Accounting For Leases

Preparing for New 'Bottom Line' on Leases

Part two of a two-part column. In part one of this two-part column, I shared with you that the Financial Accounting Standards Board (FASB) is in the processing of revising guidelines related to the accounting of leases, effectively eliminating the concept of an off-balance sheet operating lease. While the new guidelines aren’t yet finalized, these changes are likely to impact – in some way – almost any business that currently has operating leases. In this second part of the column, I’ll talk more about the potential impact and how to prepare for it.

Obviously, the more significant a company’s leasehold interests are, the greater the impact of the new guidelines; for example, airlines, manufacturers and retailers. Additionally, regulatory rules will likely be impacted for banks and insurance companies. And, because the new guidelines deal with the accounting for leases on the balance sheet, the greatest impact will be on companies issuing audited financial statements. Without getting into too much detail about the accounting specifics – those are details you should discuss with your accountant – rental expenses will no longer be reported on a straight-line basis. Though there will be no difference in lease-related expenses over the life of the lease, expenses will be significantly higher in the early years and lower in later years.

So what does this all mean in terms of how we structure leases in the future? Net lease structures, as opposed to gross lease structures, will likely become more appealing to corporations. For lessees renewing leases, lower contractual lease payments, coupled with shorter lease terms, will help minimize impacts of capitalization. For tenants entering new lease agreements in buildings requiring substantial tenant improvements, these changes, once codified, will likely result in higher lease rates – unless the lessee has the capital to fund the cost of the improvements. The result of amortizing improvements over a shorter lease term will be higher rates.

While the primary goal of the vast majority of commercial Realtors is to serve their clients to the best of their abilities, there will be some who see this as an opportunity to charge tenants additional fees for overseeing tenant improvements funded by lessees. Lessees whose access to and cost of funds are comparable to that of the lessor will likely opt to fund the cost of the tenant improvements themselves in an effort to minimize the liabilities they will be required to place on their balance sheets. If a lessee does a thorough and effective job of obtaining and vetting multiple quotes, there will be no need to involve a Realtor in the oversight of the construction process.

BKD Focus - FASB/IASB Update to Lease Accounting - BKD, LLP

At a joint meeting last week, the Financial Accounting Standards Board and International Accounting Standards Board tentatively agreed to reissue the exposure draft on leases before the end of 2011. The boards originally issued the exposure draft in August 2010, generating significant comments from the public and investors.

Significant changes to the original exposure draft include lessor accounting, lease payments dependent on an index or rate and disclosures in lessee financial statements.

Lessor Accounting

Current generally accepted accounting principles require the lessor to evaluate if the lease falls into the sales, direct financing, leveraged or operating category. In the revised exposure draft, lessors have only one option:  the “receivable and residual” approach, similar to the “derecognition approach” discussed in the first exposure draft. At the commencement of a lease, the lessor will recognize a right to receive lease payments—the sum of the present value of the payments—and a residual asset. The residual asset is initially measured as an allocation of the underlying asset’s carrying amount. The lessor will recognize profit on the leased asset at the commencement of the lease if it is “reasonably assured.” This profit will be the difference between the lease payment receivable and the carrying amount of the underlying asset.

This approach could create complex calculations in multitenant commercial and retail lease situations.

Variable Lease Payments

Leases containing variable lease payments based on an index or a rate have been a source of confusion for both lessors and lessees in the calculation of the present value of the future lease payments. For the revised draft, the boards tentatively decided leases with an index or rate should initially be measured using the index or rate existing at the commencement of the lease. This means potential future lease payment changes based on an index will not include expected rate changes in the initial calculations of present lease payment value. Lease payments dependent on an index or rate will be reviewed at the end of each reporting period after commencement of the lease. If changes are made in carrying values, lessees will account for these changes in profit and loss if they relate to current or past periods and as an adjustment to the right-to-use asset if they relate to future periods.

Accounting for leases, FASB statement no. 13 as amended and interpreted through May 1980 : incorporating statements 13, 17, 22, 23, 26, 27, 28 & 29, and interpretations 19, 21, 23, 24, 26 & 27

CCH Accounting for Leases, Interpretations of FASB Statement No. 13, Accounting for Leases, as Amended

Accounting for leases, comments to the Financial Standards Board

Accounting for leases, interpretations of FASB statement no. 13, Accounting for leases, as amended

Accounting for leases