Top tips to prepare for the new lease accounting standards
The way that corporations report the assets that they lease is changing – and that includes the way they report real estate leases. While this is principally an accounting issue, it will require corporate real estate teams to prepare for the upcoming changes with the information that they collect.
Since 2010, The Financial Accounting Standards Board (FASB) and its international counterpart, the International Accounting Standards Board (IASB), have been developing a global accounting standard to increase the visibility of the full extent of companies’ lease liabilities to investors.
In order to provide this greater financial transparency, the accounting boards proposed that the majority of leased assets could no longer be reported as operating leases and therefore hidden from investors as part of monthly profit and loss expenditure. They argued that the majority of leases should be addressed on the company’s financial statements. In short, companies’ perceived debt in their accounting statements would balloon at the beginning of a leasing period.
Many in the corporate real estate sector argued that transferring these obligations to the balance sheet would affect financial ratios, which could ultimately impact borrowing rates, cash flows and increase the demand for short-term lease or purchase agreements.
Last month, the FASB and IASB met to classify how different leases should be reported. While no definitive answer has been given as yet, it appears that all long-term leases (more than a year in length) will appear in some form or another on companies’ balance sheets. On the whole, leases of property would be straight-line leases i.e. they will be equal payments spread out of the lifetime of the lease. In some cases real estate leases, such as those for equipment, will be front loaded with higher payments at the start of the term.
The final rules are expected to be announced in the summer of 2013 and corporations will have to report to that standard in 2016 while accounting for the tracking of lease terms two years prior, so that means there is not a lot of time to prepare.
James Katz, Director, WorkPlace Technologies & Information Management, Johnson Controls GWS, gives his top tips to prepare for the changes.
- Capture essential data for all leases - This includes all critical data, such as lease commencement and expiration dates, option notification dates and terms, rent and income escalations, additional rent contingencies, security deposit and tenant allowance information, and any provided landlord incentives (including free rent and tenant improvements)
- Take advantage of intelligent software - Use a real estate management software that’s capable of producing the necessary calculations and able to integrate with your existing enterprise resource planning (ERP) systems. These systems tie multiple databases together to produce seamless total cost of occupancy reporting. A strong real estate portfolio database tracks the details from operations and then feeds high-level detail into a financial database so that expenses may be processed, revenue can be invoiced, and chargebacks assessed. This provides the foundation for total cost of occupancy reporting and planning
- Make data accessible - Data and reporting should support your company’s response and readiness for the impact of the new rules. While a client’s financial component of an ERP system will provide all necessary FASB / IASB reporting, it is important that the real estate system, as part of your total ERP package, be able to capture the essential data for historical and forecasting purposes. These real estate systems capture the details required for reliable executive support system reporting and effective company decision making
- Analyze the situation – Assess the new standard’s impact on the value of your lease obligations on a capitalized basis. This is done by calculating the total cash payments of your leases, any anticipatory changes in the total lease term length, the imputed interest expense (as derived from your company’s costs of capital), and amortizing the costs over the anticipated length of the lease