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What to Expect from New Lease Accounting Standard ASC 842


By Ralph Petta, President and CEO, Equipment Leasing and Finance Association


proved in 2016, so now lessees are considering how the new standard will affect them. Many of the lease accounting changes are relatively neutral and should not impact the ability of companies to acquire pro- ductive equipment to operate and grow their businesses. The primary reasons to lease


N


equipment will remain intact under the new standard, which is known as Accounting Standards Codification Topic 842 (ASC 842). However, it is important to understand what is dif- ferent about lease accounting under ASC 842 and to know the appropri- ate steps to aid businesses in this transition.


Changes to Financial Statement Ratios


One of the key changes: leases


previously classified as operating leases under current accounting


ew rules for lease accounting by the Financial Accounting Standards Board were ap-


standards will now be capitalized, and thus reported on corporate bal- ance sheets. With the changes in bal- ance sheet reporting, some financial statement ratios may be affected. A financial statement and its


corresponding ratios are a key indi- cator of a company’s financial health and are relied on by lenders and re- viewed by potential investors, so it is important to understand any chan - ges to financial statement ratios un- der the new standard. Under ASC 842, operating leas-


es will no longer appear simply as a table of future payments in the foot- notes; they will appear as a “right-of- use” asset and an offsetting lease lia- bility on the balance sheet. We un- derstand from credit agencies that the lease liability should be consid- ered a non-debt type of liability; that is, an “other” operating liability. As a result, the return on as-


sets (ROA) financial ratio is likely the only ratio that will change, al- though total liabilities will increase.


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Other financial ratios should remain unchanged. It is expected that there will be minimal impact on debt covenants and no impact on debt lim- it covenants. Overall, the new rules should have no impact on the profit and loss or income statement be- cause the lease-related costs should remain the same. To illustrate the changes


in the key financial ratios, ex- amine the difference between leasing a $50,000 piece of equipment under the current standard, ASC 840 (formerly known as FAS 13), and the new standard, ASC 842. Look- ing at the methods for calcu- lating typical financial ratios, you will see that some ratios are unchanged, while some decline and some increase (see figure).


No change. ROE is calculated as net income divided by equity. This ratio is unchanged because there is no change in the lessee’s lease expense for an operating lease from ASC 840 to ASC 842. Both are straight-lined, and there should be no change in equity as a result of the accounting change.


l Return on Equity (ROE) —


requires two years of comparative balance sheets, so 2017 is the start for capturing data for public compa- nies, and 2018 for private companies. That means the sooner a company prepares for lease accounting changes the better. To help business-


August, 2017


Comparison of current lease accounting standard ASC 840 and ASC 842.


es prepare, here are some high-level steps for lessees and lessors to take:


Start now. Budget time and re- sources to perform the work needed.


ROA is calculated as net income di- vided by assets. While there is no change in net income because the lessee’s lease expense is straight- lined under both guidelines, the amount of assets reported do in- crease under ASC 842, since the op- erating lease will be capitalized on the balance sheet. An increase in the denominator (assets) will thus re- duce the ROA ratio.


the lease liability is on the balance sheet under ASC 842, the lease obliga- tion is considered an “other” liability, but not classified as debt. Since there should be no increase in debt, there should be no change to the ratio.


l Debt to Equity — No change. While


lease liability is now on the balance sheet under ASC 842, resulting in an increase in liabilities.


l Total Liabilities — Increase. The


change. EBITDA is calculated as Earnings Before Interest, Taxes, De- preciation and Amortization. The EBITDA margin is calculated as EBITDA divided by revenue. There is no change to the EBITDA or the EBITDA margin because the lessee’s rent in an operating lease is recorded as lease expense under both the cur- rent and future guidance.


l EBITDA and EBITDA Margin — No


Key Steps for Transitioning While ASC 842 will not go into


effect until December 15, 2018 for public companies and December 15, 2019 for private companies, the Se- curities and Exchange Commission


l Return on Assets (ROA) — Decline.


Designate a project team that will oversee the transition process, estab- lish timelines and be responsible for timely, effective project completion.


Know the new rules, including im- plementation deadlines, challenges and risks, and how organizations must adapt to address them.


Build a detailed implementation plan that identifies deliverables, processes, timelines, and implemen- tation deadlines.


Inventory all equipment leases, real estate leases and other agreements in a centralized, electronic repository.


Prepare a high-level “if/then” analysis on a sample size of agree- ments in the inventory to determine whether to apply one or both of the two specific practical expedients, or accounting policy options, provided in the new rules.


Assess IT capabilities and re- quirements to determine whether issues such as data extraction, infor- mation and document storage and the reporting requirements of the new standard must also be assessed.


Identify gaps in performance and capabilities. Become familiar with existing lease accounting poli- cies, procedures and controls to de- termine which ones require changes


to conform to the new rules. Contact: Equipment Leasing


and Finance Association (ELFA), 1825 K Street NW, Suite 900, Wash- ington, DC 20006 % 202-238-3430 E-mail: rpetta@elfaonline.org Web: www.elfaonline.org r


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