In February 2016, the Financial Accounting Standards Board issued an accounting standards update codified under section 842, Leases. And now, after several delays and amendments, the new reporting requirements for leases under GAAP are finally here. The standard and applicable amendments are applicable for fiscal years beginning after December 15, 2021, for private companies, which includes most small businesses. For most contractors, the standard will be implemented for the calendar year 2022. The new standard could affect any company that leases property or equipment for use in its business.
Is my business impacted by this new standard?
While those companies who own property or equipment and earn income by leasing it to others are largely unaffected by the new rules, lessees must be prepared. Under the old standards, it may have been difficult to determine the longer-term financial impacts of a company’s leasing. Using this old guidance, a lessee may have accounted for the lease as either a capital or operating lease, which was largely determined by whether the asset was transferred to the lessee at the end of the term, or whether the lease term approximated the economic life of the asset.
For example, if the lease was classified as an operating lease, only rent expense was recorded by the lessee, and there was little to no balance sheet impact. As part of the updated standards, a “right-to-use” asset and a corresponding lease liability for the present value of the payments is recorded at the inception of the lease.
How will this affect me and my business?
While many lenders and sureties have become familiar with the new standards, contractors will need to pay special attention to how the recognition of these additional balance sheet items can impact financial ratios or debt covenants. The “right-to-use” asset will be considered a noncurrent asset, and the lease liability will be broken up into a current and noncurrent portion. The result on many common ratios used by financial institutions and in bonding are as follows:
|Current Ratio||Current Assets/Current Liabilities||Decrease|
|Working Capital||Current Assets-Current Liabilities||Decrease|
|Debt to Equity||Total Debt/Equity||Increase|
|Working Capital Turnover||Revenue/Working Capital||Increase|
It should also be noted that the new standards do not change the company’s overall obligations or operations; it simply changes how they are required to be presented in the financial statements.
Reach out to our Construction Team for assistance with implementing this standard and any other industry needs.