Pub. 5 2016-2017 Issue 2

20 San Diego Dealer The standard utilizes an accounting concept that considers the right-of-use lease asset to be a long term nonfinancial asset similar to intangibles and property, plant and equipment, even though you’ll be required to classify the portion of the lease liability to be paid in the coming year as a current liability. What leases do most dealerships have that they need to consider? ASC Topic 842 redefines the term lease, making it broader than under legacy guidance (ASC Topic 840) in certain circumstances. Under the new definition, a contract is—or contains—a lease if the following two conditions are met: • The contract explicitly or implicitly specifies the use of identified property, plant, or equipment. • The contract grants the customer control of the identified asset for a period of time in exchange for consideration. Dealershipsmay be party to amyriad of different leases based on the definition above, ranging from large assets such as real estate, data man- agement systems, and fleets to smaller items such as copy machines. When will the guidelines take effect and how should dealerships prepare for them? The new guidance is required to be adopted by public business entities (and certain not- for-profit entities and certain employee benefit plans) in fiscal years beginning after December 15, 2018, including interimperiods within those years. Nonpublic business entities must adopt the new guidance in fiscal years beginning after December 15, 2019 and interim periods within the following fiscal year. Both public and nonpublic business entities may early adopt the new guidance. Once adopted, the guidance must be applied on a modified retrospective basis, starting with the earliest period pre- sented in a company’s financial statements. This means dealerships should begin accumulating information now for accounting under the new standard so that information for 2017 and 2018 is readily availablewhenpreparing 2019 financial statements. Any leases you currently have, or will be entering into, will be shown on your balance sheet once the new guidance takes effect. What is the difference between a capital lease (soon to be referred to as a finance lease) and an operating lease, and howwill they changewith the new guidelines? Careful consideration must be given when determining if a lease agreement qualifies as a finance lease, which was formerly referred to as a capital lease. Often, the proper analysis has not been completed by dealerships to determine whether the arrangement is a capital or operating lease. Currently, themost significant financial statement difference between a cap- ital lease and operating lease is balance sheet recognition with often little attention focused on the front loaded expense recognition of a capital lease versus the straight-line expense recognition of an operating lease. Under the new lease accounting guidance, the balance sheet recognition will be nearly the same for both lease classifications and the front loaded expense treatment and statement of cash flow classification are likely to gain more attention than they do today. While the total cash flow impact will be the same under both methods an operating lease will be classified 100% as operating cash flows and finance lease will have a portion classified as a financing and a portion classified as an operating activity. Additionally, the increased expense recognized in the earlier years of a finance lease could impact key financial ratios of the dealership, requiring additional planning and discussion with a dealership’s financial statement users, including its owners, third-party lenders and franchisors. Arrangements classified as a finance lease will generally have a higher EBITDA than those classified as an operating lease. What impact will this new guidance have on dealerships? Aside from potentially requiring a significant amount of work from your accounting depart- ment, ASCTopic 842 could change the numbers reflected on your balance sheet, whichmay alter stakeholders’ perception of your company’s financial strength. Many companies’ largest Continued from page 19