HOUSTON, Aug. 6, 2014 /PRNewswire/ -- While lease accounting standards have been under review for a number of years, it is imperative that businesses start preparing now for the coming changes, according to the third quarter edition of "Ask the Expert," featuring Mike McLain, Transwestern's chief accounting officer. In this edition, McLain explains where the proposed changes stemmed from, outlines three proposed changes and advises businesses on actions they should take now in preparation for the imminent changes.
The need for new accounting standards stemmed from two primary reasons: a desire for greater transparency in financial reporting and the importance of universal reporting standards as commercial real estate becomes a more global industry. Categorizing leases longer than 12 months as a financing transaction allows interested parties, such as lenders, to evaluate all of a company's liabilities.
Most real estate leases are considered "Type B" leases, meaning the lease doesn't consume a significant portion of the asset's useful life or the rental payments do not amount to a substantial portion of the fair value of the asset. This is the biggest divergence between standard setters, with the FASB in favor of separate treatment and the international board favoring one set of rules for all leases.
For Type B leases, the value of the "right-of-use" asset and corresponding liability would be calculated based on the present value of expected future lease payments. Present value takes into consideration future lease options, lease incentives, variable lease payments and other cash flow impact lease terms.
The lease expense for Type B leases would be treated as a single line item on the income statement and recognized straight-line over the lease term. The right-of-use asset and corresponding lease liability would be "amortized" using the effective interest method, not straight-line.
In the best case scenario with final approval by the end of the year, balance sheets would likely be impacted in 2018. To prepare for the coming changes, companies should begin taking into consideration how lenders will view this information when the debt-to-EBITDA (earnings before interest, taxes, depreciation and amortization) ratio changes. They should ask if additional debt on the balance sheet will make it more difficult to borrow money or otherwise affect financing arrangements. These changes will also require additional record-keeping capabilities. Occupiers may even consider self-funding tenant improvements in favor of shorter lease terms or lower rental rates.
"Ask the Expert" is a Q&A with Transwestern experts and leaders. Download the full version at twurls.com/ate-mclain.
Transwestern is a privately held real estate firm specializing in agency leasing, property and facilities management, tenant advisory, capital markets, research and sustainability. The fully integrated global enterprise leverages competencies in office, industrial, retail, multifamily and healthcare properties to add value for investors, owners and occupiers of real estate. As a member of the Transwestern family of companies, the firm capitalizes on market insights and operational expertise of independent affiliates specializing in development, real estate investment management and research. Transwestern has 34 U.S. offices and assists clients through more than 181 offices in 40 countries as part of a strategic alliance with Paris-based BNP Paribas Real Estate. For more information, please visit transwestern.com and follow us on Twitter: @Transwestern.