We all know lease accounting is changing for private companies starting in fiscal 2020. With leases being such a big component of the restaurant business, the new lease standard will have a significant accounting impact on restaurants. Gone are the days of having off balance sheet impact. Now, those operating leases will be grossing up the balance sheet with a right of use asset offset by a lease obligation. Depending on the classification, the impact to the P&L may be minimal. Check out our overview of the new lease standard.
- Contrary to popular belief, there will still be two types of lease classifications (and really three):
- Finance leases – These are essentially capital leases under the old standard (and same accounting)
- Operating leases – Capitalized on the balance sheet as an asset and a corresponding liability
- Short term leases – Leases of 12 months or less that are expensed as incurred
- Since nearly all leases will be capitalized, your balance sheet will have additional “debt” in the eyes of creditors. Beware financial covenants that include maximum ratios over debt!
- Your lease obligation will be separated between current portion and long-term portion. The asset side is all long-term. This means you will have an increase in current liabilities with no offsetting current asset. Beware financial covenants that have minimum liquidity ratios!
- Since all leases are recorded on the balance sheet, there may be an advantage to structuring your leases as either finance or operating. Remember, finance leases have a higher expense recognition during the initial periods and lower in the last periods. And, the expense is split between amortization expense and interest expense. Operating leases are expensed as a single expense line item on a straight-line basis. Calculations of EBITDA are likely to be higher under a finance lease scenario!
- The new lease standard requires that leases be capitalized at the later of the earliest period presented in the financial statements or the commencement of the date. This means, if you’re a December 31 year-end, the standard is effective January 1, 2020. HOWEVER, if presenting a comparative financial statement, you will have to book operating lease assets and liabilities on your 2019 financial statements!
What’s the bottom line?
The lease standard will change how your balance sheet and income statement will look to constituents. What can you do?
- Identify all your leases and document their terms.
- Start modeling the effect of the new lease standard on your balance sheet so you understand the impact.
- Start talking to your bank, investors and other users of the financial statements to discuss this change.
You are not alone! Studies have shown the new lease standard will result in over $1 trillion of debt for public companies alone! So, figure out what the damage is and start talking.
Matt Waller, CPA