In February, 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standard Update (ASU 2016-02) that amends the accounting guidance on leases. The guidance defines new principles for the recognition, measurement, presentation, and disclosure of leases for both lessees and lessors. Under this new standard, a company is required to recognize most leases on its balance sheet, whether it was previously treated as a capital lease or an operating lease. A key difference with the new guidance is the requirement for lessees to recognize, on their balance sheet, lease contracts with lease terms greater than 12 months. Specifically, lessees are required to recognize at lease commencement, both:
- A right-of-use (ROU) asset: representing the lessee’s right to use the underlying asset over the term of the lease.
- A lease liability: representing the lessee’s contractual obligation to make lease payments over the term of the lease.
Leases will be classified as either a finance or operating lease, comparable to the current capital and operating lease classification. Overall, lessor accounting is unchanged from the new guidance, with the exception of some revisions made to ensure consistency with the revised lessee guidance.
The new standard will impact dealership financial statements but the impact is not expected to be as significant as other industries, such as telecommunications, airlines and banks. The range of the balance sheet impact is currently being evaluated by dealership groups. In its March 31, 2018, SEC Form 10-Q filing, AutoNation disclosed that it expects to recognize additional ROU assets and operating liabilities ranging from $375 million to $475 million. CarMax disclosed in its May 31, 2018, Form 10-Q filing that it expects to record a $400 million to $430 million increase in both assets and liabilities on its balance sheet as a result of the new lease standard. Beyond the financial statement effects, the new standard may affect multiple aspects of business operations, including certain key metrics and debt covenants. Some of the potential metrics that may be impacted by the updated guidance include the following:
- Leverage ratio – debt/equity
- Current ratio – current assets/current liabilities
- Debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) – debt/EBITDA
- Return on assets – net income/assets