IN 2018, FASB (the Financial Accounting Standards Board) began requiring public companies to report all operating leases on their balance sheet to provide more transparency to investors. THE TRANSITION HAS PROVEN MORE DIFFICULT THAN ANTICIPATED FOR MANY COMPANIES.
Two-thirds of companies that have begun the transition have experienced difficulties, according to a study from LeaseQuery. But only 37% of 200 surveyed finance professionals (mostly from public U.S. companies) actually anticipated difficulties before starting the transition.
With the fast-approaching deadline of January 1, 2020, it’s important that private companies address the difficulties and make the transition a successful and smooth process.
Many of the unanticipated difficulties stem from tracking down leases, evaluating lease terms, and recreating financial statements; but the technical issues of how to restate the lease figures are critical. Misstated lease accounting can affect a company’s liquidity and solvency ratios. In addition, it can influence investor sentiment and potentially impact the company’s cost of capital.
Under new leasing standard (“ASC 842”), the leases with a term over one year must be recorded as a right-of-use asset and a corresponding liability. The liability is measured by using a discount rate to calculate the present value of future lease payments.
The primary technical issue with the new lease standard is estimating an appropriate discount rate. Some leases have interest rates that are explicitly set forth in the lease terms or at least can be calculated given the level of detail provided in the lease term. Should a lease have an explicit rate, this would be the discount rate to use.
However, the vast majority of leases do not have an explicit rate, or at least cannot be easily estimated. In these cases, the incremental borrowing rate is used. The incremental borrowing rate is defined as, “The rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term . . . in a similar economic environment.” Here at Economics Partners we have the capabilities to determine the incremental borrowing rate for our clients and can deliver this information in a variety of different formats. Some clients request a report format, while other clients request an Excel workbook that can be applied to hundreds of different leases. More information can be found on the FASB site.
The new accounting standards can have a large impact on your company and it’s best to seek counsel from qualified individuals to guide you through the process. Economics Partners assists with estimating the incremental borrowing rate and removing the difficulties in the process that so many professionals have experienced. Reach out to one of our experts to get advice on this process here.