“New Accounting Standard Could Change How Tenants Lease Space and Substantially Impact the Commercial Real Estate Market” by Frank C. Carnahan
The Financial Accounting Standards Board is working to merge its generally accepted accounting principles (GAAP) with the International Accounting Standards Board standards, with an impact on the accounting for leases. Currently, American and foreign companies list many leases as footnotes in their financial statements. A new standard to be completed next year and enacted in 2013 that will require companies using GAAP to book leases as assets and liabilities on their balance sheets. Companies will record the cost of rent over the remaining term of the lease as a liability (reducing over the term) and their right to use the space as an asset. There will be no grandfathering under the rule, so any active leases will have to be recorded on the balance sheet.
Landlords will record the obligation to provide space as a liability and rents they are to receive as an asset. Landlords currently book their revenue as rental income, but under the new standard rents received will be recorded partly as interest income and partly as a reduction in the obligation to provide space.
A renewal option term must be included in the term and thus included on the balance sheet if it is likely that the lessee will execute the renewal option. Because this increases debt on the balance sheet, renewal options could become less popular. Retailers with contingent rents based on a percentage of sales will have to estimate their sales numbers over the entire term of the lease to book the contingent rent on their balance sheet. These estimates will have to be reviewed and adjusted annually. Having to estimate the likelihood of exercising a renewal option or future sales requires forecasting what the lessee is going to pay rather than their legal obligation to pay.
The new rule is meant to stop significant off balance-sheet lease activity and remove many of the differences in the way companies account for property that they own and property they lease. It may most heavily affect companies
already struggling under heavy debt loads, large retailers with hundreds or thousands of leases, and commercial banks with multiple branches. It may cause more companies to buy their offices and drive down demand for leased space, and shrink the length of leases to diminish the amount required to put on the balance sheet.