Lease accounting implications for the consumer industry

Preparing for the new lease accounting standard in the consumer industry

The leasing standard is meant to address concerns about lessees using operating leases as a form of off-balance-sheet financing. And the pressure is on for consumer industry companies to prepare. The new leasing standard goes into effect for calendar periods beginning January 1, 2019, for public business entities, and January 1, 2020, for all other entities. Yet all entities have the option to adopt the new leasing standard at the same time they adopt the new revenue recognition standard.

As they dig into the background on the new leasing standard, consumer industry companies will notice two big changes:

1. Nearly all leases lasting more than a year will need to be captured on the lessee’s balance sheet—even operating leases, which have traditionally been expensed.
2. Companies will need to look more closely at their service contracts for embedded leases—and then account for those requirements as leases, not services.

What can consumer industry companies do now to prepare? Put your spreadsheets aside—nearly all companies in the consumer industry will need to deploy new IT systems to store and manage their lease data going forward. And because the required systems and processes could take many months to implement, time is of the essence.

It’s time to get in high gear. See the information below for a closer look at how the new leasing standard could impact companies in the automotive, retail, wholesale, and distribution, consumer products, transportation, hospitality, and services industries.

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Automotive companies

The new lease accounting standard will likely impact companies in the automotive industry. It will particularly affect original equipment manufacturers (OEMs) and suppliers (tier one and tier two), which tend to rely heavily on supply contracts involving dedicated production facilities.

For automotive companies, the new lease standard will likely affect every level of the automotive industry in a variety of common business areas, including:

• Outsourced warehousing

• Traditional operating leases

• Embedded leases in services contracts

Lower-tier suppliers and companies in the aftermarket business will also need to evaluate their supply contracts. They will need to understand the new lease standard and carefully assess its impact. One reason for this: Their situations are less clear-cut and will require more judgment and accounting expertise to make the correct determinations.

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Consumer products companies

Consumer products companies—particularly beyond the obvious areas such as real estate, equipment, and automobile leases—could experience a significant impact from the new lease accounting standard. One thing to watch out for: Sometimes service arrangements could meet the definition of a lease in accordance with ASC 842. Here are a few examples:

• Contract manufacturing. If an entity takes substantially all the output from a vendor’s production facility or dedicated line and also determines what, when, and how the product will be produced, generally those contract manufacturing services would be considered leases.

• Outsourced warehousing. If a service provider only has one warehouse; an entity obtains 90 percent or more capacity; and an entity makes decisions about what, if, and when items will be stored, then the arrangement will meet the definition of a lease, not a service.

• Logistics and delivery services. If a service provider has vehicles or other plants, property, and equipment (PPE) dedicated to an entity, the associated assets should be accounted for as a lease.

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Retail, wholesale, and distribution

Retailers, wholesalers, and distributors should take note: The new lease accounting standard is likely to have a major impact on these industries. But retailers, in particular, need to do their homework. They typically have a large number of operating leases (and, potentially, leases embedded in service contracts) that will now need to be captured on the balance sheet.

Such leases could include everything from real estate leases for individual stores and distribution centers to vehicle leases and office equipment leases. They could also include embedded leases on property, plant, and equipment associated with a service or supply contract.

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Transportation, hospitality, and services

Companies in the transportation, hospitality, and services industries will also be impacted by the lease accounting standard.

• Transportation companies will likely see a big increase in the size of their balance sheets, creating a significant ripple effect throughout the business and potentially onto the bottom line.

• Hospitality companies are expected to be greatly affected by the new standard. Large hospitality companies typically have thousands of operating leases—or service contracts with embedded lease components that need to be treated as operating leases. These all now need to be aggregated and analyzed, then accounted for on the balance sheet. Also, the recognition, measurements, and disclosures of hotel room revenue will need to be evaluated for material difference under ASC 842, as compared to those under ASC 606.

• Services companies, in theory, could experience a relatively low impact because they tend to be less reliant on property, plant, and equipment leases. However, most services companies are not “pure” service businesses and could find many aspects of their operations significantly affected by the new standard.

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