ASC 842 requires companies to bring certain operating leases onto the balance sheet to be reported as assets and liabilities. The increase in liabilities on the balance sheet could mean that some companies will violate their debt covenants. However, FASB has said that ASC 842 characterizes operating leases as operating liabilities rather than debt, so there should be minimal effect, if any, on debt covenants.
1. How many current operating leases are there? What will the impact of those leases be on the balance sheet and financial ratios after the implementation of the new standards?
2. What are the terms of the debt covenants? Are there terms that provide protection against financial ratio change due to change in accounting standards?
3. Are lenders aware of how the new standards will affect their customers? Are they prepared to deal with any issues resulting from the accounting change in terms of staff knowledge and availability?
What the Experts Think
Links to Additional Resources
During the upcoming implementation period, it is imperative for users of financial statements to understand the scope and implications of these changes. In particular, contractual covenants typical in debt financing arrangements will need to be carefully analyzed and crafted to avoid adverse consequences such as inadvertent default.
May 1, 2018
In this Forbes article, a contributor from New Contracts explains how operating leases have been included in their models in the past, and how operating leases will be included in the future.
Although most companies are focused on the impact new lease accounting guidelines will have on their financial statements, the guidelines also impact other external reporting, functional, and operational areas—including loan covenants.
March 16, 2015
This Wall Street Journal article reviews what the International Accounting Standards Board has said about the impact of the new lease accounting standards on debt covenants.