When it comes to future accounting standards, community banks are talking mostly about the current expected credit loss (CECL) standard. One new standard, Accounting Standards Update (ASU) 2016-02, Leases (Topic 842), seems to be hiding in the weeds and could have a significant impact to community banks. The impact could be from both the lessor and lessee side. The focus of this article is the lessee impact for community banks; specifically, what community banks should do now to prepare for the new lease standard.
Under the current accounting model for leases, operating leases are not recorded on the balance sheet. With the new standard, virtually all leases will be recognized on the balance sheet as a right-of-use asset with a corresponding lease obligation. To prepare for this change, community banks should begin educating themselves on the actual standard, prepare an inventory of all significant contracts with third parties, develop a standard documentation process and controls around the determination of leases and evaluate the potential impact the standard will have on the bank.
Familiarize the Community Bank with the New Standard
The first step is to educate the bank’s management team with the general requirements of the standard. ASU 2016-02 is available on the Financial Accounting Standards Board (FASB) website at https://www.fasb.org/leases. The standard is divided into three parts, and the focus should be put on Section A on the amendments to the Codification. In this section, the FASB details the changes in the standard and also helps to define a lease. Before moving to the next step, bank management should to read through the understanding of the new standard. The FASB has also included some videos on the new lease standard. There are post-issuance activities and amendments that the bank should also be aware of.
After spending some time going through the new standard, the bank should prepare an inventory of all significant contracts it has with third parties. The reason for the inventory is to identify potential leases that could be embedded in standard third-party agreements. The definition of a lease will change with this new standard, which notes property, plant or equipment can be the subject of a lease. Expect this inventory to take some time, as most agreements are not all housed in one central place at a bank.
Update Processes and Controls
Once you have a complete inventory of all leases, the bank will need to consider updating the process and controls surrounding entering into, modifying and terminating a lease. The process and controls should be established to ensure accurate and consistent records are kept to reflect the proper accounting associated with the new lease standard. There will also be additional financial statement disclosures under the new lease standard, and controls need to be implemented to support management’s significant judgments and estimates.
Impact to the Community Bank
The final step will be evaluating the impact of the new lease standard on the community bank. The Federal Financial Institutions Examination Council posted their Supplemental Instructions for the Second 2018 Call, number 284. In these instructions, the agencies noted that a right of use asset must be risk weighted 100% under Section 32(I)(5) of the agencies’ regulatory capital rules, and the asset will be included in the institution’s total assets for leverage capital purposes. Based on the accounting for the new lease standard, it is possible to have a cumulative effect adjustment to retained earnings on the date of adoption. In addition to these regulatory capital and equity impacts, the bank could have covenants on borrowings that might be affected by these changes.
ASU 2016-2 is effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. For public business entity community banks, the initial impact of adopting the new lease standard will be recorded in the March 31, 2019, call report. All nonpublic business entity community banks will have an effective date for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. For nonpublic business entity community banks, the initial impact of adopting the new lease standard will be recorded in the December 31, 2020, call report.
It is important to take these necessary steps noted above, and the time to start is right now. Please contact your Eide Bailly assurance professional if you need assistance with the new lease standard.
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