Big changes are in the works for the financial accounting of commercial leases. The Financial Accounting Standards Board (FASB), which sets American standards, is working with the International Accounting Standards Board to align its generally accepted accounting principles (GAAP), with international standards.
The two boards have come up with a new standard, to be completed next year and enacted in 2013, requiring companies to book leases as assets and liabilities on their balance sheets. Under current standards commercial leases are frequently only mentioned as footnotes in the company’s financial statements.
The accounting change is meant to stop “significant off-balance-sheet activity for leases,” said Russell G. Golden, the technical director of FASB. Placing commercial leases on the balance sheet, will change the way companies view their lease. “On the day the standard gets implemented, all these companies will suddenly have to record much higher rent, and they are going to have to record this as a significant liability on their balance sheet, ” says Mindy Berman, a managing director of corporate capital markets at Jones Lang LaSalle.
A likely impact of the accounting change will be to shorten the length of leases. “If you have a 10-year lease, it will mean putting twice as much debt on the balance sheet as a five year lease, so some companies may want to go short term,” said Dale F. Schlather, an executive vice president for Cushman &Wakefield and chairman of the New York chapter for the industry group CoreNetGlobal.
Lease renewals will also be affected by the accounting rule change. Many
companies sign leases with renewal terms, like a five-year lease with an option to renew for another three years. Under the new rules, if it is likely that the company will execute the renewal option, they must account for the lease as if it were actually eight years. This will mean showing more liabilities on the balance sheet, making renewal options less attractive.
The accounting rule change may also lead more companies to buy their space as opposed to leasing it. One of the advantages of leasing has been to keep the obligation off the books. When that advantage is taken away, buying will be more attractive for some companies.
According to Julie Satow, writer for the New York Times many companies say they support recording their leases on their balance sheets in the interest of transparency. What is controversial, however, is how to enact this change. Having to estimate the likelihood of a renewal option, “requires forecasting what you are going to pay rather than the legal obligation of what you will have to pay,” said John Hepp, a partner at the advisory firm Grant Thornton. “Accounting is supposed to be pragmatic, but now we are being asked to think more like economists. That is a whole different ballgame.”
This accounting rule change illustrates the importance of getting good, time advice in making commercial leasing decision. In addition, to obtaining the help of an experienced and knowledgeable commercial leasing broker, a company should consult with their CPA prior to making a real estate decision.
Article by: Mark Casey
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