The New Accounting Math
The Pending Implementation of ASC 842
By Paul B. Finch, MBA | 5/07/2019
Beginning January 1, 2020, all growers and producers of wine will be required to report leases under the new Generally Accepted Accounting Principle known as ASC 842. Why is this important? It is important because under the “old” standard, growers and producers were allowed to maintain two different types of leases, (i) Capital Leases, and (ii) Operating Leases. The former, Capital Leases, were capitalized on the firm’s Balance Sheet (and depreciated over time) while the latter, Operating Leases, were expensed on the firm’s Income Statement. Under the “new” standard (ASC 842), the vast majority of leases (with few exceptions), including leases for buildings and property “in use” will be subject to Capitalization.
The New Accounting Math
Under the “new” standard, the way growers, producers, and banks will measure a firm’s financial performance changes significantly in proportion to the dollar value of leases held by the firm. Specifically, many growers and producers will proportionally report higher earnings before interest, taxes, depreciation and amortization (EBITDA) as well as higher free cash flow, a measure of cash earned from operations after capital expenditures. At the same time some credit metrics used by banks, such as liquidity and solvency/leverage ratios will become weaker, placing stress on key banking covenants and conditions (such as Debt-to-Equity, and Total Debt Ratios).
What Can You Do?
It is imperative that growers and producers become proactive as it pertains to planning for the implementation of ASC 842. If growers and producers, and their respective bookkeepers, choose to ignore the effects of ASC on their financial reporting until after the implementation date, they run the risk of lengthy discussions (or worse) with banks soon after the implementation date in the event the “new” standard places their firm in default of key covenants and conditions. The following is how I am advising my clients:
Step 1: Recast and Adjust Two Prior Years Financial Performance
By doing this [recasting two prior years financial statements utilizing the “new” standard] you will be able to measure actual financial performance with the “New Accounting Math” that would otherwise have been applicable had you reported under ASC 842 in earlier years.
Step 2: Meet with Your Bank to Discuss Your Prior Years Financial Performance Under the “New” Standard.
This will greatly assist you and your bank in determining appropriate new key covenants and conditions for your firm, given your specific degree of debt under the “new” standard, and avoid any unwanted surprises.
I am additionally suggesting to my clients that they actively engage in planning, in the form of budgeting, looking forward over the next two to three years while utilizing the “new” standard to ensure continued compliance with key banking covenants and conditions. This is especially important if a grower or producer is anticipating significant capital expenditures (new product lines or expansion of existing operations) going forward.
Paul B. Finch, MBA, is co-founder and Executive Director for Benchmark Solutions (www.benchmarksolutions.us.com).Benchmark Solutions, Inc. is a boutique business advisory which provides high quality corporate finance and management accounting services to some of the most innovative and creative businesses and emerging companies in the beverage, healthcare and technology industries. Paul specializes in the areas of Business Planning, Business Valuation and Business Optimization. You can contact Paul at firstname.lastname@example.org