Brent Thompson, BridgeTower Media Newswires
The Financial Accounting Standards Board (FASB) is implementing two new major standards that will affect every for-profit entity issuing financial statements using Generally Accepted Accounting Principles. They are the new revenue recognition standard and the new lease standard.
The transition to using these new standards has been a long time coming. For non-public entities, the revenue recognition standard became effective January 1. The new lease standard was set to begin January 1, 2020, but on August 15, a FASB-issued exposure draft announced a delay in implementation for one year. There is still a chance for a change in this plan prior to a final ruling, but it seems like a pretty safe assumption the effective date will be delayed to January 1, 2021.
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New revenue standard establishes industry-neutral method to recognize revenue
The objective of the new revenue standard is to establish an industry-neutral method of recognizing revenue, which is one of the most important measures used by users of the financial statements. The new standard focuses on completion of performance obligations and calls for more robust disclosures within the financial statements, providing more information on the company’s revenue streams, policies, procedures, and risks in dealing with revenue.
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New lease standard provides clearer view of future liabilities
The new lease standard serves to bring all contractual lease liabilities onto the books. Users of the financial statements will now easily see all the future liabilities the company is contractually obligated to repay.
Under historical standards, it was quite common to have lease liabilities “off the books” if the company did not lease the asset for most of its useful life or pay for the purchase of the asset through the lease. For example, if your business entered into a five-year lease for office space from an unrelated entity, you neither used the building for a majority of its life, nor did you pay for the purchase of the building through the lease, so the lease would not have been recorded as a liability on the books. With the new lease standard, a liability like this will appear on the balance sheet.
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Potential for disruption
At a minimum, these standards will have extensive disclosure requirements. At their worst, both standards have the potential to disrupt the continuity of the financial statements.
The revenue standard has a special provision that allows the presentation of comparative financial statements with the earliest year prepared under historical accounting standards and the recent year prepared under the new standards. With the change in timing between the old and new standards, there is a real possibility certain revenue may not be recorded in either year, which would be extremely disruptive to any trend analysis and ratio analysis that includes revenue as a factor.
With the lease standard, new liabilities are brought onto the books for certain leases based on the present value of future obligations. So, if there is an SBA loan that requires a 20-year lease of your facility at $200,000 per year, you will now have a “new” $2.6M liability on your balance sheet. Your debt-to-equity, debt service ratios, and the like, are not going to be anywhere close to acceptable using historic calculation methods.
It follows that banks will have to revise their measures on loan evaluations to compensate for revenue dropping off income statements, liabilities appearing out of nowhere, trend analysis skewed, and ratios drastically changing. Keep in mind, nothing has changed in reality. The only change is how this information is presented on the financial statements.
Since loan officers and credit analysts do not have mandated education requirements, they may not yet have a deep understanding of these changes. The banks are left with two choices: back out the changes resulting from these new standards to see the historical calculations, or determine a new acceptable ratio or measure going forward.
What can you do to prepare? Consult with your accountant sooner rather than later to determine exactly how these two provisions are going to affect your financial statements, keeping in mind these financial statement accounting changes do not change tax return accounting methods. Then, present everything to your bank to make sure they are up to speed on this new normal.
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Brent Thompson, CMA CGMA CPA is a Director with Canon Capital Management Group located in Harleysville providing Certified Public Accounting, Payroll Services, Wealth Management, and Technology Services to thousands of businesses and individuals.
