FASB Lease Accounting Changes - An overview of what you need to know
In February 2016, the Financial Accounting Standards Board issued ASU 2016-02 (Topic 842 which supersedes Topic 840) intended to improve financial reporting over leasing transactions. The new standard aims to provide the financial statement users with transparent and comparable financial statements by recognizing lease assets and lease liabilities on the balance sheet.
Currently, the majority of operating leases are treated as off-balance sheet transactions with limited reporting on the income statement and in the notes to the financial statements. After adoption, entities will be required to report all long-term leases on the balance sheet as an asset and liability. This will have a significant impact on the way entities account for leases internally, and externally in regards to disclosure, financial reporting and impact on existing relationships (ie: relationships with warehouse banks and investors). Entities need to consider the impact on their accounting software, their balance sheet and income statement, their internal controls, the size of their accounting department and the need to inventory all leases. Additionally, entities need to be aware of issues surrounding bank covenants, investor relationships, and other vendor relationships that the new standard could impact. This ASU affects all entities that lease assets such as real estate, airplanes, and equipment. However, lessees with leases shorter than 12 months are allowed to make an election to not record these transactions on the balance sheet. For public companies, the amendment is effective for fiscal years beginning after December 15, 2018. For all other entities, the amendment is effective for fiscal years beginning after December 15, 2019.
What this means for mortgage companies:
The typical mortgage company will fall on the lessee side of the transaction by leasing equipment or real estate. Although almost all mortgage companies will be affected, large retail mortgage companies that have branch offices with leases in several locations could be significantly impacted because they will now be required to record an asset and liability on their books for all existing lease obligations. The lease liability will be recorded at the present value of the future cash flows using the company’s borrowing rate (unless an implicit rate is known). The lease asset will be recorded at the lease liability amount plus any initial direct costs less any incentives.
What mortgage companies need to consider:
ASU 2016-02 will impact entities’ financial reporting, internal controls, operations, lending relationships, investor relationships, etc. Companies should begin preparing now by evaluating their accounting systems and internal controls to ensure the systems can handle the transition. If not already done so, companies need to begin to log the leases the company has in effect and evaluate if each lease is impacted by the standard (ie: any lease less than 12 months can be excluded from adoption). Additionally, entities should begin discussing the impact on the financial statements with their lenders, investors and any other users of the financial statements. After adopting the standard, the financial statements will have new assets and corresponding liabilities on the balance sheet which may affect covenants, investor relationships, etc.
Any questions over the new standard or the impact on your company, please contact Dustin Pfluger Partners at BKM Sowan Horan, LLP.
About the author
Dustin Pfluger has over 13 years of public accounting experience with both national and regional accounting firms and for the past 8 years has focused primarily on providing assurance and consulting services to independent mortgage companies of all sizes and models. He is currently a Partner at BKM Sowan Horan, LLP, a public accounting firm located in Texas, that provides assurance, tax, and consulting services to mortgage companies throughout Texas and the southwest.
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