A New Approach to Lease Accounting: Will You Be Ready?
Mar 6, 2018
In the construction world, there are few companies that do not have some sort of lease obligation that impacts their financial picture. From real estate leases to vehicle and equipment contracts, leases are a fact of business life in the industry; which is why construction company executives need to be aware of an important accounting change that’s looming on the horizon.
A new standard for how private companies account for lease agreements will take effect on January 1, 2020 – a date that seems far away until you consider that most companies will need to adjust some of their previous financial statements and perhaps their existing internal accounting and control systems – in order to comply with the new approach before it takes effect.
For public companies, whose switch over to the new accounting method takes place a year earlier on January 1, 2019, the task of locating all of a company’s leases and extracting the data required to comply with the standard has been slow going. A survey of 500 financial executives conducted late last year by KPMG found that 34 percent said they had not even begun to address the issue, while only 19 percent were assessing the accounting impacts. Further, only 18 percent said they had completed a lease inventory, and only one percent said they had completed the implementation of the new standard.
The bottom line is this: the sooner companies begin to adapt, the less painful and costly the changeover will be.
The net result of the new standards is not insignificant. The financial statements for a typical company will likely change in several important ways:
- Operating leases over twelve months in duration will now have an asset and a liability for the lease on the balance sheet;
- Ratios such as debt-to-equity could be impacted, which means that any loan covenants based on those ratios to which the company is bound might change;
- Lessors could be effected, as property currently being depreciated on the balance sheet may need adjusting;
- The cumulative effect of the new approach may require a retained earnings adjustment for the tax year beginning on January 1, 2020.
There are a number of steps that companies should be taking now to prepare for the new lease accounting standard.
- Get a handle on your current lease portfolio. Calculating the effect of the change on the balance sheet and internal systems as of January 1, 2020 is job one. The identification of all leasing arrangements for many companies will be a large, time- and resource-consuming exercise involving detailed data collection, data entry and frequent decision-making.
- Review current ratios and covenants. Your company’s balance sheet serves as the cornerstone of your financial reporting, and helps to answer the question “How leveraged is my company?” The debt-to-equity ratio is a key barometer that measures leverage, and is one of the key metrics that lenders rely on when making – and calling – loans. It’s likely that the new lease accounting standard will alter your company’s financial ratios and, in turn, the loan covenants under which you currently finance your business activities.
- Determine how to manage both current and future contracts. Well before the January 1, 2020 implementation date arrives, changing lease management techniques may require changes to internal systems and controls. For a company with relatively few leases, an Excel-based system may suffice. But for organizations with a large and growing lease portfolio, a specialized lease management software solution may be in order. Whatever the choice, your system will need to be sufficiently flexible to account for new leases as well as existing ones.
- Keep those who will be impacted informed. Under the new standard, lease terms can have significant repercussions for an organization’s ongoing financial health. It will be especially important to discuss the coming changes with your financial team members – banks, bonding company, insurance agents, accountants, lawyers, and others – and alert them to changes they may see on both previous and future financial statements.
As you can see, with all the work and resources that will be required, it’s high time for companies to acknowledge the coming changes, and rev up for the new lease accounting standard. The year 2020 is closer than you think.