Now that the Financial Accounting Standards Board has released its long-awaited lease accounting standard, companies and their accountants will need to get ready to put their operating leases on the balance sheet.

Companies will need to inventory all the leases that are currently out there as operating leases and then calculate the asset and liability amounts at the date of adoption in order to include them on the balance sheets, according to Jared Rosen, a director at the Baltimore accounting firm Ellin & Tucker.

“We’re going to be advising our clients to gather information on all their existing leases and capture data for new leases as they’re entering into them now because they will be affected by the new standard if they’re long-term leases and still in place a few years from now,” said Rosen. “I think it’s also going to affect the way leases are negotiated. In the past there was an advantage to negotiating a lease that would be treated as an operating lease if a company did not want to have that liability recorded on their balance sheet.”

He believes the new standard will have an impact on financial covenants, benchmark ratios and leverage. “That will be a key impact that will need to be discussed with lenders in advance because many financial ratios are going to be impacted, including debt to equity ratios, return on asset ratios, and just overall leverage of the balance sheet, said Rosen.

The accounting standards update will take effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2018 (see FASB Releases Lease Accounting Standard). For all other organizations, the ASU on leases will take effect for fiscal years beginning after Dec. 15, 2019, and for interim periods within fiscal years beginning after Dec. 15, 2020. Early application will be permitted for all organizations.

There are some differences between FASB’s version of the standard for U.S. GAAP and the version released last month by the International Accounting Standards Board for International Financial Reporting Standards. “Probably the biggest and most notable difference is the difference around the expense attribution of the various leases,” said Sean Torr, advisory director at Deloitte & Touche LLP. “Whereas under IFRS there is a one-model attribution of expense, which will be a front-loaded finance lease model, the U.S. GAAP version is going to have a dual model where some of the leases will be following the same approach as IFRS, which is the finance model, and others will be following a different model, which is an operating lease model. That’s probably the most notable difference. There are some other items as well. For example, the IFRS version had a specific materiality component of the standard and we’ve not expecting that to be in the U.S. GAAP version.”

Technology will be an important component of the effort to adjust to the new leasing standard. “There’s a significant amount of effort around data, and systems and technology and processes that will need to be comprehended to comply,” said Torr. “There’s also the financial statement impact, which is going to be much more pronounced visibility in the financial statements about leasing transactions, with assets and liabilities on the face of the financial statements or disclosure in the footnotes. But beyond that it’s the process data and the technology aspects that are going to drive a significant amount of work for companies to comply with this requirement, both to get this implemented for the first time, but also to maintain this on a go-forward basis.”

The leasing standard may require a re-examination of a business's technology systems. “Most companies will need to revisit their technology around leasing because the requirements for the new standard are so different from a data perspective and a calculation perspective as well as a footnote disclosure reporting perspective,” said Torr. “So systems will need to be reviewed. How companies address that will differ, depending on the systems that are currently used. This might be an opportunity for companies to revisit their systems, or it might be an opportunity to implement a new system around this compliance requirement. Depending on what the company’s current systems landscape looks like, most companies would need to have some modification to their technology to accommodate these new requirements.”

However, according to FASB officials, the new standard should not require a significant technology upgrade. “If companies are being told they need to implement costly or complex solutions, be skeptical,” FASB vice chair Jim Kroeker told Accounting Today. “I think it’s built in a way that should allow companies to leverage their existing systems.”

There are some differences from the IASB’s version for IFRS. Multinational companies will need to be aware of some of those differences if they are preparing financial statements in both U.S. GAAP and IFRS.

“We did agree on some first-order principles, that is, the definition of a lease, so you’re dealing with the same population, which is very important, because if you’re dealing with different populations of what a lease is, it could be relatively more difficult,” said Kroeker. “The other first-order principle is we agreed they should go on the balance sheet, with an exception for short-term leases.”

He noted there are some differences in the details. “The IASB has provided an exception for small-ticket leases,” said Kroeker. “That shouldn’t pose a problem for multinationals because that’s an election you can make under IFRS. The biggest difference that people talk about is our continuing to distinguish operating leases from capital leases. While they’re both on the balance sheet, we have different recognition treatment of the underlying expense for operating leases than they have. Our change was in direct response to stakeholder feedback that the 2013 ED [exposure draft] proposed to distinguish between a capital lease and an operating type lease, or a finance lease and an operating lease. We called them A and B leases in a fundamentally new way, and constituents’ feedback broadly to us was 'while we think there should be a difference, you should keep the dividing line that you have today.' We reached out to multinationals in the U.S., saying, ‘OK, but if the IASB doesn’t head in the same direction, what would be the impact to you?’ By and large—and I can’t think of anyone who told us otherwise—they told us it was more important for them to be able to leverage their existing systems in the U.S. than it was for us to facilitate a global platform. So that was the reaction.”

Companies can start preparing for the new standards as they take effect over the next few years.

“We’re going to be advising our clients to gather information on all their existing leases and capture data for new leases as they’re entering into them now because they will be affected by the new standard if they’re long-term leases and still in place a few years from now,” said Rosen. “I think it’s also going to affect the way leases are negotiated. In the past there was an advantage to negotiate a lease that would be treated as an operating lease if a company did not want to have that liability recorded on their balance sheet.”

The standard may encourage some companies to negotiate shorter-term leases. “Any leases less than 12 months in duration are excluded from the scope of this standard,” said Rosen. “That will be a consideration.”

However, he believes it will be difficult for companies to get out of leases that they’ve previously entered into just based on the effect of the standard. Most renegotiations that take place will probably relate to new leases. “That could be new leases that are being entered into now because of the retrospective application of the standard,” said Rosen. “If a lease is entered into now and it’s a five-year lease, it will be affected by the standard because it will still be ongoing as of the date of adoption.”

Lease vs. buy decisions may also be affected by the new standard. “There are many aspects to consider when a company is determining whether to lease or buy equipment, but from a financial statement reporting perspective the new standard eliminates the difference in reporting as far as capital leases vs. operating leases vs. finance purchases so it sort of brings those three from a financial reporting perspective in line,” said Rosen.

His main advice for clients is that they get all the necessary information in order. “We’re going to be advising our clients to make sure that they gather all the information on their current leases and think about the controls in place in order to capture both existing leases and any new leases that are entered into and then develop accounting policies that will enable them to record these leases properly when the new standard is adopted,” said Rosen. “That could lead into information technology, with new accounting software considerations for large companies that have many leases in order to manage all this data.”