The current way of listing leases as footnotes in financial statements is going to change in the next two years. Get ready for accounting standards for leases to be enacted in 2013 that will require companies to book leases as assets and liabilities on the balance sheets. GAAP principles are set to be merged with international standards through collaboration between the Financial Standards Board which sets American standards and the International Accounting Standards Board which set international standards.
Leases are affected by the new standard by having to record much higher rent and post it also as a liability including the cost of rent over the remaining term. This change could impact the way tenants choose lease space. Investors could see this as a weakness that could also impact credit ratings even though rent obligations are already taken into consideration by ratings agencies.
The additional disclosure proposes to stop off the balance sheet activity that has been significant up to now for companies struggling under heavy debt loads. It will also affect large retail companies that hold thousands of leases. While the banking is still recovering from the recession they will be significantly impacted due to having multiple branches. It will be necessary to analyze factors that will surely make this complicated for businesses as well as the IRS.
The leasing market could be impacted if the distinction in accounting methods for posting property owned and property leased is merged, also there is a thrust to reduce the length of a lease which will reflect additional debt on the balance sheet. Renewal terms will now list both the original lease term and the option to renew term, meaning a 5 year leas with a 5 year option to renew will be posted as a 10 year lease. There’s more, industries that sign contingent rents based on a percentage of sales will have to estimate their sales over the term of the lease to post it on the balance sheet.
Although landlords currently list all of their revenue as rental income, under the new standards rents will be recorded partly as interest income and partly as a reduction of the obligation to provide space, current standards require this to be recorded only as a liability.
The up side is that when the new standards are enacted, companies that lease space will be considered to be buying the right to use the space for a specified period of time and will record rent as a major liability that will reduce over the term of the lease. These efforts are designed to create transparency. It will take some time to work out the challenges and getting businesses to comply in the face of the current economic downturn in the market this will be a big adjustment for everyone. Start now to analyze how this will affect the way your company will create leases in the future.