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Many contractors were relieved that the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) on June 3, 2020. It grants a one-year effective date delay applying the lease accounting and revenue recognition standards due to COVID-19. Early application continues to be permitted. Contractors may apply the new leases standard for fiscal years beginning after Dec. 15, 2021, and to interim periods within fiscal years beginning after Dec. 15, 2022.

The International Accounting Standards Board has not proposed any delays to its new lease accounting standard, International Financial Reporting Standards (IFRS) 16. That standard will still become effective for private companies for fiscal years beginning after Dec. 15, 2020. Public companies were required to comply with the leasing standard for fiscal years beginning after Dec. 15, 2018.

Private contractors with international operations and reporting obligations under IFRS must be ready to adopt IFRS 16 under the standard’s original timeline. These companies should consider implementing the FASB standard at the same time.

Lease Accounting Standard Requirements

Generally, all contractors that lease assets such as real estate, equipment or vehicles must be in compliance with the ASU. It requires that capital and operating leases are recognized on the balance sheet. The “right-of-use” value of property or equipment must be recorded as an asset and the present value of scheduled lease payments as a liability. Right-of-use assets include initial direct costs (legal fees, advanced payments, lease incentives, etc.).

This ASU applies to related party leases based on the “legally enforceable” terms of the agreement. Short-term leases of 12 months or less that do not include an option to renew may be exempt.

Identifying how many leases a company had entered into could be challenging. Contractors can do the following.

  • Collaborate with all departments and projects to identify existing leases and their terms.
  • Review service contracts for embedded or implied leases.
  • Create or update a complete lease inventory.
  • Identify data gaps, such as the market value of a leased asset or the discount rate used in the lease’s valuation.
  • Evaluate software to support lease tracking and reporting requirements.
  • Work with external auditors, investors and banks to discuss the implications of the new standard.
Impact of the New Lease Accounting Standard

The lease accounting standard could impact:

  • Balance sheet: Lease obligations generally increase assets and liabilities;
  • Financial ratios: A contractor’s working capital ratio and debt-to-equity ratio may be pushed above the acceptable threshold;
  • Expense recognition: Capital leases typically result in accelerated expense recognition for financial statement purposes under the ASU. Operating leases have a constant annual cost. The “right-of-use” cost can generally be amortized over the lease term on a straight-line basis. The lease liability is based on an effective interest rate calculation;
  • Sale and leaseback transactions: Real estate transactions may qualify for sale and leaseback accounting;
    Taxable income and deductions; Contractors may have to recognize deferred assets and deferred liabilities in reporting excess on “right-of-use” assets and the related lease liabilities according to generally accepted accounting principles; and
  • Valuation allowance: Changes recorded in deferred tax assets and liabilities, as well as how book-to-tax differences are reversed under the ASU. A contractor’s valuation allowance and net-operating-loss carry forwards can be impacted.

There are many other factors to consider regarding the lease accounting standard, such as the tax implications of leverage leases; state sales and use taxes, franchise, net worth and other non- income-based taxes; and interest expense, personal property or real estate taxes and transfer pricing.

Lease modifications require the lessee to determine whether the proposed changes are a modification of the existing lease contract or are an entirely new contract. The potential difference can have a big impact on financial statements. Contractors entering into lease modifications should analyze the potential effect.

A contractor’s key performance indicators (KPI) may be negatively impacted by the lease accounting standard. Financial results may be under or overstated. Contractors should discuss this with sureties. A true year-over-year or month-over-month comparison of KPIs will not be possible.


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