Lease Accounting Changes Are Coming, And Tenants Need to Be Prepared

Patrice+CookBy: Patrice Cook, Vice President of Cresa

Unlike the US converting to the metric system, this looks like it will really happen. The Financial Accounting Standards Board (FASB) will be enacting changes to Financial Accounting Standards (FAS) that will affect all publicly traded companies, nonprofits, and other organizations following Generally Accepted Accounting Principles.

Specifically, FAS 13 will require any lease obligation over one year to be carried on the balance sheet as an asset and liability instead of in a footnote. The desired effect is to create greater transparency of a company’s required obligation and greater comparability between US companies and those following International Accounting Standards Board (IASB) standards.

Yes, you might have heard rumblings of this in 2008, when the first proposal to change FASB standards to better align to IASB accounting standards was released for public review. Well, it’s back. In May 2013, the board came back with a new-and-improved version for public comment, and it accepted feedback until September 13, 2013, with release of the final plan slated for January 2014. Implementation is scheduled for 2017 with a restatement of financials back two years. There will be no grandfathering of leases. In other words, any lease signed from today on with a term greater than two years will impact financial statements. So, companies with more than a couple of leased facilities will need to be prepared.

The changes will require that all leases over 12 months carry all non-contingent rent on the lessee’s balance sheet as a “Right of Use” asset and a “Future Lease Payment” liability. As the term of the lease expires, expense will be reflected on the income statement.

Complicating this is the decision to have two types of asset classes: Type A is generally for equipment, and Type B leases are leases of real estate property. The good news is that Type B leases will be straight-lined and easier to account for. Type A leases will have accelerated expenses similar to accelerated depreciation. This is similar to how capitalized leases are recorded now, though under the proposed plan, the rules are less definitive.

A lease is a Type A asset under the following circumstances: the lease is for a major portion of the underlying asset’s remaining economic life (15+ years), or the net present value of the lease payment is substantially all of the fair market value of the underlying asset.

Accounting for Type A leases is a bit more involved. Type A leases will be carried on the balance sheet at the net present value of the calculated rent above. The discount rate to be used is either the rate the lessor changes if available, or the lessee’s incremental borrowing rate as of the date of the lease commencement.

There have been many objections to the proposed plan, specifically around the added expense and time it will take to account for leases. Most companies do not have the infrastructure and internal systems needed to place these off-balance sheet assets and liabilities on the balance sheet.

Changes will impact financial ratios, credit ratings, and potential loan covenants, and shorter-term leases will create greater risk to lessors and potentially higher prices to businesses.

In preparation for these new standards, tenants should review and possibly upgrade lease administration systems, collect needed data on leased facilities (Fair Market Value, imbedded base year expenses, etc…), and consider corporate strategy when analyzing real estate decisions such as length of term, tenant improvements, and buy vs. lease.

Patrice Cook is the Vice President of Cresa

About Cresa
Cresa is an international corporate real estate advisory firm that exclusively represents tenants and specializes in the delivery of fully integrated real estate services, including: Transaction Management, Project Management, Strategic Planning, Workforce and Location Planning, Subleases and Dispositions, Portfolio / Lease Administration, Capital Markets, Sustainability, Industrial / Supply Chain, and Facilities Management. With more than 55 offices, Cresa is the largest tenant representation firm in North America.

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