Understanding the New FASB Lease Accounting Rules

Here's an overview of the key changes.

FASB Change #1: Every "Off Balance-Sheet" lease is moving to the balance sheet  

In an attempt to achieve more transparency and comparability in financial reporting, a company will now have to capitalize all leases and report them on the company balance sheet.

What It Means

Depending on how many leases you maintain in your portfolio, this migration could be formidable.   Every lease – not just real estate, but equipment, automotive, technology, etc. – is going to have to be reentered and carefully assessed and managed to ensure it gets classified correctly.  If you have a slew of leases, this will be time consuming.

Your lease administration software must be able to capture and manage the data moving forward to ensure accurate compliance and optimize your business strategy.

What To Do

First, make sure your lease administration software is capable of handling these new requirements.  It needs to be able to quickly migrate the essential data of each lease, catalog it, and manage it correctly. And the data needs to be easily accessible.  Our program and project management software has been reconfigured and updated to ensure the transition is timely and easy to implement.

FASB Change #2: Different leases, different classifications, different impact on your financials

Following GAAP, you now need to assess every lease to decide if it is more akin to a rental or a finance.  Based on that determination, you will need to classify each as either an operating lease or a finance lease.  Leases with terms greater than 12 months (which are most real estate leases) will need to be recorded at a right of use (ROU) asset because you are deriving a “benefit” from using something. However, your future stream of lease payments will be treated as a lease liability on the balance sheet.

What It Means

Let’s start with the finance lease because it’s easier to grasp the concept.  If your intention is to use up all of the value of the asset – so that you just about own it by the end of the lease term – then it’s a finance lease. 

It’s a finance lease if:

  • There is a plan for you to assume ownership of the lease in part or whole
  • You are reasonably certain to exercise an option to purchase the asset
  • You use up the value of the asset or pay for it all

So what is an operating lease?  Everything else.

In the simplest terms any lease with a term greater than 12 months that doesn’t meet the finance lease criteria above is an operating lease. If the lease term is less than 12 months, forget about it.

What To Do

You should try not to do much as at all.  Instead, let Blitzn do the heavy lifting.  Unless you’re one of the few people who find these kinds of detailed calculations exciting, you can simply let our technology figure it out for you. The software will calculate interest expense on the lease liability, amortize the expense of the ROU asset, and put them right where they belong in the income statement.

Change #3: The timing and intention of your leases must be accounted for and reflected correctly.

Now you have to recognize your new assets and liabilities using the present value of the lease payment discounted by the company’s borrowing rate, plus adjusted initial direct costs or improvements.

What It Means

Calculating the time frame of your new asset it simple. It’s just the term of the lease.  But there’s a catch: When did the lease begin or when was it renewed? You have to capture that information with more accuracy than before. You may have to backdate everything to the date of your renewal even if your escalation doesn’t occur until some later date.

And if you are reasonably certain that you are going to exercise an option to extend the lease, then you’ll have to figure the expected escalation and additional lease extensions into the calculation.

“Reasonable Certainty.” Are you reasonably certain about anything in business these days? You might be, if you have a retail store in the perfect location. Then you might be reasonably certain to renew.  In other words, if you’re going to stay put, your leases and the option to renew get lumped together and you’ve got a long-term asset on the balance sheet.  But if there is a reasonable likelihood things might change and you will not be renewing your lease, there are other factors to consider.

What To Do

Clearly there are many contingencies and unintended consequences that can arise from the way different leases are written and configured. In order to make good business decisions on how to handle real estate and other leases, it’s essential that you have accurate, accessible data and reports.