By: Gulu Dubash
On January 1st, 2019, the Financial Accounting Standards Board implemented a new series of rules and regulations to govern how accountants classify and report leases on taxes. This program is known as FAS 13. If your company leases any assets, you will see changes to how you put operating and finance leases onto your company’s balance sheet.
How Has the Definition of Lease Changed?
FAS 13 will now define a lease as a contract that gives your business the ability to use an asset for a certain time period. Your company will pay the leasing company for the right to use this asset. You will have to determine what assets contain a lease when you decide to obtain them. This new definition differs from the old one in that, under FAS 13, your company can have all of the economic benefits that come with this asset. In addition, you can use your leased assets in whatever way you choose. You did not have this right previously.
How Has FAS 13 Updated Lease Classifications?
Under FAS 13, you will have to use a series of calculations to classify your leases as either an operating lease or a capital lease. Your accounting team can help you run these tests and define each of your assets. You will have to answer the following questions to determine if your lease is Capital (also known as Finance):
- Did the leasing company transfer the ownership of the asset to you at the end of the lease?
- Did your lease include a bargain purchase option?
- Did your lease term equal 75% or more of the asset’s estimated economic life?
- Is the present value of your company’s minimum lease payments at the beginning of your lease equal to 90% or more of the asset’s fair market value?
If you answer yes to any of these questions, the asset is a capital lease. If you answered no to these questions, you have an operating lease. Your accountant will have to treat your operating lease as an ongoing expense, while they will have to treat the capital lease as a one-time transaction between a buyer and a seller.
As a result of these changes, your company will have to adjust how you report capital leases. Instead of reporting the asset as an expense, your accountant will need to report it as an interest and obligation payment. Your accounting team will need to prepare for these new accounting standards.
How Does This Impact Financial Statements?
This new requirement makes capital leases less desirable than operating leases, which can affect the ratios on the company’s balance sheet. This, in turn, can change the way investors and creditors perceive the company’s overall financial health. The change can also make buying real estate more appealing than renting, for some companies, providing the impetus to buying when it would not have been possible before.
How Can You Prepare for These Changes?
There are a few steps you can take to prepare for the FAS 13 changes.
- Make sure you have a central place where you store information about your leased assets and liabilities that last more than 12 months and have a high value. Store information on all assets worth the same amount as a lease for a single personal computer or higher.
- Speak with your accountant on how you will record depreciation on your upcoming operating statements.
- If you work solely with paper records, it’s time to make the switch to electronic data. Begin the switch as soon as possible so that you have accounting data available in the event of an audit.
- Determine how you plan on integrating your leased asset and fixed asset data. Speak with your accountant about adjusting depreciation if you cannot include leased assets in your current fixed asset systems.
Do you need accessible and affordable accounting services to prepare for FAS 13? Contact Chugh LLP today to find an accountant near you.