Business owners have new financial accounting rules. As has been widely reported, the Financial Accounting Standards Board released new guidance on lease accounting. Under the new rule, all leases with terms in excess of 12 months must be included on the balance sheet-generally a right-of-use asset, and a liability equal to the present value of the payments over the term of the lease. Private companies and nonprofits must implement this standard for fiscal years beginning after December 15, 2019.
Prior to the effective date of this rule, it will be important for companies to adopt a process to inventory and report their leases-which will stretch across asset classes, and may even be bundled in services agreements. Companies with debt covenants and performance standards will need to be mindful of the added liabilities lease payments will reflect.
In the past, operating leases (leases which do not transfer the “risk of ownership”) were treated as an operating expense and not included in assets and liabilities. The operating leases could not exceed 90% of the fair market value of the asset, or 75% of the asset’s usable life, and could not transfer the asset at the end of the term, or include an option to buy at an artificially low price. Leases that failed were treated as a “finance” or “capital” lease. While the FASB now requires inclusion of all leases with a maximum term over 12 months in the balance sheet, it provides for different treatment depending on whether it is a finance or capital lease.
These new rules affect small, medium and large businesses whether real estate based or other types of commercial enterprises.
Our corporate and real estate attorneys adopt a tax-sensitive approach toward transactions, and work closely with outside tax professionals to ensure a complete picture of operations. If you’d like more detail on these new rules, see the most current information released by the FASB.