The New Lease Accounting Standard and Debt to Equity Ratios

By | April 16, 2013

In the past, we have discussed various aspects of the new lease accounting standard that is currently being jointly proposed by both the FASB and the IASB. The new standard will require that all leases, except short term leases, be recognized as liabilities on the lessee’s balance sheet. This will result in a dramatic change from current practice for operating leases, will require complex calculations and will result in significantly more assets and liabilities (debt) to be recognized on the balance sheet. One of the more significant aspects of this change that can be overlooked is the effect that this will have on financial ratios, such as the debt to equity ratio, which is an important barometer of financial health and generally is a key component of the financial covenants contained in debt agreements. The debt to equity ratio is a measurement of the current debt load incurred by the entity as a percentage of the owners’/shareholders’ equity in the business. By recognizing all leases as liabilities in the financial statements, the debt load will be increased which will have a negative impact on the debt to equity ratio.

Once lessees review the provisions of the revised Exposure Draft that is expected to be issued next month, it will be important to establish a plan for how to address the calculations required for compliance with the proposed new standard. But lessees should not overlook planning for other important business ramifications. Will the perception of the financial health of my business be negatively impacted? Should I contact my lender about the impact that this will have on compliance with any financial covenants? What can I do to mitigate any negative impact?

Planning starts by getting the right tools in place. iLeasePro, the lease management and accounting solution that we are currently developing, will allow the user to capture all the information needed to manage, account for and analyze its portfolio of leased assets (both real property and equipment). Having the relevant information centrally located in one consolidated system is the start of an effective implementation plan.