Lease accounting standard to hit almost every company’s balance sheet

Beginning next year, all private companies will have to include each of their leases – from company cars to office space to equipment – on their balance sheets.

The new accounting standard is a significant shift. Moody’s Investors Service described it as “one of the most transformative accounting changes in recent history,” and experts advise companies to start preparing now.

Mike Kuhn, shareholder at Vrakas CPAs + Advisors, emphasized the importance of developing a strategy to collect all necessary data and information. For companies with just one lease, the process is straightforward, but for those with multiple locations, leases are often not well tracked.

According to the Financial Accounting Standards Board (FASB), which issued the Accounting Standards Update on leases in 2016, the change affects all companies and organizations that lease assets. Any lease with a term of 12 months or longer is included. The standard went into effect for public companies this year and will apply to most private companies beginning in 2020.

The FASB made this change because, while capital leases are already included, operating leases are not recognized on balance sheets. Including all leases is intended to increase transparency in financial reporting.

The first step for businesses is to identify all leases and review their terms. This includes checking for variable payment components, options for lease duration, payment amounts, and any cost increases. The goal is to identify expected lease payments and value them using net present value.

Balance sheets will look different, mainly due to higher numbers from the inclusion of liabilities for future lease payments. This could affect some bank covenants, especially those using debt-to-equity ratios. Companies should ensure that covenants are not violated solely due to this accounting change, and it is anticipated that bankers will adjust accordingly.

The standard change may also impact companies’ budgeting and planning. Improved internal controls over leases are expected, and lease-versus-buy decisions may be influenced. The underlying business activity is not changing—only the reporting is.

Hartford-based startup LeaseCrunch® LLC has developed accounting software tailored to the new lease accounting standard. Co-founder Ane Ohm is marketing it to CPA firms preparing to implement the standard for clients with multiple leases. The LeaseCrunch® platform guides accountants through categorizing leases, evaluating terms, and providing correct footnote disclosures.

Ohm, a former auditor, encourages CPA firms to discuss the new standard with clients during busy season. She recommends business owners talk to their bankers early about potential impacts on debt covenants due to added liabilities on balance sheets. Banks have regulatory limits on liabilities, so clients near those limits could be affected.

It is also important to make new policy elections related to leases across the company, as the new standard requires these decisions to be documented.

Potential leases include office space, company vehicles, photocopiers, or equipment. Even embedded leases, such as a crane leased during building construction, must be considered. Businesses should review expenses for items that could be considered physical assets.

Gathering key dates, terms, and details of leases is essential for financial disclosures. Leases are often managed locally and treated as expenses, but now require consolidated reporting.

There is no standardization with leases; terms can vary widely between agreements.

“As long as it’s a physical asset,” Ohm said, it should be considered. Businesses must ensure all relevant lease information is included in their financial reporting under the new standard.