The compliance deadline for new lease accounting standards took effect in January for calendar-end public companies. That means public companies, whether they report under International Financial Reporting Standards or current Generally Accepted Accounting Principles (GAAP), are now required to recognize operating lease assets and liabilities on the balance sheet. Private companies have until 2020 to comply.
This change affects a large number of companies, with the U.S. Securities and Exchange Commission (SEC) estimating that companies have approximately $2.3 trillion of operating lease commitments.
However, a survey of companies around the world reveals that some companies haven't fully completed their implementation programs and will be relying on interim solutions to enable compliance workarounds, KPMG found in its recent report titled, "Lease Accounting is Here: Are You Ready?"
"Some organizations have something of a grace period if they have a non-calendar year-end or are a non-public business entity that applies U.S. GAAP, but nevertheless with system implementation alone likely to take four to six months or longer, many of these companies will also be facing a race against time," KPMG said.
KPMG found that just three percent of companies had fully completed their lease accounting compliance project, and 67 percent indicated that they were not on track due to challenges they were facing. Just under half of the respondents — 44 percent — had completed a lease inventory and only a quarter had completed an accounting assessment.
The Core Changes
The Financial Accounting Standards Board (FASB) has said the new guidance is intended to improve the financial reporting of leasing transactions and provide better alignment with international accounting standards.
The primary standard for lease accounting is Statement of Financial Accounting Standards No. 13 (FAS 13, ASC 842 under FASB’s new coding structure). As part of the new lease accounting standard, FASB retained the FAS 13 (ASC 842) framework for lease classification.
The lessee's expense accounting is identical to their historical accounting for a Penske Truck Leasing Operating Lease on the income statement. The balance sheet will now include a right-of-use (ROU) asset and a lease liability, and Penske will provide customers with a right-of-use calculation, upon request.
Additionally, although companies will record an operating lease liability on the balance sheet, it will not be classified as debt, which is great news for U.S. companies because debt metrics remain unaffected. While the FASB has clearly articulated its view on classification of the lease liabilities as a liability, not debt, the FASB cannot dictate how individual banks and other lenders will view such amounts.
FASB said the changes were in response to requests from investors and other financial statement users for a more accurate representation of an organization’s leasing activities. They should provide better visibility of operating leases that are not currently on the balance sheet and provide investors across the globe with more transparent, comparable information about lease obligations held by companies.
The balance sheet will now include a right-of-use calculation, which Penske will provide to its customers upon request.
For a full-service lease, the ROU amount is calculated as:
- The Present Value (PV) of Penske’s net fixed lease charge for each vehicle during the lease term:
- PV is calculated using the customer’s borrowing rate;
- If not available, estimated borrowing cost is substituted.
- The net fixed lease charge equals Penske’s Schedule ‘A’ fixed lease charge, minus prepaid and service-related costs (maintenance, licenses, PPT, subs, overheads, washes, etc.):
- The remaining amount is approximately equal to the depreciation and interest portions of the fixed lease payment;
- This is the same value (i.e., minimum lease payment) used for the FASB 13 90 percent test.
- ROU asset and ROU liability are reduced each month on the customer’s balance sheet.
The Benefits of Leases
Operating lease benefits are still in play. Penske believes customers will benefit from an operating lease for all of the traditional reasons, including no residual risk, no obsolescence risk, no effect on debt ratios, budget certainty and the reduction of risk and volatility.
For GAAP purposes, the lease liability is not considered debt. There will be no impact on debt ratios or loan covenants and feedback from bankers and rating agencies will not impact a company’s credit or rating.