There’s some further welcome news for businesses and nonprofits that use GAAP (Generally Accepted Accounting Principles) for their financial statements. There is now an additional delay on implementing fairly cumbersome new revenue recognition and lease accounting standards.
Due to the coronavirus pandemic, the Financial Accounting Standards Board (FASB) voted last week to delay the start of new revenue recognition and lease accounting standards.
Revenue Recognition Changes
Private businesses and nonprofits were required to start applying the revenue recognition standard, ASC 606, in 2019, but for those companies that did not yet issue their financial statements for 2019, now have until next year to comply with the new standard. Public companies have been using the revenue recognition standard since 2018.
The new effective date for private businesses and nonprofits will now be for annual reporting periods beginning after Dec. 15, 2019, and interim reporting periods within annual reporting periods beginning after Dec. 15, 2020. Early application will continue to be permitted.
ASC 606 – the new revenue recognition standard – provides a framework for businesses to recognize revenue more consistently. It seeks to eliminate variations in the way businesses across industries handle accounting for similar transactions.
The new revenue recognition rules break the contract process into the following 5 steps:
- Identify the contract with a customer: This step outlines the criteria that must be met when establishing a contract with a customer to supply goods or services.
- Identify the performance obligations in the contract: This step describes how distinct performance obligations in the contract must be handled.
- Determine the transaction price: This step outlines what must be considered when establishing the transaction price, which is the amount the business expects to receive for transferring the goods and services to the customer
- Allocate the transaction price: This step outlines guidelines for allocating the transaction price across the contract’s separate performance obligations, and is what the customer agrees to pay for the goods and services
- Recognize revenue when or as the entity satisfies a performance obligation: Revenue can be recognized as the business meets each performance obligation. This step specifies how that should happen.
Lease Accounting Changes
ASC 842 Leases – a standard requiring the capitalization and debt of virtually all leases on the balance sheet – was supposed to take affect for private businesses and other nonprofits for fiscal years starting after Dec. 15, 2020. Now the new standard will take affect for fiscal years starting after Dec. 15, 2021.
The new lease standard started for public companies for fiscal years starting after Dec. 15, 2018.
Operating leases generally include the rental of real estate, office space and some equipment. Conversely, capital leases presently include those that meet any one of four conditions. It essentially had the lease extend over most of the asset’s useful life or offered either a bargain purchase price or the transfer of ownership at the end of the lease.
Under the new GAAP requirement, virtually all operating leases and capital leases will be recorded as “right of use” assets and “capital lease obligations.” While this may not sound dramatic, in terms of debt covenants, it is. Since operating leases are generally for expensive and long-term items, the calculation will generally create a large liability that was not there before.
This could potentially distort bank covenant calculations. The consequence is that companies may not meet their bank covenants. Currently, only capital leases are considered debt and therefore affect covenant calculations.
Some banks will be willing and able to change the covenant calculations to address the new accounting standards, although some banks may be less willing or able to do so. This may put you in default if you fail the covenants. By speaking with your bank today and identifying their plans for the future, you will be able to ensure that there is no gap between your financials and your bank.
Other alternatives would be to determine if the bank is willing to accept special purpose framework financial statements, such as income tax basis of accounting, rather than GAAP. The changes proposed by FASB would not affect this reporting method. Another alternative is to ask for a GAAP exception for the new lease standards.
We’ve done the research and have the tools and strategies ready to embrace these changing requirements. Contact us today to assess the impact to your company and set up the best practices to track all of the new requirements.