Working with leases

From 1976 through 2018, the accounting for leases was among the most deceptive accounting practices in existence. For example, in 2016 alone, these lease accounting standards allowed publicly traded companies around the world to avoid reporting three trillion dollars in obligations under non-cancelable lease contracts. The lease accounting rules were changed starting in 2019. Let's discuss the old bad rules, the new better rules, and the financial statement impact of both. Now, before we go any further, let's define what we mean by a lease. A lease is a contract specifying the terms under which the owner of some property transfers the right to use the property to someone else, without transferring legal ownership. Here's an example. Let's say that I am a package delivery company, like FedEx. I need the use of an airport warehouse for the next 10 years. Rather than buying the warehouse from its legal owner, I can lease the warehouse under a contract that gives me exclusive right to use that warehouse for the next 10 years. I don't legally own the warehouse, but I do have the legal right to use the warehouse. That seems simple enough, but the incredibly controversial accounting question is this. During the 10 year period of the lease, should I, the user of the warehouse, report the warehouse as an asset on my balance sheet? And when I sign the 10 year non-cancelable lease contract, should I report on my balance sheet the value of the obligation to make those future contractual payments? Historically, a major challenge for accountants has been to establish accounting standards that prevent companies from using the legal form of a lease to avoid recognizing future payment obligations as a liability. This is called off-balance sheet financing. The phrase itself sounds pretty unsavory. Off-balance sheet financing. The very purpose of the balance sheet is to report the sources of a company's financing. In 2016, the FASB in the United States, and the IASB in London, adopted a new lease accounting rule mandating that all longterm leases be reported on the balance sheet. Both the leased assets and the associated obligation to make the lease payments. This rule eliminates the off-balance sheet financing aspect of the old controversial lease accounting. This rule goes into affect in the United States starting in the year 2019. The impact? Trillions of dollars in lease obligations previously excluded from the balance sheet will now go on the balance sheets of companies around the world. This new lease accounting rule treats the lease arrangement exactly the same as if the company had gone to a bank and borrowed the money, which was then used to purchase the exclusive right to use the asset during the length of the lease. So lease financing is now on the balance sheet. In July 2018, LeaseAccelerator, a leading provider of lease accounting software, published a list of the publicly traded US companies with the largest unrecorded lease obligations that the new lease accounting rule will now put on the companies' balance sheets. Because retail companies have historically leased many of their store and distribution facilities, there are many retailers in the top 20. The large banks are in the top 20, because they usually lease their locations. Another industry with a long history of leasing important assets is the airline industry. For American Airlines, the new rule will put on the balance sheet an additional nine billion dollars in facilities, airplanes and other equipment used under previously unreported lease arrangements. Yep, the new lease accounting rules will substantially impact the reported financial numbers and resulting financial ratios for many, many companies.