Major challenges of the lease accounting standards

Debt Covenants

Organizations must include most leases on their balance sheets and report them as right of use assets and lease liabilities. Depending on the standard(s) with which an organization must comply, there are differences in the impact of how lease liabilities are classified on the balance sheet. The classification may increase the liabilities to the point where debt covenants may be impacted. For ASC 842, there may be minimal impact, since operating leases are considered operating liabilities, and not debt. However, in the approach that the IASB took for IFRS 16, it’s possible that lease liabilities might be classified as debt, which could affect the debt covenants. Debt covenants should be reviewed and possibly updated, or waivers may need to be obtained, given that lease liabilities are now on the balance sheet.

Key Considerations

1. Financial Statements & Ratios

Assess the number and value of leases to be included on the balance sheet and determine the impact on financial ratios.

2. Terms

Assess the existing debt covenant thresholds and guidelines. Evaluate if there is any protection against changes to financial ratios due to shifts in standards.

3. Lender Knowledge

Lenders need to assess the impact the standards will have on their customers. The lender’s staff needs to understand the standards and their requirements.

Download the ASC 842 Handbook

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