Richards Layton & Finger
 

New FASB Rules and Your Balance Sheet

March 29, 2016

On February 25, 2016, the Financial Accounting Standards Board (FASB) issued a long-anticipated Accounting Standards Update (ASU) that may dramatically affect many lessees. Although the new ASU will not be effective until late 2018 or 2019, depending on whether the entity is public or non-public, companies should start planning now for the possible impact of these new rules.

What do the new rules do? Generally, the new ASU requires companies to report most leases on the balance sheet. This will effectively end off-balance-sheet reporting of assets and liabilities related to operating leases. The reach of the new ASU extends beyond commercial real estate leases and includes asset leases as well. Existing FASB accounting standards characterize leases as either capital leases or operating leases. Lessees recognize assets and liabilities for capital leases, but not for operating leases.

The new ASU governs all leases over twelve months for land and/or depreciable assets. Leases are now to be differentiated between operating leases and so-called finance leases (which are essentially the same as capital leases under current standards). However, operating leases now will be disclosed on the balance sheet, although the accounting treatment for an operating lease will differ from that of a finance lease.

There are several foreseeable effects on lessees. A lessee’s balance sheet will grow, and the company will appear more leveraged. This may have a potentially adverse impact on financial covenants of the company because of the effects of these accounting changes on financial ratios. The structuring of rent payments under build-to-suit leases and sale/lease-back transactions will likely change in order to minimize the effects of these accounting changes. EBITDA may increase because the rent expense is replaced with depreciation and interest expense.

Companies who lease assets and use GAAP accounting should take prompt action to investigate the potential effects of this new ASU.

Related Links

FASB's Accounting Standards Update

Related Practices