It’s 8:42, Do You Know Where Your Operating Leases Are?
In years past (yes, I am old.) there was a public service announcement that would appear on television late in the evening. A stern voice would ask, “It’s ten o’clock, do you know where your children are?” Parents of teenagers know that they get to the point where they may not know, or even want to know. But sooner or later, youthful indiscretions will come out and must be dealt with.
Likewise, some banks are still behind the curve on their ASC 842 accounting. Banks are required now to account for leases using this standard, but it has been a change that some have ignored. But like teenage hijinks, accountability for the accounting will eventually come around.
I will leave it to the accounting profession to explain why this rule is useful and important. Your local CPA will be happy to explain and audit it for you. Practically, what it means is that the fair value of the liability for an operating lease must be booked as an intangible “Right of Use” asset for leased property. This is offset by a Lease Liability account and amortized over the life of the lease.
The calculation for the Right of Use asset is:
Fair value of the lease liability (total of lease payments):
+ Outstanding value of prepaid rent
- Cumulative value of remaining deferred rent
+ Initial direct costs
- Lease incentives paid at or before the commencement of the lease
For simple operating leases without prepaids, deferments, initial costs, or incentives, you are just looking at the fair value of the payments. Since fair value depends on a discount rate, we recommend you use the services of a CPA to calculate the initial Right of Use asset. If you use their Ouija Board, instead of yours, it is less likely to be questioned.
ASC 842 applies to financial leases too, but the treatment is about the same as it was under the prior standard, ASC 840.
The amortization of the Right of Use asset should have no effect on reported profit. I see two practical impacts, however. First, it increases total assets and further leverages bank capital. The more leases you have and the greater their value, the more the impact.
Second, the asset is subject to impairment. If you are going to close a branch operating from leased premises, be sure you understand the impact on the bank’s finances.
Since operating leases did not appear on the Call Report prior to ASC 842 - they were invisible to your analyst. But if you don’t report them, you leave yourself open to a “gotcha” at a future examination. You don’t want to have the cops ringing your doorbell at 1:00 in the morning with your teenager in tow, and you don’t want your examiner wagging her finger at the exit meeting!
