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New Accounting Standard to Have Big Effect on Lessee Balance Sheets Beginning in 2020

Posted by Admin Posted on May 02 2016

The main change in the new standard is that lessees must recognize, in their balance sheets, leased assets and lease liabilities for operating leases.  Currently, lessees do not record either assets or liabilities for operating leases.

The new standard covers all entities – both for-profit and nonprofit - that issue financial statements in accordance with U.S.. generally accepted accounting principles (GAAP).

For non-public entities, the standard takes effect in years beginning after December 15, 2019 (i.e., calendar 2020), with early application permitted. It will apply to all leases in effect as of the beginning of the earliest comparative period presented; in other words, if 2019 comparative statements are included with 2020 statements, leases in effect at January 1, 2019 will be covered.

 For lessees-

  • At the start of a lease, lessees must record both an asset and a liability for the net present value of future lease payments. The asset will be amortized to expense, and lease payments will reduce the liability, over the lease term. How that is done depends on whether the lease is an operating or a finance lease.
  • The biggest effect to lessees will be on their balance sheets. The new standard will gross-up lessee’s assets and liabilities for leases, which will change financial statement ratios and may affect compliance with loan covenants.

 

For lessors-

  • Unless a lease is sales-type or financing lease, lease income is simply recognized when earned, and there is no grossing-up of assets and liabilities.

 

Depending on the number and value of leases, the new standard could have a large effect on lessee balance sheets by increasing both assets and liabilities. This, in turn will affect certain balance sheet ratios, particularly the current ratio and the debt-equity ratio. Since many loan agreement contain covenants that specify minimum current ratios and maximum debt-equity ratios, lessees may want to discuss the effects of the new standard with their lenders before it goes into effect and make appropriate adjustments to affected covenants.