Jun 23 2010

Beware: New Lease Accounting Guidelines Coming!

Repost from http://bobcook1234.wordpress.com

If the two accounting-standards boards stay on schedule, a new set of standards for lease accounting will be in place by mid 2011. The impact on corporate real estate will be BIG. And it will be SOON. Those corporate real estate execs who think these new standards are something just for the accountants to worry about risk being like a chef with his pants down stumbling around frantically trying to get his kitchen in order before the health inspector arrives.

The European-based International Accounting Standards Board (IASB) and the U.S.-based Financial Accounting Standards Board (FASB) are working together and plan on issuing a draft set of lease accounting guidelines within five months, with compliance required perhaps as early as a year later. They already issued a document last March that outlined their thoughts and which sets the general tenor of the standards.

You can see the status of the joint project, as well as links to the Discussion Draft, dated March 2009, here.

In a nutshell, each operating lease will go on the company balance sheet as both an asset and a liability, both valued at the present value of the lease payments to be made. The impact on company balance sheets will not be subtle. Many companies will have billions of dollars of new items on their balance sheet. There also will be an income statement impact as “rental expense” gets replaced with a “depreciation expense” and an” interest expense”. For corporate real estate portfolios, there will be a permanent ratcheting up of expenses related to lease payments. While the new standard is long overdue and is necessary to more accurately portray the financial condition of companies, it’s going to cause a lot of heartburn among corporate real estate execs.

The new standards are going to effect corporate real estate in four ways. First, it’s going to shine a spotlight on lease transactions and bring a lot of questions from upper managements, such as “who is responsible for negotiating these large financial obligations?” “Do they have finance backgrounds?” “Do they have a financial strategy?”

Second, at some companies, the new accounting is going to precipitate change in the internal accounting used for budgeting, internal pricing, chargebacks, and even bonuses. There are going to be a lot of food fights to see who has to eat what part of the negative soup that oozes from the new standards.

Third, except for those few companies who are confident enough to not worry about their performance as expressed by their financial statements, the new standards will change real estate finance strategy, particularly as it relates to own vs lease and the length of leases. And, interestingly, there will be no grandfathering of leases; leases written today will be re-accounted for once the standard is in place. This means new lease strategies to address the new accounting are needed today — or, actually, yesterday.

Finally, in order to comply with the new standards, companies are going to have to establish a whole new set of policies and procedures to capture the information and make the forward-looking assumptions that will be needed to account for leases. These are going to have to be SOX-compliant; they can’t be cooked up overnight.

Last fall, JonesLangLaSalle published a report citing how few corporate real estate execs had begun making preparations for the new standards. Half a year later, I doubt that the situation has changed even though the kitchen timer is ticking. In future blogs I’ll look at the reasons for the accounting changes and discuss the implications in more depth.

About the author

Bob Cook

Bob Cook is a corporate real estate consultant whose focus is strategic and financial planning. He has worked in Fortune 100 companies (Northrop Grumman, Cisco, Sun Microsystems), mid-sized tech companies (JDSU), government (City of Chicago), and academia (National University of Singapore). He presently lives in Silicon Valley.