Private Businesses Have More Time to Adopt New Accounting Standards for Leases, Credit Losses by Hector E. Aguililla, CPA
The Financial Accounting Standards Board (FASB) recently issued ASU 2019-10, extending the deadline for privately held businesses and not-for-profit organizations to comply with new accounting standards for recognizing leases and credit losses.
Both standards were introduced in 2016 in an effort to improve financial reporting transparency and to provide readers of financial statements with a clearer representation of entities’ leasing arrangements and the credit quality and related risks of their financial instruments. However, the FASB has extended the compliance deadlines several times to provide affected entities with more time to review and update their existing policies, procedures, systems and processes and prepare their stakeholders for the material changes that will be reflected in their financial reporting.
Lease Accounting
The FASB delayed by one year the effective date that private companies and non-profits must comply with the new lease accounting standard (ASC 842); affected entities must adopt the new standards for reporting periods beginning Jan. 1, 2020. Publicly traded businesses and employee-benefit plans were required to apply the new lease standards starting is fiscal year 2019.
Under ASC 842, businesses must, for the first time, recognize all of their operating leases on their balance sheets, which will result in material changes in the reporting of various balance sheet and leverage ratios, operating income, after-tax income cash flow, debt and equity. The FASB estimates that more than $3 trillion in lease assets, liabilities and expenses will move to businesses’ ’ financial statements. Businesses with large portfolios of lease assets will need to report significantly more amounts of debt on their lease obligations than they did in prior years, which may adversely impact key debt-covenant compliance agreements. Affected businesses should work with their advisors and accountants to evaluate the impact on such covenants and to determine the next steps.
Accounting for Current Expected Credit Losses (CECL)
The FASB also delayed the effective date that private companies and non-profits must comply with the new accounting standards for measuring credit losses on financial instruments by two years to January 2023. Publicly traded business must begin employing ASC 326 for fiscal years beginning January 2020, including interim periods within those fiscal years.
Under the Current Expected Credit Loss (CECL) model, businesses must recognize an estimate of the losses they expect to incur over the contractual life of all loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivable and other non-cash financial instruments they hold during the current earnings reporting date. By making these forward-looking estimates about the life of financial instruments upon origination or purchase, businesses will need to consider historical events, current conditions and reasonable forecasts that support the amount they do not expect to collect in the future on loan portfolios and other assets they hold currently. This, in turn, will require enhanced disclosures to provide investors and other users of financial statements with better transparency regarding businesses’ underwriting standards, credit quality, and the way in which they estimate potential losses.
Despite the extended compliance deadlines, affected business entities and non-profit organizations should not put off time- and resource-intensive compliance planning, implementation and testing. Because adoption of this standard will require reviews of historical trends, it is not too early for affected entities to begin the information-gathering process. Working with experienced accountants can go a long way toward ensuring a smooth transition.
About the Author: Hector E. Aguililla, CPA, is a director in the Audit and Attest Services practice with Berkowitz Pollack Brant, where he provides business consulting services, conducts audits, reviews, compilations, and due diligence for mergers and acquisitions. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.
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