In the somewhat subdued world of accounting, 2014 is shaping up to be charged with change and potential change.
A Grand Valley State University professor says the changes will matter to many businesses — especially banks, she predicts — while a manager in the audit practice at Crowe Horwath in Grand Rapids notes three changes in particular that will impact “a lot of business.”
One that both experts mentioned is the potential change in accounting standards pertaining to lease expenses.
Rita Grant, director of the School of Accounting at the L. William Seidman Center at GVSU, said the leasing issue dates to the 1960s, “when money was tight in the U.S.” and “somebody — lawyers and accountants,” she guesses, designed a business transaction that was essentially a purchase with debt financing, “but drew it up to make it look like a rental instead.”
A true rental has no balance sheet implications as far as liabilities go, she noted. But in a purchase with debt financing, the business balance sheet must include the asset and liability, thus affecting all the debt ratios.
That went on for some time, she said, “until some healthy-looking companies imploded” because of off-balance sheet financing. The U.S. accounting industry, which basically polices itself through the Financial Accounting Standards Board, then came out with new rules on leasing “to basically try to reflect the substance of the transaction rather than the legal form.”
If the substance of the transaction was a purchase with debt financing, it had to be treated as a “capital lease,” which did require listing the asset and debt liability on the balance sheet.
However, she said, in the real estate industry, lease terms are easy to set, and a lease of 10 years under the current standard would not meet the FASB rules qualifying it as a capital lease.
The new proposed standards now being considered by FASB would require any lease of longer than one year to be listed on the balance sheet as a capital lease, according to Grant.
She figures this may be a big issue in banking because many banks lease the buildings they occupy.
“They have capitalization requirements from the FDIC,” said Grant. “All of a sudden, if they have to capitalize those leases, they’re going to have bigger liability and they’re going to need more equity.”
Darren McKnight at Crowe Horwath said the proposed new standard on leasing is “still in the pipeline” and not yet scheduled to take effect, as is another standard pertaining to revenue recognition. Both are ongoing joint projects of two standard setting bodies: FASB and the International Accounting Standards Board.
Currently, revenue recognition requirements under U.S. GAAP (generally accepted accounting principles) have a variety of criteria specific to certain industries. McKnight said the proposed change would set up just one standard, a common framework of principles — rather than rules — covering all industries.
He said the impact on companies will vary depending on how specific their industry revenue recognition criteria are under the current standards.
“There are certain industries that have very specific recognition criteria and those industries are going to have to review this new principle-based guidance,” said McKnight. Examples of those types of industries include construction and software development.
Changes are also underway on the standards that determine how private companies report. McKnight said two organizations are working on that: The new Private Company Council, part of FASB, is establishing alternatives for private companies following U.S. GAAP guidelines for reporting. The other organization is the American Institute of Certified Public Accountants, working on another framework for private companies to report under.
One of the areas of major importance to finance professionals at private companies are the PCC alternatives to full GAAP that will relieve private companies of the burden to separately recognize certain intangible assets acquired when two businesses combine.
McKnight said that under the full GAAP guidelines, an expert would often be required to separately recognize the intangibles, such as patents, customer lists, goodwill and interest rate swaps.
“The PCC is providing alternatives that allow for more simple approaches to accounting for complex transactions” involving intangible assets, said McKnight.
Once the PCC takes effect, private companies will need to compare notes with their auditors and bankers to make sure they are in sync.
McKnight said he believes the changes involving leases are further out than the PCC and revenue recognition changes.
“It’s very different from what the current guidance is” and there is “a long process that goes into getting it approved.”
That change in the standards is more than a year away, in McKnight’s opinion. “But it is still moving forward.”