How Will New Lease Accounting Rules Affect You?
If you borrow money from a bank for farm operations, you will likely have loan covenants that call for certain net worth to debt ratios. Recently released accounting standards regarding lease accounting may require your bank to change these covenants. Knowing how these new rules will affect your farm is important so that you can plan with your bank accordingly. The good news is that these rules do not go into effect until 2020.
If you purchase equipment using a capital lease, the rules do not change too much. There is some tweaking on how the lease is calculated and how to report the lease in the your footnotes to your financial statements, but that is about it.
The major change deals with operating leases, especially cash lease farm ground. If you rent farm land under a cash lease and the contract is for more than a year, you will be required to capitalize the lease payments as both an asset and a liability on your balance sheet. Many farmers have rental arrangements that can last ten years or more. Also, if the lease is only for a year, but it is highly likely that the lease will continue, the rules require you to determine your estimated length of the lease and book those payments too.
For example, assume Farmer Jones cash leases 1,000 acres at $300 per acre on a five-year contract. He will be required to book an asset of about $1.5 million (it will be less due to an “interest” discount) and a liability for about the same amount (there can be differences based on timing of lease payments). Under the old rules, no asset or liability was required. If his net worth was $1 million and he had debt of $1 million, his net worth to debt ratio was 1:1. Under the new rules, his net worth remains the same, however, his liabilities now rise to $2.5 million. This reduces his net worth to debt ratio from 1:1 to .4:1 which is a dramatic drop even though economically nothing has changed.
Additionally, if Farmer Jones had farmed this ground for many years and is expected to continue farming after the five years is up, he may need to book even more of a liability.
The key is to know the new rules and how it might affect your operation and your relationship with your bank.
Paul Neiffer, CPA