Pub. 9 2018 Issue 4

www.wvbankers.org 12 West Virginia Banker Are You Ready? How the New US Lease Standards Could Affect You By Alex S. Campbell Introduction In February of 2016, the Financial Accounting Standards Board (FASB) issued the Accounting Standards Update (ASU) 2016-02 Leases (Topic 842). This update was implemented to increase comparability and transparency among organiza- tions by recognizing lease assets and lease liabilities on their respective balance sheets. This new standard is set to be- come effective for public entities with fiscal years beginning after December 15, 2018, and effective for all other entities with fiscal years beginning after December 15, 2019. The Change Prior to the new lease accounting standard, organizations were only required to report leases classified as “Capital Leases” on their balance sheets. Therefore, any leases that were classified as “Operating Leases” were considered to be off-balance sheet. Under the new standard, the previously classified capital leases are now considered to be “Finance Leases.” However, the underlying lease classifications to de- termine the distinction between finance and operating leases have remained largely the same. The main goal of ASU 2016-02 is to change the current handling of operating leases by bringing them on to an organization’s balance sheet. This new guidance states that a lessee must recognize an asset and liability for a lease with terms greater than twelve months, regardless of the lease’s classification. For operating leases with terms less than twelve months, the FASB has permitted an accounting policy elec- tion to not recognize the underlying asset and liability. With the exception of operating leases with terms shorter than twelve months, organizations should be prepared to bring a substantial portion of operating lease assets and liabilities onto their balance sheets in the near future. What This Means With the FASB’s shift for transparency and the push to recognize both finance and operating leases on the balance sheet, there are several things that an organization should consider before adoption of this new standard. Two of the main areas of impact that organizations should be aware of as a result of ASU 2016-02 are debt covenant and regulatory calculation compliance. From a financing perspective, organizations will need to consider the impact of bringing additional debt onto their balance sheets as a result of ASU 2016-02 now requiring operating leases to be recognized. In the past, many or- ganizations have been able to benefit from the off-balance sheet financing for operating leases. Many organizations are subject to debt covenants with various lenders as part of their loan agreements. Now, with the requirements of the new lease standard, organizations could potentially be required to add additional debt obligations from operating leases to their balance sheets, potentially impacting their debt cove- nant compliance. In addition, this is something lenders will need to consider going forward as they are evaluating debt positions of current borrowers. The new lease standard also poses new challenges for financial institutions from a regulatory standpoint. Financial institutions should prepare for this by understanding how the shift of adding any operating leases to their balance sheet could impact their regulatory calculations. With the addition of operating lease assets and liabilities to the balance sheet, financial institutions should begin to understand how this could affect their capital adequacy ratios and if any additional regulatory capital would be needed to remain in compliance. Conclusion The FASB’s guidance on the new lease standard aims to bring transparency to organization’s assets and liabilities arising from leases. Nonetheless, with change there also comes challenges. Organizations should prepare for the future implementation of ASU 2016-02 (Topic 842) by first identifying any leases they currently have, determining the proper classification of their leases, and evaluating the impact that the new reporting guidance will have on their financial statements. By identifying these elements early, it will allow preparation for potential debt covenant and regulatory compliance issues that might arise from these new reporting guidelines.  Alex Campbell is a Supervisor at Arnett Carbis Toothman LLP, Certified Public Accountants, Charleston, West Virginia. Mr. Campbell has over three years’ public accounting experience. He provides audit, internal audit, and loan review services to community banks through the firm’s Financial Institution Services Group. Mr. Campbell can be reached at 304-346-0441 ext 3474 or Alex. Campbell@actcpas.com.