Business Accounting

Why Financial Institutions Care About Your Lease Accounting Practices

2020-01-14 | by Gene B. Reynolds, CPA

One of the primary drivers of the new ASC 842 lease accounting standard is to provide more comparable, transparent, and reliable financial information to financial institutions.

While the process of adopting ASC 842 is a painstaking endeavor, it should ultimately help bankers and financiers more accurately assess your company’s financial position when making lending and investment decisions.

Why the Change to Lease Accounting Practices?

Prior to the ASC 842 standard being implemented, companies were only required to report minimal details on operating lease agreements, typically in the footnotes of financial reports. These agreements were essentially converted to bills that companies paid monthly and expensed the payments until the lease came to term.

Once the lease came to term, a company had the option to renew the lease, acquire the asset, or return the asset. Only if the company acquired the asset would the asset appear on the balance sheet with a corresponding liability.

There simply was not enough information reported about these operational lease agreements, especially on leases that were critical to support the ongoing, day-to-day operations of a company.

For example, if your company entered into a 18-month lease with a vendor to utilize a multi-million dollar piece of equipment that is essential to the functionality of your business, that is a critical piece of information that a financial institution would need to know when evaluating the financial health of your organization.

Prior to ASC 842, your company would only have been required to expense each monthly installment of the operational lease agreement without capturing the true value of the asset.

Because of how important the value of the asset is to the overall financial picture of your organization, financial institutions need access to more detailed accounting information pertaining to the value of the lease.

Now, under ASC 842, every lease agreement of 12 months or longer is treated like a capital lease agreement. It does not matter what type of asset you are leasing or why you are leasing the asset, it must be reported on the balance sheet on both the asset and liability side.

Why Financial Institutions Need Access to Asset Information

Any type of financial decision-maker — whether a banker, financier, underwriter, or investor — needs a clear picture of a company’s assets.

Previously, companies could keep operational leases off their books, preventing financial institutions from seeing what assets were being utilized to support operations.

The adoption of ASC 842 creates uniformity through a more universal approach to accounting for operational lease agreements. There is no longer a gray area for lease agreements of 12 months or longer.

– ASC 842 also helps financial institutions obtain more accurate information to calculate the present value of assets. This is a critical function when determining the risk associated with lending money or investing in a new business venture.

Prior to ASC 842, it was difficult for financial institutions to perform a true risk-based calculation because the present value of a dollar to one person could be different to another person.

While we understand that the present value calculation is part of what makes the standard hard to comply with, ASC 842 strives for a universal approach to reporting lease agreements to help smooth out the gray area associated with calculating present value. This will allow bankers and financiers to create more reliable risk models to use in their evaluations.

Why Does the New Lease Accounting Standard Matter to Your Business?

When viewed on the surface, you may think that the introduction of ASC 842 creates more difficulty in obtaining financial support or being approved for a business loan.

You may even think that the new lease agreement standard could lower the value of your business after accounting for operational lease agreements that were previously expensed as a monthly bill.

The opposite is true. The introduction of ASC 842 creates a clearer picture for financial institutions to accurately assess your company and make loans/investments that match the true value of assets utilized in your company.

The benefit to your company could be a lower interest rate on a loan because the financial institution can perform a more accurate risk evaluation. Or, you will be protected from a credit hit by receiving a loan that aligns with your company’s ability to pay back the loan.

While the process of changing the valuation of operational lease agreements may seem like it’s more cumbersome than beneficial, the short-term difficulty will ultimately lead to long-term financial benefits to your company.

Work with a CPA to Align with the Financial Institutions

The key for your business is to ensure leased assets placed into operation are properly reflected on your balance sheet as an asset and liability.

This transition to adopt the ASC 842 standard may require a tremendous amount of detail work and recordkeeping. That’s why we recommend working with a CPA firm such as Reynolds & Associates to ensure that your records accurately reflect the value of each asset.

When you achieve accuracy, you can present a more reliable financial picture of your company to financial institutions to help them make lending and banking decisions.

Our CPA firm can also help you look ahead to future operational lease agreements, including how to structure new lease agreements that align with ASC 842 and how to look favorable to financial institutions evaluating the financial health of your business.

Consider scheduling a consultation with our team to discuss how we can support the new lease accounting practices for your company. Complete our contact form, email info@reynoldscpafirm.com, or call us directly at 713-316-4560.

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