Goering Center news: Lease standard impacts small business

By Kelsey Baker

The Financial Accounting Standards Board (FASB) is changing the way businesses prepare their financial statements and the way companies account for leases. The FASB first introduced guidance on these changes in February 2016 and the required implementation date for non-public entities is quickly approaching. No matter the size of your privately held company, ASU 2016-02, Leases, could have a significant impact on your financial statements.

Previously, companies would have to record leases on the balance sheet if the length of the lease, the transfer of ownership, a bargain purchase element, or the present value of the payments dictated it so. If the above criteria did not indicate the lease was a capital lease, it would be classified as operating and the payments were simply recorded as rental expense.

With the new standard, all leases, including tenant leases for office space, with a term greater than twelve months will be recorded on the balance sheet as a Right of Use asset and a liability representing the present value of all future rental payments. The accounting for these leases will be a significant change for many companies. Aside from the accounting changes, management should be made aware of another important repercussion.

The most significant issue caused by the new lease standard could be in the company’s loan covenants. With previously classified operating leases now being required to be shown on the face of the financial statements, the company’s liabilities will increase, which could potentially cause a technical default on the company’s loan.

This change was needed to bring consistency among all worldwide companies, whether a United States based company reporting using Generally Accepted Accounting Principles (GAAP) or an internationally based company using International Financial Reporting Standards (IFRS). This consistency will allow financial institutions and investors to easily compare companies, whether reporting using GAAP or IFRS.

We would encourage all companies with existing leases to gather their lease documents and reach out to their CPAs. Begin discussions with your CPA regarding how each lease may be affected as well as how the presentation of the financial statements will change. We also encourage companies to reach out to their financial lenders regarding the change to the financial statements, how the lending institution will treat these increased liabilities, and whether or not the loan covenants need to be renegotiated.

There is much awareness needed prior to the effective date of the new standard, which for non-public companies is for years beginning after December 15, 2019. Although several months stand between now and the effective date, many thoughts and questions should be circulating within a company’s management team in regard to the new standard.

Will your company be ready for the changes?

Kelsey Baker, CPA, MS is a Senior Accountant at Mellott & Mellott, and has been a part of the firm for three years with her primary focus being on the audits and reviews of not-for-profit organizations. Reach Kelsey at kbaker@mellottcpa.com