Change to Leasing Implementation

The FASB is in the process of issuing an important amendment to the leasing standard that public companies must adopt in 2019. (Private companies get one more year and must adopt in 2020.) The change will allow companies to defer the date of initial application of the standard to the date of adoption.  The change is optional. That is, companies could decide to not change the date of initial application and follow the requirement of the initial standard to use the date of the earliest financial results presented as the date of initial application of the standard.

What does the change really do?

The change in when the standard is applied impacts the historical comparative periods presented in the financial statements.  The option is like the modified retrospective option in the revenue standard in that it would not require the restatement of prior periods.  An example would probably help you understand the impact.  Assume a public company enters into a five-year lease at $100 a year on January 1, 2016.  Under the initial lease standard, the company would have to restate its 2017 and 2018 financial results to reflect the new leasing standard.  Under the new option, a company would not have to restate the 2017 and 2018 financial results, but instead would just reflect the changes in the 2019 financial results.

The option would, at first glance, appear to be a no brainer to use because the work needed to adopt the standard would be reduced.  Any leases that expired before January 1, 2019 would not need to be included in the adoption work effort and there would be two years less data to have to get re-audited.  These are good benefits, but there are some implications that need to be considered.

The first implication is lack of comparable information. Will your investors be satisfied with not providing comparable information, or will they ask for comparable results anyway?  Many companies may think that this is a balance sheet only exercise and because the income statement impacts for operating leases are not really changing, there isn’t much of a comparability issue. That is true unless you have changes that do impact the income statement, such as deferred gains on sale-leaseback transactions, that will disappear under the new standard and potentially significantly increase your lease rent expense.

The second implication is a little less obvious, but one that should be considered.  Because the standard requires that the lease term on all existing leases be considered to start as of the date of initial application, the option to delay the date of initial application has the impact of effectively shortening all the lease terms on existing leases.  A shorter lease term will result in a lower discount rate, resulting in a higher present value of the remaining lease liability.

Whether or not such differences matter will be up to company management, but the point is that implementing the option has implications beyond just the adoption work.  The decision to elect the option should therefore be subject to at least a high-level analysis of the differences, rather than simply made in a vacuum, by the team working on implementing the new standard.  In the end, I believe most companies will likely elect the option to not restate prior periods.  The reduction in work to implement the standard is too compelling, but I will be interested to see which companies don’t make the election and, more importantly, why they don’t.  That is, if they are willing to share such information.

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