Member Perspective: Accounting Changes

Thousands of U.S. businesses could be affected by a proposed regulatory change that would substantially shift the way they account for the real estate they lease, and could have a seismic impact throughout the American market and beyond.

The proposed change, which could take effect as early as 2017, would prevent American companies from listing leases as an “operating” lease, an off balance sheet transaction and would require them instead to include all leases on their balance sheets in one form or another.

Essentially, leases would no longer be classified as a “capital” lease or an “operating” lease but referred to as a “Type A Lease” or a “Type B Lease.” The typical commercial real estate lease would be a “Type B Lease” and may cause a lessee to account for their lease on the lessee’s balance sheet.

The proposed rules from FASB & IASB (Boards) would make it necessary for companies to include all lease liabilities and assets on their financial statements, forcing firms to list all of their leases on their balance sheet as a liability, and would provide a more complete picture of their financial well-being.

The updated reporting requirements may make some companies appear more leveraged. This could affect their credit ratings and create problems with existing loan covenants, especially if long-term leases are involved. The new rules would apply to existing leases, regardless of when they were implemented, but would not affect how a lease is treated for income tax purposes.

Proponents of the change contend that it will create uniformity in global accounting standards, and make it easier to compare the financial status of various companies now that they all will be required to include leased assets and liabilities on their balance sheets.

The effect on companies could be dramatic. Adding the increased liability to their balance sheets may force some businesses to have their current loans called because of changes in their financial ratios. And it could make it much more difficult for them to attract investors and lenders.

Owners and landlords would also feel the pinch from the rules change. Companies discussing new leases would likely try to negotiate more flexible terms, while businesses currently leasing space would try to renegotiate for shorter lease terms and more renewal options. At the very least, those companies would be forced to monitor renewal dates and termination clauses to a far greater degree than before.

What all this means to owners and landlords is they may well have to change the way they do business. For starters, they’ll need to develop strategies to address far more demands from lessees during negotiations. The expectation is that many companies would respond to the new reporting requirements with demands to renegotiate and restructure their current leases.

Financial industry experts say adoption of the proposed change is virtually assured. The shift in rules would significantly change the playing field for commercial real estate brokers, who would be able to count on new opportunities as more companies respond to the rules change by buying, rather than leasing property. Any time there is a change in the market, there is opportunity!

Joe Larkin is a 30+ year veteran of the commercial real estate industry. He is a Senior Instructor for the CCIM Institute, and received his MS in Real Estate and Construction Management from the University of Denver along with the CCIM, CIPS and SIOR designations. For the complete article visit www.JoeLarkinCCIM.com.