How Will the New Lease Accounting Rules Impact You?
12 Questions CEOs Should Be Asking About the Business Risks from Lease Accounting
Trillions of dollars in new leases are going to appear as assets and liabilities on the balance sheet in the next few years as a result of the new lease accounting standards. With these new assets and liabilities, financial metrics such as return on assets, EBITDA, interest coverage, and operating leverage could change significantly for some companies. How will shareholders, bondholders, lenders, and credit rating agencies respond to these changes? In other words, what are the business risks from lease accounting?
Some key questions are outlined below:
Top 12 Business Risks from Lease Accounting
#1) Market Capitalization
How will this impact the share price and market capitalization of big companies who have sizable leasing portfolios? Large companies will have several billions worth of leases transition onto the balance sheet.
#2) Credit Ratings
Will this impact the credit ratings that agencies such as Moody’s, Fitch, and Standard and Poor’s issue about large companies? With these new lease liabilities, the debt levels on balance sheets will be much larger.
#3) Borrowing Ability
Will the transfer of these new debts to the balance sheet impact a company’s ability to borrow money? Will this change impact their ability to raise new debt?
#4) Debt Covenants
How will this impact the existing debt covenants that companies have with their banks and bondholders?
#5) Financial Metrics
Will this change the way companies measure their own financial performance? And the metrics they promote to investors?
#6) Executive Compensation
How will this impact executive compensation that is often based on financial metrics like EBITDA?
#7) Equipment Leasing
Will the new accounting change influence companies to stop leasing because the administrative costs and hassles of compliance exceed the benefits of leasing? Will they choose to purchase equipment like forklifts, trucks, and computers rather than lease them?
#8) Real Estate Leasing
Will the traditional leasing bias that has existed in real estate decisions disappear? Will companies choose to own their office buildings, warehouses, and retail stores rather than leasing them?
#9) Capital Requirements
Will financial institutions, whose capital ratios are closely monitored, be negatively impacted by the new accounting rules?
#10) Investor Relations
Are CFOs prepared to explain their leasing programs to investors? Do they have good processes in place to evaluate when to lease versus when to buy? Are they seeking out the most competitive financing terms as they would for any other purchase or debt transaction?
#11) Material Weakness
Will auditors find fault with the current lease accounting that public companies provide? Are the leasing obligations that companies disclose in their annual reports today really accurate or have they been poorly tracked and under (or over) stated?
#12) Reporting Burden
How much effort will be required to comply with the new accounting rules? Is this another Sarbanes-Oxley-type situation that will create massive administrative burdens for the accounting departments of big companies? Or will it just be a few months’ worth of work for the accountants and IT department?
Most Risks are Well Understood
The new lease accounting standards have been under development for over 10 years. As a result, the business risks from lease accounting are well understood by most of the institutional investors (think pension funds, mutual funds, insurers) that are shareholders in Fortune 500 companies. Banks that offer credit are also aware of these changes, as many banks sell leasing products of their own.
As a result, most experts on the new lease accounting standards believe that most professional investors have factored the accounting change into their financial models over the past few years. Of course, that does not rule out the possibility that there could be surprises.
Most experts on the new lease accounting standards believe that the majority of companies will not change their leasing behaviors. Accounting treatment is just one of many benefits of leasing. Of course, this too does not rule out the possibility that there could be a few surprises.
More Resources – New Lease Accounting Standards
White Papers, eBooks, and Webinars
With the deadlines for the new lease accounting standards approaching quickly, many companies are asking how software can help automate the tasks required for the transition period. US GAAP filers adopting ASC 842 will be required to provide three years of comparative reporting.
Learn the differences between contract-level and asset-level lease accounting in this technical white paper. Review examples of the impact of asset-level decisions, judgments, and events for material handling, data center, and IT equipment.
Considering lease accounting software to comply with the new FASB or IFRS standards? Download this eBook to understand the potential time and cost savings opportunities resulting from automation of lease classification and financial reporting.