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Borrowers’ balance sheets beware

February 2, 2017 Article 1 min read
FASB guidance on leases will affect every sector of the economy. But for lending institutions, it will require even greater foresight, as your borrowers’ financial statements will look different. Are you ready to modify covenants that affect your clients?

The Financial Accounting Standards Board’s (FASB) new guidance has far-reaching implications for how leases are reflected in the financial statements of entities in nearly every sector of the economy. The new guidance affects the accounting for both lessees and lessors in a leasing transaction. Leases are one of the most popular forms of asset financing, in no small part due to the ability to keep lease obligations off the balance sheet.

The most significant change is the requirement for lessees to report lease obligations on their balance sheet, with few exceptions. The new standard brings fewer changes for lessors, and lease accounting will continue to be largely consistent with existing U.S. GAAP. The table on the next page summarizes the major changes arising from the new guidance.

The most significant change is the requirement for lessees to report lease obligations on their balance sheet, with few exceptions.

From a lending perspective, financial institutions should be aware of how the new standard will impact borrowers’ balance sheets and key ratios, which may trigger the need to amend loan covenants or policy requirements. Many leased assets and lease liabilities that were previously not recorded will be brought onto the balance sheet, decreasing return on assets, debt-to-income ratio, and other key metrics used to determine and monitor a borrower’s financial strength.

Effective date and transition 

  • Public business entities: Periods beginning after Dec. 15, 2018 (2019 for calendar-year entities)
  • Private companies and other entities: Periods beginning after Dec. 15, 2019 (2020 for calendar-year entities)

The standard requires a modified retrospective application approach, which will shorten the time frame for implementation. For companies initially applying the new guidance in the first quarter of 2019, a retrospective application would be required for the comparative quarter in 2018. With two to three years until implementation, it may seem early to begin planning for the transition. However, as the standard requires a retrospective application, all leases existing at the reporting date must be assessed for proper treatment under the new standard.

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