In February 2016, the Financial Accounting Standards Board (FASB) issued new guidance on accounting for leasing arrangements which will bring with it a host of changes to accounting and financial reporting processes across many industries, including privately owned dealerships, beginning in 2020. The changes will impact those dealerships who present their financial statements in accordance with United States Generally Accepted Accounting Principles (GAAP). Specifically, such dealerships will have to recognize assets and related liabilities on their balance sheets —barring rare exception—for each and every one of their leasing arrangements. Under current GAAP, the majority of leases are not required to be accounted for in this way and the rent payments are simply expensed to the income statement as incurred. Dealerships should start considering the impact of the new lease guidance on their financial statements now. Three considerations of significance are as follows:
- Consider Your Leasing Arrangements: Generally speaking, all leases with a term greater than 12-months will need to be recognized in accordance with the new guidance. While many dealerships have at-will leasing arrangements (i.e., no formal leasing agreement in place), the economic substance of the arrangement may need to be considered under the new guidance. For example, if you lease your dealership facility under an at-will arrangement and it is new, recently refurbished, or is leased from the dealer principal or another related party, the likelihood of abandonment in the near term is low and the realistic terms may need to be determined in order for the arrangement to be appropriately recorded to the balance sheet. As a result, now may be the time to formalize any at-will arrangements. Further, if the dealership will be entering into any new leases over the next few years, particularly with third parties, management may want to consider shorter-term leases in order to reduce the impact to the balance sheet.
- Consider Creating a Lease Inventory: It is important to begin preparing an inventory of your dealership’s leasing arrangements, gathering all of the related lease documents and creating a summary of the significant terms such as payment amounts, lease term, extension options and likelihood of extension. Recording the lease transactions under the new standard can be quite tedious, especially as the number of leases increases. Preparing such an inventory now will allow you to begin a dialogue about the implementation of the guidance with both your internal and external accounting teams.
- Consider the Impact on Financial Covenants and Working Capital: Since implementation of the new guidance will increase the overall liabilities reported on the balance sheet (the lease liabilities), financial covenants will likely be negatively impacted. Many financial covenants factor in debt and other liabilities into the calculations so it is important to understand what financial covenants your floorplan provider and other lenders are using to evaluate your dealership and begin discussing the impact of the standard with them. Do not let the fact that the standard is a couple of years away from implementation cause complacency. Remember, the agreements you execute or are committed to today may be in effect for several years. Further, the assets required to be recorded under the new standard are recorded as long-term assets, whereas the lease liabilities are required to be broken out as both current and long-term liabilities based on the payment terms. As a result, working capital will be negatively impacted by the recognition of the leases which could challenge your ability to meet your manufacturer’s requirements.
As you can see, the new lease guidance will have considerable accounting implications on your financial statements. According to a recent Deloitte poll, just 14 percent of surveyed businesses considered themselves prepared to make the transition to the new lease standard. Our advice: Get ahead of the curve and start preparing now by considering those items outlined above.