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Private and nonprofit organizations faced a tall order in February 2016. That’s when the Financial Accounting Standards Board issued new accounting standards requiring lessees to report real estate liabilities on their balance sheets.
The standard was set to take effect by mid-December 2019, but FASB issued a one-year extension in October that gives such companies more time to compile, understand and calculate leasing data. The original deadline will remain unchanged for large public banks.
As an article published by BOMA International explains, over 85% of lease commitments aren’t listed on corporate balance sheets. Once the new standard kicks in, any equipment or real estate lease with a term longer than 12 months must be recorded on the balance sheet as a “right-of-use” (ROU) asset with a corresponding lease liability.
The standards won’t change landlords’ operations much, but tenants will demand improved transparency in their lease agreements. The impact will be especially dramatic for retailers, chain restaurants and other sectors that rely heavily on leasing for their operations. The new reporting requirements will force companies to be more rigorous in recording leasing data and the types of information that must be tracked. “Transparency around contract details will be critical,” according to Stephen Miller, global lease accounting lead for JLL and author of the BOMA article.
One key change requires renewal options to become part of lessees’ reported liability if a company is reasonably certain it will exercise its option to renew. Shorter leasing terms will reduce reported liabilities, and operating and service contracts will be excluded from balance sheet calculations.
Some experts calculate that corporate debt loads will increase by an average of 58% under the new rules. Rising debt loads elevate a company’s overall financial risk and can set off alarms with investors and shareholders. Loan covenants and key financial ratios, such as debt-to-equity and return on assets, could be affected and potentially force some companies to renegotiate or redraft their corporate debt covenants.
The BOMA article also notes that tenants might look to eliminate the standard practice of including several three- or five-year renewal options on a five-year lease. Those options must be included on the balance sheet under the new standards, so doing without them will reduce the liabilities to report. The timing of new leases may become another sticking point, since the balance sheet implications begin as soon as a lease commences.
Banks, claiming that having to book losses up front would discourage lending, are pressing for the postponement to be extended to all filers. “We remain deeply disappointed that FASB has yet to take the logical next step of pausing implementation for all companies until a rigorous quantitative impact study can be completed to assess its full effects,” Rob Nichols, president and CEO of the American Bankers Assn., said in a statement. “If FASB chooses to proceed over the objections of market participants, we urge lawmakers to quickly take up the bipartisan ‘Stop and Study’ bills in both the House and Senate to ensure the economy is spared the potential harm from a new accounting standard that carries too much unnecessary risk.”
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