Corporate filers and financial analysts, prepare yourselves: the next big change in financial accounting has pushed off the docks and is sailing to a balance sheet near you.
The change is a new lease accounting standard, adopted by the Financial Accounting Standards Board in February. The standard directs companies to report the cost of all leases on the balance sheet for the life of the asset, whether that asset is office equipment, real estate, vehicles, or anything else with a lease attached to it. The update does not go into full effect until 2019, but since companies will need to present three years’ worth of financial data retrospectively, you should prepare to panic starting with your 2017 fiscal year.
Historically, only capital leases had to be listed on the balance sheet. The cost of operating leases could be kept in the footnotes, where it received less attention. Now those operating leases will go on the balance sheet as well. (Only leases of less than 12 months will still be excludable.)
The numbers involved potentially are huge. One LeaseAccelerator study found that listed companies have a collective $3.3 trillion in leasing obligations, and 85 percent of that is not disclosed on balance sheet. Calcbench did some research of our own, and found that the number of firms reporting operating leases, plus the average dollars committed to operating leases, are bouncing around within a narrow range. (Note that our 2015 numbers are for filings year-to-date, and not complete.)
|Year||Total Dollars Leased||Average Leased Per Firm||Firms Leasing|
If you want to do more sophisticated analysis of leasing costs yourself, you can start with our Calcbench Operating & Capital Lease Disclosure Overview. That document explains how to use our database platform to find and study leasing disclosures, and how to use our Excel add-in if you want to export the data to your own templates.
The good news about the standard: the accounting and reporting legwork involved (that is, moving your disclosure from footnote to balance sheet) shouldn’t be too hard unto itself. The consequences of putting lease costs on the balance sheet, however, are where things might get tricky.
For example, companies will want to review whether their new asset and liability numbers have any effect on debt covenants, or on earnings per share. We also have that pesky fundamental equation of financial reporting: Assets = Liabilities + Shareholder Equity. So if your liabilities rise because of all these new leasing costs, either shareholder equity will fall, or you will need to increase assets by an equal amount. As seen above, that equal amount might be quite large.
You have concerns beyond simple balance sheet reporting, too. Audit firms might question the strength of your internal controls around leasing, to confirm that you capture all lease data promptly and accurately. If your business has lots of vendor service agreements, you will want to see whether those agreements include the leasing of equipment as part of the deal; that will need to be reported.
Those questions about operations are beyond the scope of what Calcbench addresses, but corporate finance executives should have no illusions—you’ll be answering those questions soon enough. Meanwhile we do have a few other materials you might find useful.