Lease Accounting Standard: Get ready! Deadlines are Fast Approaching
Don’t look now, but a deadline for adopting the new lease accounting standard that was issued two years ago is right around the corner.
If your dealership is publicly held, you must adopt the standard by December 15, 2018, if your fiscal year begins after this date. If your dealership is nonpublic, you have an extra year to adopt the new standard — until December 15, 2019, if your fiscal year begins after this date. Early adoption is permitted for both public and private dealerships.
What the standard requires
Referred to as Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842) Section A—Leases: Amendments to the FASB Accounting Standards Codification, the new standard will change the accounting treatment of leases under U.S. Generally Accepted Accounting Principles. If your dealership leases equipment, vehicles, real estate or other assets for more than a year, the new standard will require you to report these lease obligations as fixed assets on your balance sheet along with related lease liability.
Under the FASB’s new standard, both capital and operating leases will have to be recognized on the balance sheet. Specifically, you’ll be required to report a right-to-use asset and corresponding liability for your obligation to make payments on leases longer than one year. This includes long-term leases for real estate used by your dealership.
Historically, operating leases could be listed as a financial statement footnote and thus kept off the balance sheet. This structure usually benefits dealerships because keeping leases off-balance sheet generally improves financial ratios, thus making it easier to qualify for financing.
Impact on debt covenants
The new lease accounting standard’s biggest impact for most dealerships will likely be on their relationships with lenders. Including long-term lease obligations on the balance sheet, where they’ll also be classified as debt, could have a major impact on key financial ratios. This, in turn, could have a negative effect on debt covenants.
Thus, it’s critical to talk with your banker well in advance of the date when you plan to adopt the new standard. You should let your banker know that adopting the new standard could result in changes to your financial ratios that could adversely affect your debt covenants. This way, you’ll have time to discuss potential remedies in advance.
Other possible effects
Changes in financial ratios also could affect your ability to obtain financing in the future, or possibly make financing more expensive. In addition, you might incur training costs as you get your accounting department up to speed on all the nuances of applying the new guidance.
Contact your tax advisor if you have more questions about how the new lease accounting standard could affect your dealership.