Small Businesses’ Biggest Lease Accounting Pitfalls

Small Businesses' Biggest Lease Accounting Pitfalls

New lease accounting standards are in effect for publicly traded companies in the U.S. after the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) introduced changes to the way businesses account for their outstanding leases.

Though the changes are designed to improve visibility for analysts and investors into company finances, accountants and finance teams for public firms struggled to meet the January 2020  deadline after the American Institute of Certified Professional Accountants (AICPA) warned of the “significant and complex” overhauls businesses were forced to endure. As a result, the AICPA requested that the FASB push back the implementation deadline for private companies, which now have until January 2021 to comply.

That extra year will be imperative for private firms – particularly small businesses with limited resources – to fully assess how the lease accounting standard changes will impact their companies, said George Azih, founder and CEO of lease accounting software provider LeaseQuery.

While the extended deadline can be helpful, Azih recently spoke with PYMNTS about how firms, particularly small businesses, could be lured into a false sense of security now that they have more time to prepare.

“Smaller companies have a false sense of security of, ‘We now have an extra year to worry about it, so let’s not think about it now,'” he said. “This is a very dangerous thing to do, because if there’s one thing we learned when we helped publicly traded companies comply, it’s that this is a very, very difficult process.”

Lease Misunderstandings

One of the largest factors behind that false sense of security is the widespread assumption among smaller businesses that the lease accounting standard changes will not have a profound impact on their financial reporting activity. That’s often because a small business may assume they have only one or two leases on the books, likely in the form of office buildings.

But, as Azih warned, there can be several leases hiding in businesses’ vendor contracts, some of which can be easily overlooked.

“Believe it or not, you may have an agreement with a vendor that contains an embedded lease, which means the lease is hidden within the contract,” he said, pointing to laptops, copy machines, company vehicles, data servers and even parking spaces or coffeemakers that may have such agreements in place.

The new accounting standards require businesses of all sizes to analyze their contracts to determine whether any embedded leases exist, another resource-heavy process that can catch SMBs off-guard. This elevates the risk for companies to remain unaware of these lease agreements until an auditor comes in and uncovers it for them.

“You do not want your auditor discovering these leases – you should discover them,” said Azih. “This is how the complexity can creep in and take you by surprise.”

Unanticipated Consequences

Compliance is, of course, the most imperative goal for businesses of all sizes and types when gearing up for these accounting shifts. But even after companies meet the requirements, Azih noted that there are likely to be long-lasting impacts on businesses’ leasing strategies moving forward.

There is the possibility that these changes will result in fewer leases altogether, he explained.

Under the old rules, corporates found it more beneficial to lease rather than buy, because leases did not have to be recorded as a liability on their balance sheet. Under the new rules, however, leases will be recorded on balance sheets, forcing companies to take a harder look at their lease-versus-buy analyses.

“That incentive to lease is now gone,” Azih said. “What I believe is going to happen is that companies will start performing that lease-versus-buy analysis with a lot more scrutiny.”

It’s yet another resource-heavy process that could place particular pressure on smaller businesses that may be woefully unprepared for the disruption headed their way. That pressure motivated LeaseQuery to launch LeaseGuru, a lease accounting software solution designed specifically for small businesses that may inaccurately assume that these standard changes will have minimal impact on their firms.

As such, Azih is urging companies of all sizes and industries to not waste the extra year given to them.

“My message to all privately held companies, large or small, is don’t let your foot off the gas, don’t be lulled into this false sense of security,” he said. “Don’t squander the gift [of the extension], because that’s what you’ll be doing if you take your foot off the gas.”