The new leasing standard released in February 2016 by the Financial Accounting Standards Board (FASB) will unquestionably change the dynamics of lease negotiations moving forward. Since most businesses are involved in some type of leasing arrangement, you need to prepare for the new FASB standard as it may impact your company’s bottom line.
Overview
The new FASB leasing standard takes effect for the interim and annual reporting periods of public business entities, as well as certain not-for-profits and employee benefit plans, for fiscal years beginning after December 15, 2018. For all other entities, including private companies, the new lease accounting standard is effective for annual reporting periods beginning after December 15, 2019 and interim periods beginning after December 15, 2020.
The new standard will require lessees to recognize assets and liabilities on their balance sheets for most of their leases. Regardless of their length and term, all leases are subject to the recognition criteria in the new standard. Under an available accounting policy election, a lessee may elect to not record an asset and a liability for a lease with a term of 12 months or less, as long as the lease does not include a purchase option that the lessee is reasonably certain to exercise.
The pain point for commercial real estate owners will be when the time comes to negotiate new lease agreements. The new leasing standard will likely change the nature of these negotiations as tenants will be seeking shorter leases to minimize the financial impact of the new standard. Depending on which side (lessee or lessor) has market leverage, we may see a trend towards shorter leases or, instead, a new middle ground will emerge. One thing is for certain, this standard may radically change the negotiation process for leases moving forward.
Preparing for the new standard
While the adoption dates for the new standard are well in the future, companies should not delay their assessment of the leasing standard’s impact on their financial statements. As a starting point, they should begin proper training for their accounting staff and consultants.
And what kind of training is necessary? Stakeholders will need to familiarize themselves with the new standard and the accompanying changes to U.S. GAAP (Generally Accepted Accounting Principles). Business leaders should encourage their employees, especially those that deal with overall accounting and lease accounting issues, to complete this training well ahead of the adoption dates to troubleshoot any potential issues.
Sector impact: retail may be hardest hit
Which commercial real estate sectors may be affected most by lessees who want to restructure their lease agreements at renewal time because of the new standard? We believe the biggest impact be in the retail space. Retail companies may see the implementation of the new standard as an ideal time to consider buying vs. leasing, or, at minimum, making updates to the terms of their renewal contracts. These retail companies may also wish to review their entire real estate portfolios and consider issues such as maintenance management, space and facilities management, and general capital project management, in order to optimize efficiency and bottom-line results.
Multinational impact: dual reporting may be necessary
For a multinational company that holds leases outside of the U.S., preparation is of utmost importance. Differences between local accounting standards overseas and U.S.-based reporting should be anticipated. Some companies doing business globally may require dual reporting structures to comply with both U.S. GAAP and International Financial Reporting Standards (IFRS).
New lease standard does offer opportunities
Preparing for, and complying with, the new leasing standard is not all bad news. In fact, smart businesses should treat the implementation of the new standard as an opportunity to re-evaluate, and then optimize, their leasing strategies. Companies should closely examine their current leasing contracts. They should also revisit their lease vs. buy decision criteria in light of the standard to determine which option makes the most sense for their business.
The implementation deadline for the new FASB lease standard is approaching and will be here before we know it. It will impact most businesses well beyond an accounting exercise. As such, now is the time for your business to examine its leasing process and gain input from your key business leaders.
Howard Barash serves as principal of CohnReznick's advisory practice and has more than 30 years of experience in the real estate capital, multifamily and commercial real estate markets.