Joshua Lorenz of Meyer Unkovic & Scott.

Private companies are likely to get a year-long reprieve from implementing new standards that will significantly change how leases are presented on financial statements, bringing a sigh of relief for many in the construction industry (and plenty of others) who may have been slow to adhere to the coming, potentially disruptive changes.

The Financial Accounting Standards Board (FASB) voted in July to propose delaying the effective dates for a set of accounting standards, bumping back the effective date for the new lease standards on companies that are not public business entities one year to financial periods beginning after Dec. 15, 2020, (Jan. 1, 2021 for calendar-year-end companies) and for interim periods between fiscal years beginning after Dec. 15, 2021, (Jan 1, 2021 for calendar-year-end companies). Early adoption will be allowed, however.

The FASB expects to issue its proposal in mid-August, followed by a 30-day public comment period. The board will discuss the feedback at a future public meeting and could finalize the proposal as early as the fall.

The instant impact for private business owners in the construction industry is it gives more time to understand and implement these new measures before being caught off-guard. Many contractors, subcontractors, managers and related businesses in the construction industry have assets that will be affected by the new standards—but they might not know it.

That makes the present a good time for business owners and their financial and legal partners to review the new standards, audit how they will directly affect their reporting practices and make a plan as to how to apply them moving forward. The earlier they can do so, the better.

What the New accounting Standards Say

Announced in 2016, the new accounting standards are aimed at making a “more faithful representation of a lessee’s rights and obligations arising from leases,” according to the FASB. The board said the previous standards failed to meet the needs of the users of financial statements because they did not require lessees to recognize assets and liabilities from operating leases on their balance sheets. The main thrust of the new standards, then, is to ensure lessees recognize all assets and liabilities created by leases with terms of more than 12 months.

Now, finance leases (referred to as “capital leases” in the previous guidance) and operating leases both should be recognized, but how they are reported on financial statements will differ:

Finance Leases

• Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position.
• Recognize interest on the lease liability separately from amortization of the right-of-use asset in the statement of comprehensive income.
• Classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows.

Operating Leases

• Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position.
• Recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis.
• Classify all cash payments within operating activities in the statement of cash flows.

The FASB also emphasizes disclosures “to help investors and other financial statement users better understand the amount, timing and uncertainty of cash flows arising from leases.”

The full updated standards can be found here at https://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176167901010&acceptedDisclaimer=true.

How This Could Impact the Construction Industry

Open a business, and you likely won’t be buying everything with straight cash. That certainly holds true in construction, with businesses leasing all manner of sophisticated equipment, vehicles, trailers used for offices, real estate and countless other assets. Over years, these leases accumulate, some end, some are re-leased, and others are purchased. It’s surprisingly easy, without steadfast bookkeeping, to lose track of how certain assets are classified, especially if they’ve never been included as part of the balance sheet before.

If owners have been managing their finances through lines of credit or other financing, these new standards could shake up some businesses from a cashflow perspective. Current procedures may lead to tax liabilities or fines in the future, so they should be reexamined.

What Construction Professionals Should Do Now

Private businesses likely will have another 19 months or so to get their financial reporting procedures in compliance with the new accounting standards, as the FASB appears committed to delaying the rollout. That doesn’t mean businesses should wait that long, though.

If they haven’t begun to address these changes, it’s good to start with a full review of what leases are creating assets and liabilities. There may be multiple leases that were never reported in the past that will now be required to be on future financial statements.

At the same time, businesses should reach out to their accounting partners, financial institutions or attorneys to help them navigate through this changing landscape. It’s possible some leases may need to be re-worked or re-worded to get the best tax or financial treatment. These professionals will also have the best understanding of the changes to the accounting standards and can help formulate a plan to address them appropriately.

Most of all, business owners must be proactive. When changes like these are on the far-off horizon, it’s easy to adopt a “we’ll worry about it then” attitude, but the future catches up in a hurry. The time to review and address these changes is now so that they are prepared.

Joshua Lorenz is an attorney at Pittsburgh-based law firm Meyer, Unkovic & Scott. He focuses his practice on construction law and litigation. He can be reached at [email protected].