Corporate Lease Accounting
Will there be changes affecting accounting treatment for corporations?
September 2009
Written by Bret Hardy – Colliers Integrated Real Estate Solutions
Fact: Pursuant to the World Leasing Yearbook (2009), the international lease volume for public companies in 2007 was approximately US$760 billion.
Based upon this activity, it is obvious that there are trillions of dollars in operating leases (real estate, vehicles, plant & equipment), which are currently not reflected on corporate balance sheets. For decades the Financial Accounting Standards Board (“FASB”), which sets U.S. accounting rules, has tinkered with the idea of restating SFAS 13 (Accounting for Leases). In July 2006, FASB decided to add the discussion topic of how leases are currently being accounted for to its projects agenda. Moreover, this vote was in conjunction with an agreement by the FASB to work jointly with the International Accounting Standards Board (IASB), to try and make a uniformed decision regarding the future treatment of leases. These combined actions were seen as the first formal steps that may ultimately require companies, on both sides of the Atlantic, to recognize operating leases on the corporate balance sheets instead of in the financial statement footnotes.
The objective of the project undertaken by the FASB and IASB is to create a common standard on lease accounting and ensure that the assets and liabilities arising from lease contracts are uniformly recognized in the financial statements. Currently, similar transactions can be accounted for very differently. Additionally, the current standards provide opportunities to structure transactions so as to achieve a particular lease classification. The proposed accounting would significantly change recognition for leases that are now classified as operating leases. Assets will be classified based upon a corporation right-to-use the leased item, whereas a liability will be classified based upon a corporation’s obligation to pay rent. And this is the easy part!
So, why do we concern ourselves with corporate accounting rules? The following represents a few important reasons:
- The current discussion paper advocates changes that will impact both LESSEEs and LESSORs accounting treatment.
- The capitalization of trillions of dollars onto corporate balance sheets will result in a massive shift in financial statement presentation and will affect metrics across all industries. If the latest economic recession has taught us anything, it is that the world is truly flat. Everything affects everything!
- A major incentive for leasing by corporations will be removed. Corporate ownership in commercial real estate, which is currently significant and by some accounts more than 50% domestically, will likely increase dramatically. Wouldn’t this also significantly affect the net lease and sale/leaseback market?
- Net lease structures will likely become more appealing to corporations. Lower contractual lease payments, coupled with shorter lease terms will help to minimize capitalization by corporate lessees. Furthermore, the structure of options and guarantees will be further scrutinized.
- We are certain that the accounting changes will add more DATA on financials, but will it add clarity? Currently, organizations argue that the new rules will only add complexity and uncertainty. With uncertainty comes a more onerous approval process and certainly increases in the cost of accounting for the new lease treatment. In other words, will the likely significant increases in accounting costs result in real substantial benefits?
- For certain, the traction formulated by the combined forces of the FASB and IASB has created a lease accounting juggernaut. Given the fact that no “grandfathering” of existing leases will be permitted, even now the financial scrutiny of lease structuring within corporations has increased. This scrutiny will only add increased time associated with approvals in an already paralyzed transactional marketplace.
What are the next steps by the FASB and IASB? The following is a summarized timetable of next steps:
- March 2009 – Discussion Paper Issued
- March – July 2009 – Public Comment Period
- Mid-2010 – Exposure Draft Legislation and Publication
- Fiscal year end 2011 – New Standard Implementation (No “Grandfathering”)
Colliers is not able to predict whether the accounting rules will ultimately change, nor can we predict the timing of these changes. However, we are certain that there is strong clarity and purpose behind the FASB and IASB, which indicates that they intend to make radical changes to accounting treatment policy. Moreover, based upon the public comments published, there is a tremendous amount of support from the global investment and accounting community. Colliers will continue to monitor the accounting rule discussions and pending rule changes. Let us help you remain informed and knowledgeable of the potential impacts to your business.
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Bret Hardy
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