- Learn about the new accounting rules regarding leasing and how they could affect your balance sheet.
- Find out how some companies are choosing to set up leases to avoid the new guidance.
- Learn about the pros and cons of buying rather leasing in light of the new rules for leasing.
The rules for reporting leasing transactions are changing. Though these changes have been delayed until 2021 for private companies (and nonprofits), it’s important to know the possible effects on your financial statements as you renew leases or enter into new lease contracts. The new requirements are making many companies reevaluate their thinking on the issue of lease vs. buy. In some cases, you might decide to modify lease terms to avoid having to report leasing liabilities on your balance sheet. Or you might opt to buy (rather than lease) property to sidestep being subject to the complex disclosure requirements. Wondering how this might affect you? Fiducial has the scoop on the latest developments in the debate and new rules regarding leasing.
In 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, Leases. The effective date for calendar year-end public companies was January 1, 2019. Last fall, the FASB deferred the effective date for private companies and not-for-profit organizations from 2020 to 2021.
The updated guidance requires companies to report long-term leased assets and leased liabilities on their balance sheets, as well as to provide expanded footnote disclosures. Increases in debt could, in turn, cause some companies to trip their loan covenants. This is something you'll want to check into, and your Fiducial rep can help guide you through this process.
Updated lease terms
The updated standard applies only to leases of more than 12 months. To avoid having to apply the new guidance, some companies are switching over to short-term leases.
Others are incorporating evergreen clauses into their leases, where either party can cancel at any time after 30 days. An evergreen lease wouldn’t technically be considered a lease under the accounting rules — even if the lessee renewed on a monthly basis for 20 years. But there are some important factors to consider with this decision. This might not be the best approach from a financial perspective because the lessor would likely charge a higher price for the transaction. There’s also a risk that short-term and evergreen leases won’t be renewed at some point. And so, the lease vs. buy debate heats up.
Lease vs. buy
The updated standard is also causing organizations to reevaluate their decisions about whether to lease vs. buy equipment and real estate. Under the previous accounting rules, a major upside to leasing was how the transactions were reported under Generally Accepted Accounting Principles (GAAP). Essentially, operating leases were reported as a business expense that was omitted from the balance sheet. This was a major upside for organizations with substantial debt. Under the updated guidance, lease obligations will show up as liabilities, similar to purchased assets that are financed with traditional bank loans. Reporting leases also will require expanded footnote disclosures.
The changes in the lease accounting rules might persuade you to buy property instead of lease it. Before switching over, consider the other benefits leasing has to offer. Notably leases don’t require a large down payment or excess borrowing capacity. In addition, leases provide significant flexibility in case there’s an economic downturn or technological advances render an asset obsolete. In today's rapidly changing world, that could be a valuable consideration.
When deciding whether to lease vs. buy a fixed asset, there are a multitude of factors to consider, with no universal “right” choice. Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss the pros and cons of leasing in light of the updated accounting guidance. We can help you take the approach that best suits your circumstances. Ready to book an appointment now? Click here. Know someone who might need our services? We love referrals!