By Rusty Lane, Consulting Director
Have you ever been driving down the highway and looked ahead to see nothing but clear sunny skies, but suddenly it starts raining on you? Imagine this: Your business is doing well on Monday, and on Tuesday you receive a call from your banker informing you that you have violated your loan covenants, and you are in default. Your banker goes on to tell you that, because you are in default, you now have 90 days to cure the default or find a new source of financing. Well, this storm is coming.
The new lease accounting standard and what it means to your business
The Financial Accounting Standards Board (FASB) has published the Accounting Standard Codification Topic 842 (ASC 842), which is the new lease accounting standard. This new standard will change the way leases are accounted for on a business’ financial statements. The change will apply to fiscal years beginning after December 15, 2020, for all private companies.
The effect of the change will require convenience stores to record all long-term leases, such as underground store tanks, pumps and signs, as current and long-term liabilities on its balance sheet. The recording of liabilities will cause a business’ current ratio, debt-to-net-worth ratio and debt service coverage ratios to change, which could trigger a business’ debt covenants and put it into technical default on its loan agreements.
Many convenience store businesses might not realize how a technical default could affect them. First, the bank will issue a Letter of Default to strengthen its bargaining position going forward. Once in default, the bank can choose to increase rates and fees, call the loan, change the terms, or just force the business out of the bank. Depending on the finances and business model, this could have catastrophic consequences.
What you should do now
So, what can a c-store business do to reduce the impact of this change? After speaking with people in the banking industry, the following financial information should be provided or discussed with your bank prior to the rules taking effect:
- Forecasted financial statements showing the impact of the change.
- Forecasted covenant calculations both before and after the change.
The bottom line
The new lease standard will impact the financial statements of all entities that have leases. If you need help understanding how this will impact your business, your accounting firm should be able to assist you by preparing projected financial statements. If you do go into default, a trusted advisor can help you work with your bank to show the impact on your business and help renegotiate your terms. Will your covenants be adjusted for the impact the adoption of ASC 842 will have on your financials? If you have a lease and that answer is unknown, it may be time to have a conversation with your lender now and not after you’ve reported the effects of adopting ASC 842.
Rusty Lane, CFE, CGMA, CPA, is a Director in Moore Colson’s Consulting Group who specializes in financial advisory services for distressed and troubled companies. He has years of experience working with companies which have received a Letter of Default, turning around their operations and improving their relationship with its lenders.