Keeping Your Balance: New accounting rules proposed for leases

By Stephen H. Berardi Dolan Media Newswires ROCHESTER, NY--The Financial Accounting Standards Board, in conjunction with the International Accounting Standards Board, is proposing a new standard for the accounting for leases that could have a major impact on the way tenants choose to lease space. The proposed new standard, scheduled to be issued by the FASB in April 2011, will require companies to book the present value of all future lease payments as a liability on their balance sheets with a corresponding right-of-use asset to comply with "generally accepted accounting principles" or GAAP. Currently, most tenants reporting under U.S. GAAP detail future lease obligations as footnote disclosures in the notes to the financial statements rather than on their balance sheets. If the change is made, public companies (as well as private companies following U.S. GAAP) will need to record trillions of dollars of existing leases on their balance sheets. The proposed new rules contain no grandfathering clause, which will have significant implications for investors -- not all favorable. In many cases the effect will be to weaken the strength of a company in the eyes of investors and could also affect credit ratings and debt covenants. While rating agencies already take rent obligations into consideration, the proposed new standard requires additional disclosures that could shed new light on lease terms. Companies with heavy debt loads, as well as large retailers with thousands of leases, will be affected most. Commercial banks with multiple branches also could be severely hit when the proposed new rules come into effect. The accounting update could affect the leasing market because it removes many differences in the way companies account for properties that are owned compared to those that are leased. Companies may decide to buy offices, driving down demand for leased space, according to some experts. Reducing the term of a lease also may become more common because the longer the lease the higher the debt load on the balance sheet. Yet another complication involves renewal terms. Options to renew that are likely to be exercised must be included in the lease term as if the renewal will definitely occur. That would mean adding more debt to the balance sheet and may make renewal options less popular. Another factor to consider is contingent rents -- additional rent based on a percentage of sales or other variables. In those cases, the tenant will need to estimate the contingent rent through the entire term of the lease for inclusion on the balance sheets. The proposed new accounting rules for operating leases represent a significant change from the current accounting and financial reporting rules and are sure to have a significant effect on both tenants and landlord businesses and financing strategies. We will keep you informed of any changes or new developments to the proposed new accounting rules. Stephen H. Berardi, CPA, is a principal at Mengel, Metzger, Barr & Co. LLP and can be reached at (585) 423-1860; Sberardi@mmb-co.com. Entire contents copyrighted © 2010 by Dolan Media Company. Published: Thu, Oct 7, 2010

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