Few healthcare organizations fully understand the impact a new lease accounting standard, which takes effect next year, could have on their bottom line—even though the change was announced two years ago.
The new lease accounting standard change—Accounting Standards Codification (ASC) 842—was issued by the Financial Accounting Standards Board in February 2016. Until now, operating leases have not been accounted for on organizations’ balance sheets.
But under ASC 842, operating leases longer than 12 months will be recorded as assets and liabilities on the balance sheet.
It’s a change that could significantly impact financial covenant calculations by healthcare organizations under their borrowing agreements. It could also affect the structure of future borrowing agreements and their choice of financing product.
Kevin Gore, a partner with BKD, LLP, said that based on discussions his accounting firm has had with clients, very few healthcare organizations have reviewed their borrowing documents to determine the potential impact on financial covenant calculations.
The new lease accounting standard goes into effect in fiscal years starting after Dec. 15, 2018, for not-for-profit healthcare organizations and public companies that have debt, whether publicly issued or privately placed. For all other organizations, the new standard must be implemented in fiscal years beginning after Dec. 15, 2019. Organizations may choose early adoption.
To prepare, key actions healthcare leaders can take include:
- Talk with lenders about their interpretation of the new lease accounting standard. It’s important to understand whether recording operating leases on the balance sheet will trigger financial covenant defaults for healthcare organizations under their existing borrowing agreements. If amendments to existing borrowing agreements are needed, consult with your financial adviser and bond counsel regarding the best way to proceed.
- Make sure all new borrowing agreements feature language that excludes operating leases from the definition of debt. Borrowing agreements also should include language that clarifies that operating leases will not be considered when calculating financial ratios.
- Complete a financial statement impact analysis before making lease-vs.-buy decisions. Work with your financial adviser to evaluate all lease-vs.-buy decisions and the structure of all leases in light of the new lease accounting standard.
While the impact of the new lease accounting standard will vary by organization, healthcare leaders can implement these strategies now to mitigate their risk.
Jay Miele is a managing director of H2C, based in San Diego, California. Jenna Magan is a partner at Orrick, based in Sacramento, California.