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Owner
Outlook: continued
This change will have a profound impact
on a company’s capital structure, leasing practices, and
operational processes (it has been estimated that the
accounting change will add no less than 1.35 trillion
dollars of assets and liabilities to company balance
sheets), and property owners should be prepared for a
shift in the “market standard” for lease lengths and
rental rate structures.
How do the Current Lease Accounting Rules
Work?
At present, most standard commercial
leases are defined as Operating Leases - those in which
the owner of an asset gives the lessee a right to use
the owner's land or other assets. The lessee never owns
the asset and must return it to the owner/landlord after
the lease ends. The lessee's rent payments are listed
as operational expenses on the P&L statement, but the
leased asset stays off of the lessee's balance sheet for
the simple reason that the lessee doesn't own it.
Alternatively, non-real estate assets
such as vehicles, copiers, and computer equipment are
often "leased" as Capital Leases, in which the lessee
ultimately acquires ownership of the leased asset by
making a series of payments for the use of the asset,
and then exercising an option to acquire ownership of
the asset at the end of the lease term. Under the
current lease accounting rules, only assets leased
pursuant to Capital Leases are required to be recorded
on a lessee's balance sheet. Under the new Rules, all
leased assets will have to be shown on the lessee's
balance sheet.
Why the Change?
FASB and IASB have decided that allowing
lessees to keep certain assets off their balance sheets
has created too large of a "blind spot" in the system.
The objective of the new Rules is to increase
transparency and comparability among businesses by
requiring them to recognize their leased assets and
liabilities on their balance sheets. The new rules will
change how businesses calculate their value and will
have an impact on real estate management systems,
financial planning, budgeting and forecasting systems,
and tax planning.
How the New Rules Will Affect Both
Lessees and Their Owners/Landlords
Lessees will list their leased assets on
their balance sheets, and they will also record their
future lease payment obligations over the course of the
lease as an up‑front liability at the start of the
lease. Adding such a significantly-sized liability to
the balance sheet may prove harmful to the ability of
certain businesses to attract investors and
lenders. Therefore, owners/landlords can expect not
only new lessees to raise new negotiated terms, but also
current lessees to seek renegotiation of their existing
leases, as follows:
·
Shorter Lease Terms. The
longer the lease term, the greater the up-front future
lease payment liability a lessee must record on its
balance sheet. Therefore, owners/landlords can expect
lessees to ask for shorter lease terms and more renewal
options.
·
Triple Net Leases. The
new Rules will require a lessee to record only the
present value of future lease payments such as fixed
rent during the initial term of the lease. As a result,
lessees will want to reduce the liability reported on
their balance sheets by separating the non-reportable
future variable payments (such as taxes, insurance, and
CAM expenses) from fixed payments. The clearest way to
accomplish this is to structure a triple net lease in
which the lessee agrees to pay a smaller fixed rent
augmented by a pro‑rata share of taxes, insurance, and
CAM expenses, and repair and maintenance expenses that
were previously included in the fixed rent.
While these new rules will undoubtedly
affect lessees more than they affect owners/landlords,
the latter will surely be affected as the new rules
cause lessees to make new demands during lease
negotiations. To attract and retain lessees in this new
accounting landscape, owners/landlords will need to be
able to understand the financial pressures that will be
placed on their lessees in connection with the new
rules. This will require owners/landlords and lessees
to work hand‑in‑hand with their accountants and legal
counsel in order to carve out leases which protect
owners/landlords while allowing lessees to maintain
control of their financial statements.
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