For the last few years, the US-based Financial Accounting Standards Board and the International Accounting Standards Board have been reworking the way that tenants account for commercial real estate leases. One proposal was to have the US follow the international lease accounting standards, which would essentially end the concept of an operating lease. That proposal has been modified for the time being in the United States, but the IASB's changes for the rest of the world are going forward.
The IASB's Plans vs. the FASB's PlansUnder the latest draft of the IASB standard, there will only be one type of lease. The "Type A" lease is roughly similar to the current definition of a capital lease. The lease gives the company an asset -- the right-of-use of the leased space -- and makes a liability out of the payment stream. One of the challenges with a Type A lease is that payments aren't fully deductible as expenses. Instead, the interest portion of the expense is deducted while the reduction of the value of the right-of-use asset gets depreciated.
The FASB's new lease accounting standards have a key difference from the IASB's. While both IASB and FASB will treat already on-balance-sheet leases much like they currently do, operating leases are treated differently. Under the standard, American companies will also have to put their leases on-balance sheet. They will, however, be able to treat their payments the same as they currently do -- as a single expense instead of a split up one.
Why Lease Accounting Standards Changes MatterRight now, tenants that report under the FASB's guidelines, usually known as GAAP, are able to expense their entire operating lease payment. If you pay $20,000 a month for your office space, you write off $20,000 per month. Compare this to what you would do if you owned a building. You would write off the interest portion of your mortgage payment and depreciation on the building. Frequently, those two payments add up to less than you would pay on a lease. While this won't change in the United States, it could change in the rest of the world when you have to follow the stricter IASB standard.
Furthermore, leasing carries another important benefit that goes beyond taxes. When you sign an operating lease under current rules, you don't have an asset or a liability. This means that, compared to a company that spent the same money on owning buildings, you have fewer assets and fewer liabilities, improving your company's operating ratios. Moving forward, you won't have that benefit.
Ultimately, lease accounting standards changes impact how your financial statements look. They typically will not impact how much you actually spend or impact your net cash flow. The benefits (or drawbacks ) of leasing also don't change, other than the loss of the benefit of being off-balance-sheet. This means two things. First, it's important to talk to a qualified accountant to understand how these changes will impact your company. Second, it means that your corporate real estate decisions shouldn't change that much as a result of these new standards. Leasing is still a good idea for many companies.