For the Oregon Beer Growler
Lease accounting has never been most people’s favorite accounting topic, but the Financial Accounting Standards Board (FASB) has added another layer of complexity to the existing treatment of leases. While this new guidance is not applicable for a few more years, it’s good to understand the implications it may have on your brewery now.
Currently, leases are divided into two categories: operating and financing. To qualify as a financing or capital lease, you must meet one of four criteria:
1) Ownership transfers at the end of the lease term
2) There is a bargain purchase option at the end of the lease term
3) The term of the lease is 75 percent or more of the estimated useful life of the asset
4) The present value of the lease payments is 90 percent or more of the original cost of the asset.
The assets under these leases are capitalized and offset by a liability for the principal payments to be made during the life of the lease. The asset is depreciated as any capitalized asset would be. When payments are made, there is a principal and interest portion — similar to any financing debt.
By default, if none of the financing lease qualifications are met, you have an operating lease. There is currently no asset or liability associated with operating leases, and any payments are treated as lease expense on your income statement. Smaller breweries would typically see this in their building or property leases. Larger breweries might have additional equipment leases, such as forklifts, which would fall under these guidelines as well.
In 2016, the FASB issued Accounting Standards Update 2016-02, which changes the accounting for operating leases. Starting in 2019 for public companies and 2020 for non-public, there will now be an asset and a liability on balance sheet related to any operating leases with a duration in excess of 12 months, including extensions that are likely to be renewed. The reasoning behind this is that if a business is committed to making payments during a long-term period of time, there should be a liability representing this obligation on their balance sheet. There is now also a corresponding asset that represents the business’s right to use the asset.
Mechanically, there should be little change to the income statement. The asset and liability are amortized in tandem during the life of the lease and any lease payments still are reflected as lease expense on the income statement. However, there is the potential that a business’s bank covenants may be affected. Any ratios that involve debt, such as debt-to-equity, will have an increase in the debt side with no corresponding adjustment on the equity side. Even an asset-to-liability ratio will be affected, as the impact on the numerator and denominator will differ. The ratio that will probably see the greatest impact is the current ratio. The new asset will be classified as non-current, while the portion of the new liability to be amortized over the next 12 months will be considered current.
This change to lease guidance will impact everyone with these types of leases, from the smallest brewpub to the largest production brewery. If you have any ratios that may be affected by current leasing arrangements or if you intend to enter into new leasing arrangements, now is the time to start talking to your lending institution and financial advisors about how your covenants might be affected.
This information was provided by Matthew Diment, of Kernutt Stokes, CPAs and Consultants. Matthew and a team of professionals serve the craft brewing industry. For questions or more information, contact Matthew at 541-687-1170 or firstname.lastname@example.org.