Under new lease accounting rules, what was once a long-term operating lease off the balance sheet is now a monetary liability, while the offsetting lease asset is non-monetary.
Because only one side of the equation is monetary (subject to remeasurement), if you have non-functional currency denominated leases, this new lease liability is also a new FX exposure to track and manage. Lease liabilities can be large, so this change could significantly impact balance sheet hedge positions and program effectiveness. There may be good news if these liabilities naturally offset cash, receivables and other monetary assets thus reducing net hedge requirements. Our main concern for our Clients is that the collection of non-functional currency leases may not be part of current balance sheet exposure collection processes that drives hedge decisions. Beware--these lease liabilities may be part of your Jan 1 beginning exposure (for 12/31 year end companies).
While the accounting department has been busy identifying and justifying the fair value of lease assets/liabilities to prepare for 1/1/19 adoption, we have not seen much focus on the currency risk associated with the lease related balance sheet gross ups. Note that the FASB clearly lays out the requirement to revalue the lease liability (for lessors) as follows:
“842-20-55-10 The right-of-use asset is a nonmonetary asset, while the lease liability is a monetary liability. Therefore, in accordance with Subtopic 830-10 on foreign currency matters, when accounting for a lease that is denominated in a foreign currency, if remeasurement into the lessee’s functional currency is required, the lease liability is remeasured using the current exchange rate, while the right-of-use asset is remeasured using the exchange rate as of the commencement date.”
In other words, the liability will revalue through P&L for lessees (like a Loan or Accounts Payable), while the asset remains at the historical rate (like Inventory).
What to look for?
Identify the individuals driving the adoption of lease accounting at your company. Ask them for help identifying leases denominated in non-functional currencies. USD functional subsidiaries in foreign countries generally have leases in local currency, e.g. a USD functional facility in Ireland will likely have a EUR denominated lease(s). There are also a number of foreign countries where leases are routinely denominated in a “major” currency, e.g. many leases in Mexico are denominated in USD, Russian leases are frequently denominated in EUR or USD.
What to do?
Identify the foreign notional value quantified by accounting to record the lease liability. Be sure that the accounting organization is aware that the account should be set to revalue per ASC 842-20-55-10 (you don’t want to go 6 months and find you have a cumulative revaluation adjustment). Understand what rate accounting will use to record the liability initially. Understand how the initial lease liability value will change over time. Understand the timing of when in the month/quarter those changes will be recorded. Include these changes in your balance sheet exposure quantification processes and be sure they are part of your RTZ™ process (Hedge Trackers’ tool to reconcile the FX Gain/Loss line). Include these liabilities in your global exposure reporting going forward. Adjust your hedge appropriately.
When to do this?
Communicate with the accounting organization about the timing of the recording of the lease accounting entries. Communicate to accounting how this will impact the hedging and align your hedge activities to match their recording. For those of you that use the prior month balance sheet rate as the income statement rate for the coming period it might be too late to catch the rate on this potentially substantive exposure change….so the next best answer is to adjust as soon as possible if the leases will be recorded in January.
What is this all about?
The new lease accounting standard going into effect in 2019 requires lessees to record leases like an asset acquisition: the liability of future lease payments are recorded like debt (hence monetary) and the asset used is treated like PPE (hence the non-monetary). The lease asset and liability represent the present value of the future lease payments on the date of lease execution. This notional amount is not revisited unless there is a change in the term (but the liability does revalue if denominated in a non-functional currency). The asset and liability do eventually amortize through earnings by offsetting the asset and liability with cash payments and expense.