1. APRIL 2016
The Reilly
Business AdvisorA PUBLICATION OF G.T. REILLY & COMPANY
New lease
accounting
standards
will affect
every
business and
nonprofit
Continued next page
BY GIUSEPPE “JOE” FEMIA, CPA
VICE PRESIDENT & DIRECTOR
New accounting standards recently approved by the Financial Accounting Standards
Board (FASB) will take effect in 2020, and will fundamentally change the way leases
are accounted for on financial statements, impacting every commercial business,
financial institution and nonprofit organization that leases space or equipment.
Finance professionals should start preparing now for the
impact on their balance sheets, and start negotiating changes
in bank loan covenants to the extent possible.
Organizations will not only need to change their lease
accounting processes for everything from warehouse space
to copy machines, but they also will need to address strategic
questions about how to prepare for the changes in a way that
minimizes the risk of noncompliance.
Goal is greater transparency
The new standards, which were released by FASB in late
February as Accounting Standards Update (ASU) 2016-02, “Leases,” are aimed at
greater transparency and conformance to international accounting standards. The new
rules will shift lease obligations onto companies’ balance sheets when they take effect.
For privately-held companies and nonprofit organizations, the new standards are
effective for fiscal years beginning after December 15, 2019. Implementation may
require retrospective application to 2019 for comparative financial statements. Early
adoption of the new standards is permitted.
What the new standards do
Specifically, the new standards will require companies (as lessees) to book long-term
lease commitments as both liabilities and assets on their balance sheets. “Long-
term” leases are defined as those longer than 12 months. Under current U.S. generally
accepted accounting principles (GAAP), most lease commitments are disclosed in the
footnotes to the financial statements, not recorded as liabilities, unless they qualify as
“capital” leases (lease-to-own transactions).
The effect of shifting lease commitments to the balance sheet is intended to more
accurately portray a company’s financial position and record these lease obligations
on the balance sheet. Future rental costs under lease obligations will show up as a
liability, with the corresponding right to use the equipment or space recorded as a
“right to use” asset.
However, the change in standards has ramifications that businesses and lenders should
evaluate well in advance of the 2020 effective date. While the reporting changes will not

2. While leasing may remain
the most cost-effective
financing option for many
businesses, the change in
accounting rules makes
clear that the decision
to lease can no longer
be influenced by the
expectation of favorable
accounting treatment.
New lease accounting standards
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directly affect how business is conducted, the changes will have a significant impact on
financial reporting, including financial ratios and reported assets and liabilities.
Leasing a cost-effective financing option
Leasing is often a cost-effective or cash flow-effective alternative to purchasing or
financing equipment or property, enabling businesses to expand, obtain equipment
and rent space at a lower cost than outright purchases or other financing alternatives.
Leasing also frequently offers tax advantages.
The ability to finance expansion and physical space without booking liabilities on the
balance sheet also enables companies to access lower cost bank financing for other
operating needs.
Implications for businesses, investors and lenders
When the new standards require all lease obligations that extend longer than 12
months to be shifted onto the balance sheet, the implications could be significant,
particularly with regard to companies’ relationships with investors and lending
institutions. The implications include:
 Assets and liabilities will increase based on the present value of the expected
future lease payments.
 Lease payments will be accounted for in a manner similar to installment loans,
separated into interest expense and principal repayments. This will change return
on asset ratios, debt-to-equity ratios, capital ratios and calculations of leverage.
 The resulting asset will be amortized into operations over the period of use.
 The lease “right to use” asset will be considered by financial statement users and
investors as an intangible asset.
 Credit ratings may change and debt covenants with lenders, if not rewritten to
accommodate the new accounting requirements, may be violated, triggering
loan defaults.
How to prepare
Companies with significant lease obligations, such as multi-location retailers and
financial institutions, should begin evaluating the effect of this accounting change on
their financial statements, and all business owners should discuss with their advisors and
lenders how to make this transition with a minimal impact on their creditworthiness.
If your company or nonprofit organization is considering entering into a multi-year
lease for space or equipment, consult your accounting advisor first about the impact
the new standards may have.
While leasing may remain the most cost-effective financing option for many
businesses, the change in accounting rules makes clear that the decision to lease can
no longer be influenced by the expectation of favorable accounting treatment.
Your G.T. Reilly advisor is available to discuss your organization’s lease obligations in
order to help you plan for the transition. In the meantime, if you would like further
information, please call us at 617-696-8900 or email Joe Femia at GF@GTReilly.com.