational purposes only. It is not intended as, nor does constitute, accounting advice. You should contact your own accounting advisors to determine how the new lease accounting standard will apply to your business and your equipment/software acquisition.