Six ways to minimize the financial impact of new lease accounting standards
- Sep 26, 2017
Corporate real estate decision-makers and brokers, brace yourself. With the new lease accounting standards effective in 2019, real estate decisions are about to get more complicated. Along with adding financial technology and data collection needed for the change in reporting, you’ll also need to scrutinize your lease agreements.
Under the new standards, established by the International Accounting Standards Board (IASB) and the U.S.-based Financial Accounting Standards Board (FASB), companies will need to record any lease 12 months or longer as a “right-of-use” (ROU) asset and a corresponding lease liability on the balance sheet.
The new requirements are effective in 2019 for public companies, and reporting must also include comparable information for the previous two years. For private companies, the standards will apply to fiscal years beginning after December 15, 2019, with a one-year look-back.
If you’re a corporate real estate executive at a public company, it’s go time. Your 2019 filing must include comparable 2017 and 2018 information, so you need to get the data collection and reporting processes in place now.
One sweeping result of the change? Many organizations will see their reported debt loads rise when real estate and equipment lease obligations become line items instead of operating expenses.
To lighten the load, you can take a close look at your leasing agreements to find potential ways to keep lease expenses off the balance sheet. It’s a whole new era of leasing, and corporate real estate executives, brokers and landlords alike are going to need some new plays to get ahead. Here are a few ways to do it:
- Weigh the pros and cons of shorter lease terms. In some ways, shorter lease terms might seem like the simplest solution for lessening the financial burden of the new rules. However, any short-term financial advantages must be weighed against other related impacts, such as paying premium rent in exchange for a shorter lease term. Shorter-term leasing will also make it more difficult to negotiate incentives—unless you are in a tenants’ market.
- Examine renewal option clauses. It’s common for a five-year lease to include several three- or five-year renewal options. Under the new standard, each lease option becomes part of the reported liability. For example, a five-year lease with one five-year renewal option would become a 10-year lease liability on the balance sheet. Therefore, corporate tenants, their brokers and landlords will need to examine whether and how to include renewal options in the lease agreement.
- Review operating expenses. Operating fees are excluded from balance sheet calculations under the new standard, which makes reviewing these lease agreement terms especially important. It also means organizations with any full-service leases on their books will need to distinguish lease payments from operating and service payments to determine correct balance sheet calculations—and that can be a potentially complicated endeavor.
- Consider triple net leases. When the tenant pays a fixed rental payment in addition to property taxes, maintenance and insurance, much of the administrative burden of the new rules is eliminated for the landlord. As a result, triple net leases are expected to gain more widespread favor, as lease structures that minimize lease payment liabilities on the balance sheet should enhance the financial picture of the company.
- Review contractual language. Does the contract fulfill the definition of a lease—and should it? Understanding whether a contract stands as a legally binding lease or as a service contract agreement will become more important than ever under the new rules, which cover only the rental payment itself. By taking time early on in the planning process to review the contractual language of any major leasing agreement, you can determine whether there are opportunities to restructure the contractual language as a service contract.
- Reconsider which entities are signing leases. It is also possible to minimize the financial impact of new lease accounting standards by isolating the financial impact of the changes to key business units. For example, a holding company can sign the leases and pay the rent for charge-back to internal business units. Depending on the local regulations, it may make sense to create a separate real estate company to hold all property leases and assets.
The new era of leasing can seem daunting. But by staying informed and thinking strategically about how lease agreements are structured, you can mitigate the financial fallout.
Steve Miller is a Managing Director and JLL’s Global Lease Accounting Lead. He is a Certified Public Accountant who oversees sales and implementation of the firm’s lease accounting services and technology tools.