FASB, IASB Consider New Standards for Lease Accounting

The United States Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued a revised exposure draft outlining proposed changes to lease accounting that will alter current accounting and financial disclosure requirements for both real estate and equipment leases.

The United States Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued a revised exposure draft outlining proposed changes to lease accounting that will alter current accounting and financial disclosure requirements for both real estate and equipment leases.

This was a revision of the 2010 proposed Accounting Standards Update, Leases. The revised exposure draft will continue to require a lessee to recognize assets and liabilities for the rights and obligations created by a lease, but has modified the method of determining expense recognition and other reporting requirements that were introduced in the original draft.

“The proposed changes will significantly impact the commercial real estate business, as well as financial positions and operations,” Mindy Berman, Jones Lang LaSalle’s managing director, capital markets, told Commercial Property Executive. “For CRE, multi-tenant content, tenants are going to have to capitalize all of their leases on balance sheets. Essentially, they will take present value of operating cash flows and put it on balance sheet as liability.”

According to Berman, the impact on CRE could exceed $1.3 trillion in balance sheet capitalizations. 

Currently, accounting models for leases require lessees and lessors to classify their leases as either capital leases or operating leases and to account for those leases differently. This method has been criticized for failing to meet the needs of users of financial statements because they do not always provide a faithful representation of leasing transactions.

There has been a widespread request from users of financial statements and other stakeholders to change the accounting guidance so that lessees would be required to recognize assets and liabilities arising from leases.

“The biggest issue people had with what they proposed was not that lease applications were going to go on the balance sheet, but the way rental expense was going to be recognized,” Berman said. “What it was is that the rental expense operating lease today is straight-lined. With the first exposure draft, the profile for lease related expense was going to shift to be frontloaded. You would recognize more of the rent expense in the first half of the lease and it would decline over time. You had a profile that was almost inverse to cash flow. With a real estate lease you typically have rental escalations every year. For real estate concerns and leases in particular, that was a huge issue. What they did was they created two different types of leases.”

The proposed effective date has not yet been determined but it appears the boards want to finalize the standard in 2014 and will require reporting entities to account for leases on a retrospective basis as of the date of transition.

Berman added that the objective of the revised Exposure Draft is to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information. While REITS have things the way they want, institutional ownership is going to lose its current accounting model. 

“Today, investment companies in the U.S., and this includes pension fund managers, account for investment properties on a fair value basis,” Berman concluded. “If this goes through, they will lose their fail value accounting. There is a lot of concern on the property ownership side.”