FASB Lease Accounting Changes are Here and it's Time to Act

It’s officially 2017 and, at this point, the impending Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) new lease accounting changes should be pretty straightforward, right?

Not so fast.

If you’re not yet up-to-speed (and you should be), this year starts the first of two critical comparison statement years (2017 and 2018) in preparation for the 2019 changes. The new standard (Topic 842) will no doubt ripple through corporate real estate as it requires all leases be recorded on the balance sheet as a “right-of-use” asset and lease liability. These changes apply to publicly traded corporations, not-for-profit entities that have issued a conduit bond, and companies with an employee benefits plan that files financial statements with the United States Securities and Exchange Commission (SEC). “The SEC estimates there are over $3.3 trillion of operating lease liabilities that do not show up on any balance sheet. For some companies, this change will add tens of billions of dollars to their balance sheets and can be over 100% of the liabilities currently represented.”
You might be thinking all corporations need to do is present-value their lease-payment obligation and add it to the assets and liabilities on the balance sheet but it’s more complicated than that.

As it turns out, “The discount rate must be determined for the present-value calculation. Topic 842 requires the “rate implicit in the lease” to be used, which is, essentially, the landlord’s profit. As frustrating as that sounds, if the implicit rate cannot be “readily determined,” then the default rate is defined as the lessee’s “incremental borrowing rate”. Moreover, operating expenses or common-area maintenance charges are now considered goods and services (and therefore excluded), taxes and insurance are no longer considered a component of rent (and therefore excluded) as these are landlord expenses regardless of whether there is a lessee or not, and the lessee has the option to treat the gross lease as a single lease cost and present-value the entire amount (resulting in a lease liability of as much as 30% on the balance sheet). Like I said, it’s complicated.
While many corporations are going to be shocked by the number of liabilities this will add to their balance sheet, a recent article in CoreNet Global’s The Leader magazine (authored by NKF’s own Todd P. Anderson) titled Spotlight on lease accounting: Act now on new FASB standards, provides some levity stating, “These lease-accounting changes are unlikely to materially change any company’s real estate portfolio balance of owned and leased properties or the length of lease term. Companies hold real estate for the needs it serves to the business and not for investment purposes. Decisions are made based on expected duration of use and anticipated flexibility in size. The exceptions are likely to occur when the duration of lease is longer than normal, the extent of tenant improvements necessary are more extensive and specialized, or a company has an excess amount of cash. In these circumstances, a company is likely to buy the real estate with cash, thereby having no impact on total assets or liabilities”.

The time to act is now. Prudent CFO’s are looking past the FASB challenges and onto the silver lining. These new rules will force interdepartmental collaboration with finance, real estate, and lease administration departments. This collaboration all but guarantees data is centralized, systems are compatible, and space utilization is optimized. The collaboration and reporting standards required to meet these new FASB rules means, in the end, CRE organizations might still come out on top.

Stay tuned.

Todd Anderson
Executive Managing Director


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