How will this affect existing leases?
Existing leases will also be covered by the proposal. You have to determine the value of the existing leases and record those on the books for all periods being presented in financial statements that are issued by a company. These changes will affect everyone who prepares financial statements under U.S. generally accepted accounting principles (GAAP).
How will these changes affect companies?
It will definitely affect buy versus lease decisions. Also, companies will be more thoughtful about lease terms and provisions now, like how many options to renew or extensions they have in the document.
It also will place more of an administrative burden on companies. Now you have to maintain all these leases, know when they start and end, know when they have options to renew and extend and, most importantly, you have to keep monitoring changes in the estimates you’re making about your leased assets on an ongoing basis.
One of the other big issues that can affect companies is debt covenants. Under current accounting literature, similar lease transactions can be accounted for in different ways.
In some cases, balance sheets will reflect an asset and liability for the lease under the current treatment, and in some cases they don’t reflect the asset or liability for a very similar type lease. With the new treatment, all leases will have the asset and liability component built into it. Therefore, when banks look at those financial statements, they will see a lot more debt than before. Generally, you will see an increase in EBITDA but a decrease in the bottom line.
What should business owners do to ensure they are prepared for the changes?
One major factor is proper documentation and maintenance of all your leases, thought processes and assumptions in estimates, which will be particularly relevant in financial statement audits.
Additionally, initiate discussions with your banker about the proposed changes so as to ensure that you remain in compliance and avoid any unwanted surprises and costs. Generally, banks are aware of this change, so ask them if they are, and how it will affect compliance with financial covenants.
How can they avoid breaking compliance?
Businesses should start developing a strategy for initial and ongoing assessments of the leases they do have. There is an exposure document that has been issued. The comment period for that document is expected to end in December 2010, with a final standard expected in the second quarter of 2011, with an effective date of 2012.
Companies should initiate a discussion with their banker to come to some kind of resolution. They can do an amendment, modification or even a waiver of certain covenants. They don’t want to disrupt their business for this change; they should ask the bank for some type of modification or leniency in this period of transition.
Kamal D. Parag, CPA, is a partner with Habif, Arogeti & Wynne LLP. Reach him at (404) 814-4989 or [email protected].
