Community banks: don’t forget the new accounting standard for leases – Accounting and auditing



United States: Community banks: don’t forget the new accounting standard for leases

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Regarding future accounting standards, community banks mainly talk about the current standard on expected credit losses (CECL). A new standard, Accounting Standards Update (ASU) 2016-02, Leases (Topic 842), seems to be lurking in the weeds and could have a significant impact on community banks. The impact could be both on the lessor’s side and on the tenant’s side. This article focuses on the impact on tenants for community banks; specifically, what community banks should be doing now to prepare for the new leasing standard.

Under the current lease accounting model, operating leases are not recognized on the balance sheet. Under the new standard, virtually all leases will be accounted for on the balance sheet as a right of use with a corresponding lease obligation. To prepare for this change, community banks should begin learning about the current standard, prepare an inventory of all material contracts with third parties, develop a standard documentation process and controls around lease determination, and assess the potential impact the standard will have on the Bank.

Familiarize the community bank with the new standard

The first step is to train the bank’s management team on 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 on section A relating to amendments to the codification. In this section, the FASB details the evolutions of the standard and also helps to define a lease. Before proceeding to the next step, bank management should carefully read the understanding of the new standard. The FASB has also included videos on the new rental standard. There are post-issue activities and modifications that the bank should also be aware of.

Inventory contracts

After spending some time going through the new standard, the bank should prepare an inventory of all material contracts it has with third parties. The reason for the inventory is to identify potential leases that could be incorporated into standard agreements with third parties. The definition of a lease will change with this new standard, which clarifies that property, plant and equipment can be subject to a lease. Expect this inventory to take some time, as most deals are not all housed in one place in a bank.

Update processes and controls

Once you have a complete inventory of all leases, the bank should consider updating the process and controls around entering into, modifying, and terminating a lease. The process and controls must be established to ensure accurate and consistent records are kept to reflect the proper accounting associated with the new rental standard. There will also be additional financial statement disclosures under the new lease standard, and controls must be in place to support management’s significant judgments and estimates.

Impact on community banking

The final step will be to assess the impact of the new leasing standard on the community bank. The Federal Financial Institutions Examination Council has issued its Supplemental Instructions for Call 2 2018, Number 284. In these instructions, the agencies noted that a right-of-use asset must be weighted at 100% under Section 32 (I) (5) agencies. ‘ regulatory capital rules, and the asset will be included in the institution’s total assets for leverage purposes. Under the accounting for the new standard on leases, it is possible to have a cumulative effect adjustment to retained earnings at the date of adoption. In addition to these regulatory impacts on capital and equity, the bank may have debt covenants that could be affected by these changes.

Effective Dates

ASU 2016-2 applies to public business entities for fiscal years beginning after December 15, 2018, including interim periods during those fiscal years. For public commercial entity community banks, the initial impact of adopting the new leasing standard will be recorded in the March 31, 2019 call report. All nonpublic commercial entity community banks will have an end date. effective for fiscal years beginning after December 15, 2019 and interim periods in fiscal years beginning after December 15, 2020. For community banks of non-public commercial entities, the initial impact of adopting the new rental standard will be recorded in the appeal report of December 31, 2020.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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