As two of the accounting world's major governing bodies—the FASB and the IASB—converge, they're scrutinizing how businesses track lease expenses.
Under existing accounting standards, a majority of leases are not reported on a lessee's balance sheet. But accounting rules are changing and Raleigh business owners will now be effectively shifting leases from off balance sheet to on-balance sheet reporting.
To explain these changes and how you can prepare your business, I've turned to Ron Smith, CPA of Partner, Katz, Sapper & Miller. Click here for full report, or read a sample below:
1. What’s at Stake
Accounting rules require companies to keep two basic financial statements:
A balance sheet listing assets and liabilities showing what the company owns and owes, with recorded assets equaling, or “balancing,” recorded liabilities plus equity; and
An income statement (a.k.a. P&L) listing the company’s revenues and expenses, which makes it possible to calculate the company’s profits and losses.
These financial statements aren’t just a technical exercise in bean counting. They directly affect a company’s ability to attract investors and get bank loans, and even affect how much it pays in taxes.
2. How Current Lease Accounting Rules Work
A lease is one of the transactions that a company must account for on its financial statements. How the company does that depends on the kind of lease. There are two possibilities:
Operating leases are transactions in which the owner (a.k.a. “lessor”) gives the tenant (a.k.a. “lessee”) a right to use land or another asset. The tenant doesn’t own the asset and must return it to the owner after the lease ends. Most standard commercial real estate leases are operating leases.
Capital leases are essentially purchases in which the tenant acquires an ownership interest in the leased asset. Examples include leases that transfer ownership of the property to the tenant at term’s end, give the tenant an option to purchase the property at less than its fair value and/or last for as long as the asset’s remaining economic life.
Accounting-wise, the most important difference between the two kinds of leases is that tenants aren’t required to record operating leases on their balance sheet.
3. Why the Rules Are Changing
The new accounting rules propose to change how leases must be recorded on the balance sheet and P&L. The biggest change: elimination of the rule that tenants don’t have to list operating leases on their balance sheet. From now on, all leases will have to be shown on the balance sheet.
Explanation: The point of accounting rules and financial statements is ensuring that investors, banks, regulators, and other stakeholders in the financial system get the information they need to make sound judgments about a company’s financial condition. The boards that make the accounting standards [like the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB)] felt that letting tenants keep operating leases off their balance sheets was creating too big a blind spot in the system. According to one government report, off-balance sheet leasing commitments total approximately $1.25 trillion—and that’s only among publicly registered companies.
To continuing reading changes 4 - 8 and strategies for businesses, click here!
As always, if you need help with lease analysis or devising a new game plan for your business real estate, feel free to contact me, your Capital Compass!