If you own a business, then you have likely heard the buzz around the new lease accounting standard and the significant impact it will have on the way you record leases. For construction and other lease-heavy industries, we can expect to see major changes in not only balance sheets, but how investors, sureties, and lenders use this pertinent information to assess businesses.
In fast-paced industries like construction, analyzing accounting standards and tracking leases understandably fall low on the day-to-day priority list. However, proactive planning will be key to successfully implementing the new lease standard while ensuring your bonding and financial lending remain unaffected.
Running a business in today’s globalized world often results in receiving attention from both domestic and international investors. This has led to a need for investors to have consistent standards with which to compare businesses. The new lease accounting standard is an effort to bridge one of the largest inconsistencies between U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS).
Under current GAAP, some leases are recorded on the balance sheet and other leases are simply disclosed in the footnotes. The new lease rules will require that all leases greater than one year be recorded on the balance sheet. The increase in liabilities listed on the balance sheet will have an inherently negative effect on how those numbers are perceived.
Where to start
Lease-heavy industries should start collecting their leases as soon as possible. For construction companies, leases can include everything from equipment, trucks, storage and yard space, and office facilities. All of these leases will need to be collected, have their terms identified and values recorded on the balance sheet. For facility leases not previously recorded on the balance sheet, the values must be recorded as a “right to use” asset at their present value of the lease payments.
Why it matters
In order to obtain a line of credit or term loan through a bank, a business is typically required to maintain certain financial metrics. This could include a minimum working capital or a maximum debt-to-equity ratio. The bank uses these ratios to ultimately determine the amount of equity, and therefore risk, you have in the business as well as measure the company’s ability to make payments on time — both of which greatly influence a lender’s decision-making process. Sureties use many of the same ratios and financial metrics to determine a construction business’ bonding capacity.
Since these ratios will be negatively impacted by the increase in liabilities listed on the balance sheet, it’s best to consult with your bank and surety now so they understand the changes to come. This will allow time to make any necessary adjustments to previously agreed-upon ratios. Your CPA can help facilitate these conversations and help clear up any confusion there may be regarding your balance sheet. A CPA can also proactively work with your bank and surety to create a pro forma of what your balance sheet will look like once your leases are recorded.
Considering the magnitude of these changes, it’s best to start preparing as early as possible, be extra cautious and bring in a professional if needed. Act early in order to get the most flexibility and cooperation from your bank and surety and make adjustments if necessary. If your business is particularly lease-heavy, you may consider the help of a software package to help track your leases and automatically calculate depreciation on the related assets.
Remember, the new lease standard will affect virtually every business in every industry. Questions, struggles and successes will be widely shared throughout the construction community, particularly among public companies facing an implementation deadline of Dec. 15. If you are a privately-owned construction business, pay extra attention to lender, surety and investor reactions and learn from some of the public filings before the private company implementation date of Dec. 15, 2019.