Accounting Paper
Summarize the Impact of ASU 2016-02, Leases on the Recording of Leases
According to Casabona and Coville (2018), the Financial Accounting Standards Board (FASB) updated the Accounting Standards No. 2016-02 on leases on the 25th of February 2016. The preceding lease accounting standing was subjected to constant scrutiny for failing to address the financial needs of the users of the financial statements. Therefore FASB used a large amount of its time addressing these concerns. These changes are expected to affect the financial statements since they will impact all the businesses that deal with agreements and lease contracts. ASU 2016-02 required companies to recognize operating lease assets and liabilities on the balance sheet. Assets can be leased either as capital leases or operating leases. Capital leases usually stand in as a debt to possess the basic asset leased. For instance, if you take a loan to buy a car, payments are made in different periods and after some time, you will own the asset after repaying the loan. Operating leases do not transfer ownership of the original assets, and payments are made for the usage of the asset. For instance, if you lease a car from a dealer, the lessee makes payments for the right to use the car, but fails to gain ownership of the car and won’t own it after the lease.
The main difference between the earlier guidance and ASU 2016-02 is that the right-to-use (RIU) asset and the lease are listed under the current financial statement while in the prior guidance, they were known as operating leases. The new standards maintained the two lease classifications but capital leases were replaced by financial leases. The rules that governed these classifications were the same as those in the earlier guidance, although they are stricter. The lessee can only classify the lease as a financing lease if certain guidelines are fulfilled. First, the proprietorship of the lease should be transferred to the lessee after the tenure is concluded, the lessee is given a chance to purchase the asset, which is within their rights, and the lease term runs for a certain fraction of the economic life of the asset. On top of this, the current worth of the lease installments should exceed the impartial worth of the asset and any other residual value as stipulated by the lessee. The new standards on reporting of leases highly affect the financial position statement of the company if implemented. However, it does not have the terms that can significantly change the cash flows or the statements of operations (Morales and Zamora, 2018).
Graham and Lin (2018), say that lease recording is an important procedure to the current stability of the professional brand stability and success, thus it is sensible that if it does not work well, expansive measures should be taken to uphold the operations related to accounting quality of the involved company. Financial statement users are supposed to have an established and clear understanding of the company’s leasing activities for the sake of financial transparency. ASU 2016-2 was formulated to find the best lease liabilities and assets by those that are leased to those being characterized as operating leases under the originally known Generally Accounting Principles. ASU 2016-02 chooses to employ operating leases as its main method of processing and therefore it is important to realize that most companies prefer the reporting of operating lease since it maintains the leased assets and liabilities off the balance sheet, with future lease liabilities revealed in footnotes only. On the other hand, the reporting of a capital lease needs leases assets and liabilities to be reported on the balance sheet.
Discuss at least three (3) Elements Featured in the Current Information Reported by your Chosen Company for its Leases
According to Sakal, (2018), an understanding of the lease that the ASU 2016-02 is intended to change is vital to help in understanding the scale of accounting standard change. The company that I intend to examine to understand this concept is Starbucks. I will look into this company to have a better understanding of how a change in the standards of accounting can be used to address the discrepancies that are faced in professional entities record leases. I am going to analyze three important elements to get more insight and have more information on the association between a company and its leases.
One of the major elements is contingent rent. Starbucks depends on this method when dealing with some leases. Contingent rent is the fraction of lease payments that are not fixed in amount but is founded on the intended amount of a factor that can change other than time passage. This is an interesting element because it is considered to be predictive and therefore calls for a good interaction of prowess, research, and talent that helps professionals to realize success. Contingent rent is also closely associated with an increase in profitability and a decrease. Learning contingent rental agreements also requires one to know that they are established around the operations of the lessee and their monetary performance. The documentations at Starbucks show that a contingent rent liability has build-up occupancy costs in all accumulated liabilities as shown by their merged balance sheets. This a component that calls for a certain level of seriousness, mainly because Starbucks is an enterprise that is known and successful due to its acquisitions, profits, and sales which are important considerations (Stock Analysis on Net, 2018).
The second element concerning this company is its minimum rent expense which is referred to as the smallest total amount that a lessee can expect to pay over a certain lease term. The minimum lease payment gives a certain value to capital lease after discounts. According to Starbucks reports of 2018, for planned escalation rental clauses during the lease terms, Starbucks recorded the minimum rent expense on straight-line fundamental profit, with changes to cash rent incurred as deferred rent in the consolidated balance sheets.
The third element that can be seen on the Starbucks lease activities is the deferred rent liability. Through my examination, I realized that for rent holidays and allowances on tenant improvements that business recorded a deferred rent liability within accrued liabilities, or by other applicable long-lasting liabilities, on the common balance sheets and repays the partial rent under the provisions of the leases as it reduces to rent expenses in the sales’ cost such as in occupancy costs on the common earning statements (Stock Analysis on Net, 2018).
Analyze the Impact of the new Standard on the Reporting of Starbucks Leases
Initially, the rules on financial reporting did not require lessees to pronounce assets and liabilities accrued from operating leases (Graham and Lin, 2018). Starbucks leases retail stores, distribution, roasting, warehouse facilities, and office for corporate administrative purposes under operating leases. Most of its lease deals are marked with tenant improvement allowances, rental holidays, lease premiums, clauses on rental escalations, and other provisions on contingent rent. Adoption of new accounting standards requires companies to book around $3 trillion of lease liability on their balance sheets, depending on estimates of the International Accounting Standards Board. Reporting of Starbucks leases and its key financial ratios such as debt-equity and other leverage ratios are going to be affected adversely with the adoption of this standard, and this would have impacts on their borrowing capacity and debt agreements.
According to Stock Analysis on Net (2018), the new standards will affect how Starbucks records the termination of operations on a company-operated store under operating leases. In cases where terms which may include termination fees, are not yet negotiated with the lessee, the company may have to record the expense after agreeing with the landlord under the new standards. In cases where the landlord refuses to give Starbucks a chance to exit the lease prematurely, Starbucks may assume lease abandonment accrual tantamount to the current value of the remaining lease payments to the landlord and other payments related to the rent like the maintenance of the common area, taxes, and insurance, minus any expected sublease income at the cease-use date. Therefore, the new standards will have effects on the reporting of leases at Starbucks because the company might have to adjust from its old way of reporting and conform to the ASU 2016-02 standards.
Compare and Contrast the Impact that ASU 2016-02, Leases will have on the Financial Ratios of Starbuck Company
According to Sakal (2018), Starbucks usually asks landlords to sign a 10-year lease and after the 10-year mark, the store should be upgraded. This means that there is a significant expenditure of the capital to bring up the store to new standards. Applying the ASU 2016-02 on the 10-year lease plan means that there will be an option to terminate the lease after 5 years. This five-year termination clause in the new standards is meant to cushion the company against any unpredictable future. This adversely affects the equity of the whole investments. The value of the property is related directly to the number of years reaming in the lease term and the strength of your guarantee. In the ASU 2016-02, a guarantee is not usually the issue but the amount of the remaining term. On paper, it is clear that still you have a new 10-year lease. Therefore investors and buyers may not fail to notice the new 10-year lease. Investors will consider the option of termination in a five year periods and so as to avert this risk, they will assume the tenant will be leaving in five years’ time. This simple five-year termination plan will crush the current value as an opportunity cost against a real 10-year lease. Financially, this will be a negative ratio for Starbucks Company.
Determine the Impact of the Changes to Accounting for Leases on the Recommendations of Stock Analysts for Starbucks Company
Changes to accounting leases will have adverse effects on the recommendations of stock analysts for Starbucks Company. Financial statement users and stock analysts needed a lease accounting model that would show the real economic substance of a functioning lease transaction. The changes were effected and had impacts on any stock analyst. In Starbucks, the main impact was that all leases were capitalized resulting in a noteworthy effect on the requirements of reporting and documentation of financial statement analysts. The key financial ratios are also affected by capitalization, especially the debt-to-equity and return on assets cases (Morales and Zamora, 2018).
References
Casabona, P. A., & Coville, T. G. (2018). FASB’s New Accounting Standard on Leases: Overview of Some Key Requirements for Lessees and Implementation Considerations. Review of Business, 38(1), 59-73.
Graham, R. C., & Lin, K. C. (2018). How will the new lease accounting standard affect the relevance of lease asset accounting?. Advances in accounting, 42, 83-95.
https://www.stock-analysis-on.net/NASDAQ/Company/Starbucks-Corp/Analysis/Operating-Leases
Morales Díaz, J., & Zamora Ramírez, C. (2018). IFRS 16 (leases) implementation: Impact of entities’ decisions on financial statements. Aestimatio: The IEB International Journal of Finance, 17, 60-97.
Sakal, D. V. (2018). COMPANY ANALYSIS OF STARBUCKS CORPORATION.