Lease Accounting Overhaul Makes Headway

What started as a convergence project to assimilate lease accounting between U.S. GAAP and IFRS became a reality on November 11, 2015 as FASB Board Members voted 6-1 to send the standard for final drafting.  Those impacted the most will be companies that work with leases as a key part of their business, however, the new accounting rules will affect any U.S. company that deals with leases.  The lease overhaul will be the most significant since FAS No. 13 was released in 1976 and is expected to add trillions to balance sheets across the U.S.

Under the existing accounting model, leases are treated as either capital or operating.  Capital leases are required to be capitalized and amortized while operating leases are not.  Critics of the current model claim that operating leases result in “off-the-books” accounting as balance sheets do not reflect these lease obligations, which in some instances can be over many years and for billions of dollars.  For example, at December 31, 2014, Chipotle Mexican Grill, Inc. (CMG) had operating lease obligations of $3.044 Billion whereas their balance sheet showed a mere $534 Million in total liabilities.  The effect of adding Chipotle’s operating lease obligations to their balance sheet would increase its liabilities nearly sevenfold.  Furthermore, the new operating lease requirements would significantly alter many key ratios including return on assets and debt to equity.  It also could trigger violations of debt covenants with banks and other lenders.

Even though the accounting changes will be significant, they will not create any new obligations for companies; they merely change the way these lease obligations are reported.  FASB Board Members are currently drafting the new standard, which is expected to affect public and private companies for fiscal years beginning after December 15, 2018 and 2019, respectively.  Early adoption will be permitted and there is not expected to be any alternative recognition or measurement.

Chris Soderberg, CPA