Habif, Arogeti & Wynne, LLP’s Retail, Franchising and Hospitality group
The restaurant industry, like so many others, makes significant use of leasing. Restaurateurs typically lease everything from real estate to equipment. In the last few years, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) have released two exposure drafts detailing potential changes to lease accounting, which will impact the financial treatment of leases. While no final guidance has yet been released, it’s important to start planning for these changes now. So what’s new in lease accounting?
If you’ve got a short term lease of one year or less, you can breathe easy; there are no changes to accounting for short-term leases. For long term leases, the existing accounting models classify leases into two categories: capital leases and operating leases. The new guidelines would change those into Type A and Type B leases.
Type A would be similar to a capital lease (e.g. leasing an industrial oven). Leases representing assets that are not property will be Type A unless the lease term is an insignificant part of the total economic life of the asset or the present value of total lease payments is insignificant compared to the fair value of the asset.
Vice versa, Type B leases are close to operating leases and should be real estate, unless the lease term takes up a significant part of the total economic life of the asset or the present value of the total lease payments is substantially all of the fair value of the asset.
Type A leases will require recognition of the unwinding of the lease liability to be recognized separately from the amortization of the right of use assets, while Type B allows them to be combined on a straight-lined basis. Ultimately, this means that Type B leases will have lower expense impact in the first half and higher impact in the second half of the lease agreement, when compared to Type A.
Leases currently being accounted for as operating leases will not be “grandfathered,” according to the old guidance. Lessees will have to decide whether to implement the changes back to the lease commencement date or at the date of transition.
The most recent exposure draft, released last May, also requires a number of new disclosures on financial statements. These disclosures include but aren’t limited to: a description of the lease(s), a listing of guarantees, restrictions and covenants in the lease agreement(s), and information on leases that haven’t commenced yet.
The FASB and IASB met as recently as Jan. 23, 2014 to discuss these proposed changes to lease accounting. Even though nothing is final yet, you should take proactive steps to prepare for these upcoming changes. Review your existing leases and contracts to see if the accounting treatment may be subject to change, and consider those changes when renewing or signing new leases. Contact a tax professional; classification changes may affect state, local and personal property tax. And stay tuned for more information as the year unfolds.
Do you have a lease that might be affected by the proposed new lease accounting model? Contact Sheldon Zimmerman at firstname.lastname@example.org or (404) 814-4958 to get prepared.