Accounting Requirements Affect You Too

In February 2016, the Financial Accounting Standards Board (FASB) published a new standard on accounting for leases, Accounting Standards Codification (ASC) Topic 842, Leases. The new standards were effective for public companies after Dec. 15, 2018 and will be effective for private companies after Dec. 15, 2019. This new standard represents a complete overhaul of financial reporting in this area and the changes will affect all financial statement issuers, including mortgage companies. So, when your accounting office starts asking questions about your company’s building leases, you now know why and will provide the information in a timely fashion.

The goal of the new standard is to take operating leases, which have historically been omitted from the balance sheet, and present them as assets and liabilities through recognition and measurement. Additionally, the new leases standard is expected to increase transparency and comparability among companies that lease buildings, equipment and other assets by consistently recognizing the assets and liabilities that arise from lease transactions. In other words, current off-balance sheet leasing activities will be required to be reflected on balance sheets so that investors and other users of financial statements can more readily and accurately understand the rights and obligations associated with these transactions.

The guidance retains two types of leases and is consistent with the lessee accounting model under existing Generally Accepted Accounting Principles (GAAP). One type of lease (finance leases) will be accounted for in substantially the same manner as capital leases are accounted for under existing GAAP.  The other type of lease (operating leases) will be accounted for (both in the income statement and statement of cash flows) in a manner consistent with operating leases under existing GAAP. However, as it relates to the balance sheet, lessees will recognize lease liabilities based upon the present value of remaining lease payments and corresponding lease assets (right of use assets) for operating leases with limited exception.

The new leases standard will require lessees and lessors to provide additional qualitative and quantitative disclosures to help financial statement users assess the amount, timing and uncertainty of cash flows arising from leases. These disclosures are intended to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an organization’s leasing activities.

The new standard offers additional complexity as embedded components of lease agreements are to be separately stated after careful analysis.  This first step for any analysis by a lessee or lessor is to determine if a lease exists within the scope of the new guidance. If so, the lessee and the lessor must also analyze whether there are multiple lease components (i.e., more than one lease) that should be accounted for separately and whether there are non-lease components that should be accounted for under other appropriate GAAP.

In many respects, the final standard can be thought of as moving operating lease obligations from the footnotes to the balance sheet; basically, a change in display. The new standard is not industry-specific, so it will not necessarily affect one industry more than others. However, as mentioned earlier, the more significant the leasing activity, the greater the potential for a significant balance sheet impact.

FASB decided that a modified retrospective approach for transition, as opposed to a full retrospective approach, provides an appropriate balance between minimizing costs of transition and providing users of financial statements with comparable financial information.

The regulation and guidances that govern the accounting industry have an effect on mortgage companies, and it is important to treat request in a timely, accurate manner in order not to create unnecessary problems with regulators.