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Avison Young: New Accounting Rules – Long-Time Coming, Significant in Scope

Charles Neuhaus, principal, Avison Young’s Houston office.

HOUSTON – (By Dale King) – Many public and private companies will have to make significant changes on their balance sheets and profit-and-loss statements once new reporting standards concerning leases are fully implemented by 2019, says a report prepared by a Toronto-based commercial real estate services firm.

Avison Young’s white paper, “The Big Change to the Lease Accounting Standards,” prepared by Sean Moynihan, a principal in the firm’s Atlanta office, aims to explain the procedures of realigning bookkeeping and lease-making processes, particularly for firms that have not yet begun the transition.

“The new lease accounting rules were debated publicly and within the U.S.-based Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) for more than nine years,” says the document. “And that lengthy process lulled companies into a false sense of security.”

“Although they seem a long way off, these new standards already threaten to catch many companies unaware,” the report notes. “Furthermore, companies could suffer significant enterprise value impacts if they do not act before the new rules take effect.”

The white paper says new FASB lease standards will become effective Dec. 15, 2018, and will cover fiscal years and interim periods within those fiscal years.

The revised regulations will apply to:

  • A public business entity;
  • A not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed or quoted on an exchange or an over-the counter market; and
  • An employee benefit plan that files financial statements with the U.S. Securities and Exchange Commission (SEC).

For all other organizations, the new lease standard takes effect for fiscal years and same-year interim periods beginning after Dec. 15, 2019.

The effective date for IASB standards will be Jan. 1, 2019. A company can choose to apply International Financial Reporting Standards 16 (IFRS 16) before that date, but only if it applies to IFRS 15 “Revenue from Contracts with Customers.” IFRS 16 leases will provide guidance for companies with headquarters outside the U.S. or for U.S. companies with international locations to account for leases on their financial statements.

Who came up with all these changes – and why? “In order to create more clarity in accounting for leases, the FASB released these new standards,” said Charles Neuhaus, a principal at Avison Young’s Houston office. “This will effectively require that companies put most leases on the balance sheet whereas before, they would only have been footnoted.”

“The intended changes will list lease obligations as liabilities on the balance sheet,” he said. “In most cases, these obligations can be very large and will have a big impact on the financial picture for most companies.”

In the report, Moynihan says many public and private companies will be impacted by the changes. New rules are not likely to affect residential property holders or renters.

“Under the forthcoming lease accounting standards, a lease will create a right-of-use asset and a lease liability, to be placed into the corporate balance sheet,” said the report’s author. “Under the FASB’s model, leases will be evaluated and categorized as either finance (similar to capital leases today) or operating (similar to operating leases today).”

In the IASB’s proposed model, “all leases will be classified as a finance lease. Under both models, leases will be capitalized onto a firm’s balance sheet, but with very different effects on shareholder equity, EBITDA (earnings before interest, taxes, depreciation and amortization) and overall profitability.”

He added that “seemingly insignificant factors, such as tenant improvement allowances and lease renewal options, will have important implications for financial statements.”

Since existing leases will not be grandfathered under the new rules, every lease in a company’s real estate portfolio could negatively impact its financial statements. “All public companies listed on U.S. stock exchanges, which must include comparative financial data in their financial statements, will effectively be required to transition to the new rules in advance of 2018 to remain in compliance with SEC regulations,” says the white paper.

Examples of how the new rules will affect financial statements include:

  • A finance lease will be categorized as a financing activity… whereas operating lease payments are recorded under operating activities;
  • The liability for a finance lease will be classified as debt, having a detrimental impact on a company’s debt-to-equity ratio and threatening loan covenants; and
  • Shareholder equity will take more of a hit from a finance vs. operating classification because the asset… will be amortized differently than an operating lease on the income statement.

Commenting on the report, Neuhaus said, “We have found that most companies are not paying attention, and are not structuring leases to reflect the changes. There are certain ways to structure leases so that the change will be less impactful versus just crafting a lease, handing it to accounting and living with the implications.”

The white paper suggests a three-step risk-mitigation strategy for company executives:

  • Identify the right team members – particularly finance and real estate specialists – to help the company transition to the new standards;
  • Conduct a strategic evaluation of the existing lease portfolio and evaluate for potential impacts; and
  • Consider renegotiating leases now, even if they are not up for renewal, to mitigate less-favorable impacts that might otherwise occur.

May 25, 2017 Realty News Report Copyright 2017

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