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Accounting Changes: Leases and Contracts

By: Greg Barbish, CPA

If contracts with customers or leases are part of your privately held business – and they are an essential element of just about any business – you will have some extra work to do when preparing financial statements for your company after January 1, 2019.

These deadlines may be more than a year away for privately held businesses, but the changes in accounting principles generally accepted in the United States of America (U.S. GAAP) related to revenue recognition and leases are fairly complex, so it makes sense to learn about the changes now and develop an implementation plan. In addition, if your company prepares comparative financial statements then there may be some impact on how information for 2018 is presented.

These changes, which result from new standards developed by the Financial Accounting Standards Board (FASB), may not affect how much money your company has in its accounts but, depending on the terms of your contracts and leases, they may affect the figures in your financial statements, which could have an impact on how your bank, surety company and others with a need to know will view your company.

The new standard for revenue recognition could result in an acceleration or deferral of revenue recognized. As a result, this may impact many aspects of a business’s functions, including income tax planning, financial ratios, loan covenants, sales commissions and bonuses, to name a few. Compliance with the new standard for revenue recognition may require significant judgments and estimates, thoughtful revision of accounting policy and new required disclosures.

While the existing revenue recognition standards were mostly developed for specific industries or transaction types, the new standard is principles based. The new standard is designed to improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. The new guidance identifies five steps in the revenue recognition process:

• Identify the contract(s) with a customer.
• Identify the performance obligations in the contract.
• Determine the transaction price.
• Allocate the transaction price to the performance obligations in the contract.
• Recognize revenue when (or as) the entity satisfies a performance obligation.

The first time your business works through these steps, it is likely to be challenging and time-consuming. Because it is essential that the review be done correctly, you should consult with your accountant if you have any concerns about completing the analysis.

However, after the initial implementation, the process should become easier because, once you analyze the different types of contracts prevalent in your business; you should be able to perform a similar analysis for each contract of the same type as you move forward.

Depending on the entity, the new lease standard may be easier to analyze, but could have a bigger impact within the financial statements. In most cases, finance leases will be treated the same as capitalized leases are currently. The biggest change relates to operating leases being recorded in the balance sheet as a right-of-use asset and a corresponding lease liability, initially measured at the present value of the lease payments. The current guidance does not require the recognition of a right-of-use asset and lease liability for operating leases. As a result, all leases should be analyzed to determine the impact of the new standard.

Neither you nor your accountant will be able to predict how the application of the new standards will impact your financial statements without doing a careful study of your contracts and leases. The numbers may change a little, or they may change significantly, in either a favorable or an unfavorable direction. Remember, the new standards may affect how your business looks on paper, but it may not change how much money you have in your accounts.

Getting into compliance may be a nuisance, but getting an early start on the process will make the transition much easier. Developing and executing a detailed implementation plan now, can save your company some serious headaches down the road. Your accountant can be a valuable resource in helping your company develop and execute a detailed implementation plan.