Proposed Lease Accounting Rules:  How will they impact your business?

As the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) propose changes to the accounting for lease transactions, the Equipment Leasing & Finance Foundation (ELFF) has released a study quantifying the impact of the changes if they are implemented as proposed.

In their most basic form the proposals call for the elimination of operating leases, which allow for companies to expense lease payments each month of the lease term.  There is currently no balance sheet impact for operating lease transactions.  Under the proposed rules, all leases would need to be booked to the balance sheet:  with an asset, representing the “right to use” the asset being offset by a debt for the future lease payments.  Over the term of the lease the asset would be amortized and the liability would be extinguished via the monthly lease payments, which would be booked to principal and interest.  As is the case with the paying down any debt, interest would be front loaded, which means higher in the early months and lower in the later months.

Although there is no pretax cash impact resulting from the proposals, the ELFF estimates that these changes would increase debt on the books of US companies by 11% and reduce reported income by an average of 2.4%.   The changes would also impact various financial metrics and could impact bank covenant calculations.  You can follow this link to see more. 

Small and mid-sized companies generally do not have the time or budget to follow the accounting standards setting process, and there are likely to be numerous changes to the proposals before they are finalized and an effective date is set.  So what should you be doing about this now?

I suggest that at your next meeting with your banker, you should bring up the following:

• That you understand that certain changes in lease accounting are being proposed.
• That you have not attempted to quantify the impacts of such changes on your financial statements since you understand that the rules have not yet been finalized.
• That to the extent the new rules have any negative unintended consequences on your financial statements or loan covenants, you look forward to the bank’s willingness to work through this transition.

Doug Jones is a Director at Fahrenheit Finance, where he works with small and mid-sized companies as a fractional CFO and on special projects like planning and budgeting.  If you have questions or want to discuss the impact on your business, you can reach Doug via email at djones@fahrenheitfinance.com