Lease Accounting – Issues Summary from NAR
At the 2010 REALTORS® Conference & Expo, NAR leadership approved a new policy statement on lease accounting. The statement responded to the Financial Accounting Standards Board (FASB) and International Accounting Standards Board’s (IASB) proposal that, if passed, would put nearly $1.3 trillion in leased assets back onto companies’ balance sheets, a move that would particularly hurt especially lessees and lessors of commercial real estate. Below is the actual Issues Summary:
What is the Fundamental Issue?
The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) proposed lease accounting changes may be detrimental to our nation’s economy by reducing the overall borrowing capacity of many commercial real estate lessees and lessors. The proposal would bring nearly $1.3 trillion in leased assets back onto companies’ balance sheets, with roughly 70 percent being real estate leases. Under the proposal, companies would be required to use a “right-of-use” accounting model where both lessees (renters) and lessors (property owners) recognize assets and liabilities arising from lease contracts. Currently, accounting rules allow many businesses to classify leases as operating expenses, which do not appear on their balance sheets. Both FASB and IASB believe these changes would improve transparency as well as provide investors with more consistent and concise financial reporting. However, if enacted, this proposal could negatively impact the financial stability of many businesses, which could prolong our nation’s economic recovery.
I’m a Realtor®. What does this mean to my business?
If ratified, this proposal would hurt businesses of all sizes, especially lessees and lessors of commercial real estate. With more bloated balance sheets, some companies may see their debt-to-equity ratios increase and find it more difficult to obtain credit, especially those with heavy debt loads or still recovering from the recession. The proposed accounting changes could also complicate compliance with debt covenants or agreements between the bank and borrower, which usually prohibit companies from borrowing more than they are worth. By capitalizing new and/or existing leases, some businesses could show more debt than allowed in their agreement with the lender, and therefore be in default of their loan. This could force some firms to put up more capital for existing loans or even have their credit lines revoked.
Additionally, the elimination of off-balance-sheet financing would be detrimental to commercial property owners. More frugal lessees will want less space and shorter-term leases without renewal options or contingent rents, which will decrease cash flow for property owners. Shorter-term rents will likely reduce the borrowing capacity of many commercial real estate lessors, who rely on leases and the value of the property as collateral in order to obtain financing. Ultimately, property owners would be forced to increase rent rates due to market uncertainty and reduce tenant improvements due to shorter recovery periods. Conversely, this change could encourage some firms to consider buying instead of leasing commercial real estate.
NAR is concerned that the new lease accounting proposal will be detrimental to our nation’s economy by reducing the overall borrowing capacity of many commercial real estate lessees and lessors. Also, NAR is opposed to lease accounting standard changes that would treat the income producing real estate business as a financing business on company balance sheets. Such a step would not accurately depict the unique characteristics of the investment real estate sector and in turn discounts the usefulness of the industry’s financial statements.
FASB and IASB will accept public comments on their lease accounting proposal until December 15, 2010. Both organizations expect to have their joint proposal finalized by mid-2011. The effective date of this proposal will likely be in 2012 or 2013, where virtually all new and outstanding leases would be subject to the new accounting standard. NAR is currently writing comments to submit to FASB/IASB and will continue to work with other stakeholders to develop and implement a strategy to address this issue.