ASC 842 – The New Leasing Standard

Investment analysis and business implications? US public companies will now be reporting under the new leasing standard (ASC 842) for fiscal years, and interim periods within those fiscal years, which took effect on Dec. 15, 2018. For calendar year-end public companies that means an adoption date of Jan. 1, 2019. Comparative prior year financial statements may need to be adjusted depending on the transition method applied (private entities have an additional year to comply).

The standard requires tracking new and existing leases entered into after the effective date, including existing leases that have pricing or contractual changes that might lead to modifications and reassessments. It also includes a variety of other lease transactions such as leased assets that reach end of term, are renewed, terminated or purchased, new subleases, sale-leaseback transactions, and embedded leases contained in outsourcing and service contracts. That’s a lot.

Measuring the Impact of ASC 842

How will U.S. airline and rail lessee balance sheets look after compliance? PWC estimates the new standard will impact at least 20 industries from retail to utilities. After retail, the second biggest impact will be on airlines. With almost 40% of world aircraft leased, average balance sheet footings for air carriers are expected to increase 47% as ‘right of use’ assets and related lease liabilities are added.

And since U.S. GAAP and International standards are not completely ‘converged’ dual reporting organizations will need to maintain different reporting systems! Over time that will lead to different balance sheet and income statement impacts. For operating lease income statement purposes, U.S. GAAP rent expense will continue to be recognized on a straight-line basis. IFRS front loads the expense recognition by replacing rent with depreciation and interest.

Will these reporting changes impact the analysis, or the economics of the ‘lease vs. buy decision’? Perhaps not. Leasing is and will remain, an important equipment financing alternative. It allows access to necessary assets, simplifies the disposal of used property, and reduces a lessee’s exposure to the risks inherent in asset ownership. Although an operating lease will now be ‘capitalized’, the capitalized dollar amount will be lower than if the asset was purchased. The Tax Cuts and Jobs Act further impacts lease analysis by limiting interest deductibility while allowing unrestricted ‘rent’ deductibility and 100% bonus depreciation. ASC 842 makes relatively few changes to existing lessor accounting rules other than the elimination of leveraged lease accounting.

For aircraft and railcar lessees, recognizing lease-related assets and liabilities on the balance sheet requires the development and maintenance of internal systems that support reporting and ultimately the business implications of the new standards. As 2019 unfolds, how will these changes affect portfolio investment, equipment values, and investment analysis?

For answers to these questions, call RESIDCO.

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