New Changes to Lease Accounting Rules Will Soon Dramatically Affect Every Commercial Tenant and Landlord in U.S.

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Jones Lang LaSalle is urging businesses across the United States to prepare for dramatic proposed changes to global lease accounting standards with significant impacts predicted on real estate portfolios in the first year of the new regime.

The International Accounting Standards Board (IASB), in conjunction with the U.S. Financial Accounting Standards Board (FASB), has proposed sweeping changes to the accounting of leases. The exposure draft was released in August 2010 with final comments to be submitted by December 15, 2010.

Mindy Berman, Managing Director of Capital Markets for Jones Lang LaSalle, points out that the accounting changes implicate any business that leases assets, including real estate and equipment.

"The changes have been driven by a recognized need for greater transparency in leasing standards by taking off-balance sheet obligations and presenting leases front and center on company balance sheets. This new system demands a stronger long-term view of leases, factoring in future options, based on the balance of probabilities, and in doing so, generating considerable administrative burden," she says.

According to Kenneth Rudy, President of Strategic Consulting for Jones Lang LaSalle, "Rent represents one of the largest operating expenses for businesses. So, the most substantial hit to businesses' profit and loss statements will be in the first year of the rollout as companies report as much as 20% higher initial occupancy expenses for a 10-year lease.  Moreover, the addition of these new assets and liabilities on a company's balance sheet will impact key ratios that many companies rely upon to manage and report on their debt obligations.  In particular, the addition of these balance sheet entries will affect bank's risk-based capital requirements."

Under the new system, rent expenses will be replaced by amortizing leased assets on a straight-line basis with higher front-end interest expenses.

Companies will be required to capitalise all lease obligations on their balance sheets - recognizing their right to use leased property as an asset and their obligation to pay rent and other amounts as a liability.

The changes will potentially affect all current and future leases for both real estate and equipment, elevating the importance of real estate strategies capable of supporting the financial resilience of businesses.

Key industries set to face the greatest impact include commercial banks with large branch systems and retailers which typically lease a substantial portion of their locations.

Ms. Berman added, "We anticipate that under the new standards, companies will need far more information on their real estate leases than they have previously, and be prepared to make robust future projections, in order to accurately report their assets and liabilities for each reporting cycle. If you take retailers as an example, when they are operating on thin margins, the expenses from the first year of these changes have the ability to erase their profit margin entirely."

"Companies should assess their real estate lease exposure and consider whether they need to develop a new strategy for resourcing their asset requirements," she added.

Mr. Rudy said, "Particularly for businesses that draw heavily on lease arrangements, we are encouraging them to start preparing now for the changes - even though the final guidelines are not due for release until of the middle of 2011. They need to gear up for a level of detail that businesses have not had to comply with previously - leading to a significant shift in resourcing, data and information management and reporting. I can't understate the adminstrative impact alone of managing leases at this level of detail."

Ms. Berman suggests that some of the key considerations for businesses include:

• Reviewing current real estate portfolios and lease arrangements

• Re-assessing the principles for owning assets outright compared to lease arrangements

• Re-evaluating lease terms to understand, if not minimize, the impact of capitalization and the attendant administrative challenges

• Coordinating various elements of organisational forecasting to better understand current and future space utilization and other estimates required for capitalization

"Ultimately, businesses need to understand the specific implications of these proposed changes to manage the administrative burden of compliance and be best positioned for easing the impacts," she reiterated.

The proposed changes, likely to be effective no earlier than 2013, will impact companies reporting under either International Financial Reporting Standards (IFRS) or US GAAP including all US-based companies, most European Union-based companies and in Asia Pacific, any company based in Australia, Hong Kong, India, Japan or Korea where conformity to IFRS is or will be followed.

 

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