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Will the New Accounting Leasing Standards Affect Your Credit Arrangements?

November 20, 2017

Michael L. Hanna, CPA
Partner

This will be the first in a series of articles offering insight into new accounting standards for leasing arrangements that are due to take effect as early as December 2018.

We’ll outline the definition of a lease, according to the new standards. We’ll explain how the new guidance will impact businesses’ financial reporting processes. And we’ll run down a few questions both businesses and individuals should ask themselves before the new standards take effect.

In the meantime, though, we’ll just lay out the basics.

What’s happening – and why?

Last February, the Financial Accounting Standards Board (FASB) issued a set of new guidance for the accounting of leasing arrangements. The document, entitled Accounting Standards Codification (ASC) 842, Leases, will bring with it a host of changes to accounting and financial reporting processes across several industries.

According to the FASB, the purpose of implementing a new standard is to make lessee accounting “fundamentally consistent with existing Generally Accepted Accounting Principles.” The board claims the new standard will “increase transparency and comparability among organizations that lease buildings, equipment and other assets by recognizing the assets and liabilities that arise from lease transactions.”

When will these new standards take effect?

It depends on your entity structure.

  • For public companies and some non-profit organizations, the standard will take effect for fiscal years beginning after December 15, 2018.
  • For all other organizations, it’ll take effect for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020.

So, what is the effect on your business?

Depending on the industry in which a company operates, adapting to the new guidance could be a significant undertaking as certain industries have more lease agreements than others. Even though it may seem like these changes are not imminent, it’s incredibly important for businesses to start thinking about the new standards immediately.

The new standards could impact current and future arrangements with lenders, insurance companies, vendors and more. Many companies have debt and credit agreements that contain

certain financial covenants such as current ratio, debt service coverage, debt to net worth and return on assets, all of which need to be maintained.

Financial statements and their related ratios are key indicators of a company’s financial health. If you have existing debt arrangements, you should speak with your lenders to either have these liabilities excluded in calculations of existing ratios or have the required ratios amended. If you find that you are in a situation where you could be in violation of your loan covenants, reach out to your lender as they can assist in avoidance of potential future fees and waiver requests.

Do not let the fact these standards are not in effect until 2019 and beyond cause complacency. Remember, the agreement(s) you execute today may be in effect for several years.

According to a recent Deloitte poll, just 14 percent of surveyed businesses considered themselves prepared to make the transition to the new standards. Our advice: Get ahead of the curve and start preparing now. The first step is to contact your financial advisor today; start a dialogue about these imminent changes; and start to take inventory of any existing lease agreements you currently have in place. Watch for my colleague Michael Young’s series for in-depth commentary of the new leasing standards and how you need to prepare.

Michael L. Hanna, CPA, is a partner at BlumShapiro, the largest regional business advisory firm based in New England, with offices in Connecticut, Massachusetts and Rhode Island. If you have further questions, he can be reached at mhanna@blumshapiro.com or at 401-330-2733.

Stay tuned for additional articles on this topic.

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