Impact of New Lease Accounting Rules on Regulatory Capital
In February 2016, FASB issued Accounting Standards Update No. 2016-02, Leases. While this article will summarize some of the highlights of the new accounting guidance from the lessee’s standpoint, the real purpose of the article is to discuss the recently issued Call Report Instructions that reveal how the new rule will impact regulatory capital.
Two of FASB’s stated goals were:
- A more faithful representation of the rights and obligations arising from leases by requiring lessees to recognize the lease assets and lease liabilities that arise from leases in the statement of financial position and to disclose qualitative and quantitative information about lease transactions…
- Decrease opportunities for organizations to structure leasing transactions to achieve a particular accounting outcome on the statement of financial position.
Under current accounting rules, lessees recognize lease assets and lease liabilities on the balance sheet for capital leases, but not for operating leases. Under the new standard, lessees will be required to record a right-of-use (ROU) asset and a lease liability on the balance sheet for operating leases. The new standard generally permits a lessee to make an accounting policy election to exempt leases with a term of one year or less at their commencement from balance sheet recognition.
For community financial institutions that are not a “public business entity” under GAAP, this new standard is effective for fiscal years beginning after December 15, 2019, with early application permitted. Also, the new standard will be applied on a modified retrospective basis, which means that it will be applied to existing leases at the time of adoption, along with new leases entered into after adoption.
Thus under the new standard, more lessees, including financial institutions, will be recording more lease assets and related liabilities on their balance sheets.
So now arises the question--how will the recordation of this new ROU asset impact total assets and risk-weighted assets for the purpose of determining regulatory capital ratios. Will there be a carve out/exclusion for this intangible asset? Might there be some phase-in period to soften the potential impact?
We get our answer from the recently issued Supplemental Instructions for the Call Report. There, we find guidance that tells financial institutions that the ROU asset will be added to Schedule RC, item 6 “Premises and fixed assets”. This guidance is consistent with previous guidance on reporting capital leases. The Supplemental Instructions provide no relief or exceptions for the treatment of this new asset as it impacts total assets and risk-weighted assets-it will be treated the same as any other acquisition of premises and fixed assets.
We recommend all financial institutions assess the impact that the implementation of this new standard will have on their balance sheets and resulting capital ratios. If we can be of assistance in this analysis, please give us a call.