There are many ways the new lease accounting rules impact company balance reporting. These new accounting rules significantly affect the finances of businesses that lease properties, vehicles, or equipment. In fact, under Accounting Standards Update 2016-02, accounting processes for these operating leases are significantly affected. As a financial professional, you should learn how these new lease rules impact operating leases and business acquisition valuations. Read on to discover how new lease accounting rules impact company balance reporting.
Lease Classification Components
Lease classification components are one way the new lease accounting rules impact your company’s balances. The new lease rules provide two classifications for leases: finance and operating. Finance leases were previously called capital leases, and must meet the same criteria. This criteria includes ownership transfers or reasonable purchase options offered to the lessee at the end of the lease. However, there are several more components of this lease classification including the asset’s remaining economic life, lease terms and payments. Additional components include payments, discount rates, and the asset’s fair value. Of course, it is essential to understand the difference between finance vs. lease as well. Surely, determine new rule accounting processes by considering the variable classification components of applicable leases.
Increased Lease Liabilities
Another impact of the new lease accounting rules on your business is increased lease liabilities. The new rules require businesses to acknowledge right-of-use assets and lease liabilities. Therefore, businesses report significantly more lease liabilities on their balance sheets to remain compliant. In fact, studies conclude average company balance sheet lease liabilities increased over 1400%. This massive increase brought a significant change to company balance reporting standards. Absolutely, new lease accounting rules change balance reporting standards through increased lease liabilities.
Dual Approach Accounting
Implementing dual approach accounting models is a third way new lease accounting rules affect your balance reporting for online business. The new lease rules segment leases into finance leases and operating leases. While finance leases remain the same, operating leases require the acknowledgement of a right-of-use asset and a lease liability on your balance sheet. This right-to-use asset gets recognized at current lease payment value. However, later periods reevaluate the asset using the original lease’s assumptions. Finance leases remain the same, also including right-to-use assets and lease obligations. This way, reporting processes must account for both types of leases as a new industry standard. Certainly, the new lease rules highlight dual approach accounting models as the new reporting standard.
The next new lease rule impact on company balances is financial ratios. As stated above, the new rules cause companies’ lease assets and liabilities to increase significantly. These large increases often affect financial ratios, and have consequences for businesses with debt covenants. If your company has outstanding debt and operating leases, determine the rules’ impact. Start by finding the minimum and maximum financial ratios required by your covenants, including interest coverage, debt to equity, and debt to total assets ratios. Then, calculate how your increased assets and liabilities affect these ratio calculations. Definitely, maintain existing debt covenants by determining the rules’ impact on your financial ratios.
Lease vs. Buy Decisions
Lastly, lease or buy decisions are the final impact of the new lease rules on company balance reporting. Since so many leases move to balance sheets, the financial weight of lease versus buy decisions is significantly increased. For example, average restaurant industry lease liabilities increased by over 1700% due to the inclusion of equipment and other leases on their balance sheets. Therefore, evaluating the pros and cons of buying or leasing equipment becomes a crucial determination among stakeholders. Of course, new lease accounting rules increase the weight of lease vs buy decisions drastically.
New lease accounting rules impact company balances in a myriad of ways. For example, determine new rule accounting processes by considering the variable classification components of applicable leases. Second, they change balance reporting standards through increased lease liabilities. Third, they require businesses to impact stakeholders via evaluating the feasibility of leases. Next, maintain existing debt covenants by determining the rules’ impact on your financial ratios and increasing business agility. Finally, new lease accounting rules increase the weight of lease vs buy decisions drastically. When wondering how the new lease accounting rules impact company balances, consider the impacts described above.