New Lease Standard – How It Affects Contractors

Written by Daniel Brock, CPA, CVA

In 2016, the Financial Accounting Standards Board (FASB) issued a new standard that will significantly change how businesses record and report their leases.  The new standard will go into effect for fiscal years beginning after December 15, 2019 for nonpublic companies.

The most significant change in this new standard is that all leases with terms in excess of twelve months will be reported on the balance sheet.  Under the current standard, leases that qualified as operating leases were left off the balance sheet and recorded as lease expense as they were paid.

While this will generally not result in a significant change to your net equity, it does have the potential to greatly affect two key areas that rely on the financial statements:

Bonding capacity

One of the most critical components of the financial statements is working capital (current assets minus current liabilities), as this shows the contractor’s ability to service upcoming obligations.  Working capital is also a major factor in your bonding capacity.

Under the new leasing standard, working capital will decrease, as the next twelve months’ worth of lease payments will be added to current liabilities, while the leased asset will be noncurrent.

Debt covenants

If you have bank loans that require you to maintain certain financial ratios, these could be negatively impacted by the new lease standard.  For example, a maximum debt to equity ratio could pass under the current law, but fail after the leases are added to the balance sheet as liabilities.

As the time to implement these new rules gets closer, you will need to contact your CPA to see how they will impact your balance sheet, your bonding agent on how this will affect your capacity and your banker to make any necessary adjustments to your agreements so any ratios or covenants do not become unreasonable under the new standard.

If you would like to hear more on this and the other new FASB standards, as well as the new tax law, and how they will impact the construction industry, BMSS is having a panel discussion on October 9, 2018.  Keep an eye on our website and social media for more information on this event.