by Ryan L. Furman, CPA and Benjamin Sumner, CPA, Dannible & McKee, LLP
On Feb. 25, 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) intended to improve financial reporting of leasing transactions. The ASU affects all companies that lease assets such as real estate, construction equipment, cars and trucks. For private companies, the new standard on leases will take effect for fiscal years beginning after Dec. 15, 2019.
Under the current accounting model, lessees and lessors are required to classify their leases as either capital or operating leases, and to account for those leases differently. Those models have been criticized because they do not provide a faithful representation of leasing transactions, particularly obligations of lessees.
Under the new guidance, a lessee will be required to recognize assets and liabilities for leases with lease terms greater than 12 months. Consistent with current Generally Accepted Accounting Principles (GAAP), the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee will depend on its classification as a finance or operating lease. However, unlike current GAAP, which requires only capital leases to be recognized on the balance sheet, the new standard will require both types of leases to be recognized on the balance sheet. Lessor accounting will remain largely unchanged from current GAAP.
For companies with significant operating leases, the new requirement to add the liability for operating lease payments to the balance sheet may have an impact on the computation of working capital and other financial ratios used by banks and bonding companies. Although the economic fundamentals of the company have not changed in any way, the company could now be out of compliance with loan covenants and its bonding capacity could be negatively affected.
Contractors must carefully watch the implementation of this standard and understand how it might impact their financial statements. Evaluation of the impact from this change could take considerable amount of time and effort depending on the complexity and volume of current leases.
Dannible & McKee, LLP, a Syracuse, NY based public accounting firm with more than 90 professionals has been providing services to the construction industry since its inception in 1978. You may contact them at 315.472.9127 or visit the firm online at www.dmcpas.com.