Depending on your age you may remember Enron, the company that was masterful at hiding significant off-balance sheet liabilities. Bad case of obvious manipulation, but adhered to GAAP (for the most part or at least they could get it past the auditors…Arthur Andersen, former Big Five accounting firm).
For this purpose, we are going to isolate the topic on operating leases – office leases (“Right-of-Use Asset”).
Part of your job as an accountant beginning as an auditor is to write (really just update) the footnotes to the financial statements. Each year you find the number from last year and plug in the current year number. Rather mindless work. When it came to the lease footnote it was mindless if they didn’t have any deferred rent. Boring and not overly useful to the reader.
This is where it gets interesting, the lease footnote described the lease terms which were typically 5 to 10 years of obligations defined as monthly payments and locations of the properties. Moreover, the footnote included a little chart that described the payments over the term of the lease broken out by year. Great information for the reader of the financial statements. BIG PICTURE, the reader of the financial statements is reading about a liability NOT booked on the balance sheet. Quick math produces a ~$330k un-booked liability with a small $5k month lease, 5% annual escalations for 5 years.
Excluding management, generally, the only outside readers of the financial statements include bankers and tax preparers. Bankers never understood this to be a liability.
Fortunately, beginning 2018, FASB issued a new Account Standard Update to include this liability on the balance sheet. The liability is offset by a “Right of Use” asset and depreciated on a straight line basis effectively getting back to the same income statement impact as the traditional method of handling.
My takeaway is simple, this liability always should have been booked. Regional bankers rarely ever ask about the lease liabilities (maybe because they get their guarantees elsewhere), but this is a much needed important change and makes financial statements more informative to the reader.