For years, American companies have enjoyed special accounting treatment for their operating leases relative to the rest of the world. These rules have led to an explosion of interest in leasing space for its tax and accounting benefits in addition to the real estate benefits that it brings. Changes to the Financial Accounting Standards Board's rules for corporate real estate leases to bring them more in-line with the globally accepted International Accounting Standards Board's rules are going to bring a major shift in how leases are treated. If you're leasing space, this change will impact your company's strategy moving forward.
Leases Today
Today, you have a choice as to how you account for your real estate leases. If you choose to treat a lease as a capital item, your right to use the property is an on-balance-sheet asset. You claim a portion of your lease payments as an interest write-off on your company's taxes, and claim depreciation on the balance of the lease that you use up.
Accounting as an Operating Lease
Many companies choose to account for their leased corporate real estate as operating leases, instead. These transactions are off-balance-sheet. In an operating lease, you claim the entire lease payment as an expense and don't show any assets or liabilities. At the same time, you may also be able to depreciate some or all of the cost of your tenant improvements.
The New Standard
Under the FASB 13 standard as it sits today, as long as your lease term is 75% or less of the property's estimated economic life, the lease doesn't give you the ownership of the property. When a company with extensive leased corporate real estate holdings calls itself debt-free, it's because of the FASB 13 operating lease rules.
FASB 13 Changes
The rest of the world isn't as kind to corporate real estate as the US has been. As such, U.S. balance sheets aren't comparable to other ones globally. To this end, the FASB has been working since 2006 to bring its lease accounting standards to parallel international standards. A new draft of the proposed standards has been recently released and the comment period will end on September 13, 2013.
How will the New Standard Affect Me?
Under the new standard, just about every lease of over 12 months will go on your company's balance sheet. Corporate real estate leases will usually qualify as "Type B" leases, which means that you need to put the value of the lease and a corresponding liability on your balance sheet and reduce it on a straight-line basis. This won't change your cash flow and it won't change your company's profitability, but it will change your assets and liabilities. This could affect the perception of your company's performance in the public markets. It'll also affect how you report your company's financials.
How Should I Prepare?
The accounting treatment of leasing is changing, but that's all. If your corporate real estate strategy uses leasing because it's flexible or because it's less expensive than owning, you'll still want to lease. If you're doing it for your operating ratios, though, you may want to reconsider your balance of leased to owned space since you won't get the same benefit from leasing that you once did. You may also want to expedite the process of getting out of spaces that are leased that you aren't fully utilizing. Ultimately, these changes can be significant or subtle, depending on your specific company. Your accountant and your corporate real estate broker can help you adjust your strategy, if necessary.
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