New FASB and IASB accounting rules may have dramatic impact on corporate financial statements
Avison Young investigation finds few companies ready for upcoming changes
TORONTO, June 23, 2015 /PRNewswire/ - The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are nearing completion of new lease accounting rules, which are proving to be a challenge for public and private companies – and many are unprepared for the changes. Few companies have analyzed how the rules will impact their financial statements, and most firms are not on track to be in compliance once the new rules take effect in 2018, according to commercial real estate services firm Avison Young.
"While the exact details of the proposed lease accounting standard will be subject to ongoing refinement, the broad requirements have become more defined — and there are many things that real estate lessees and lessors can, and should, be doing today with respect to their lease structures, business operations and financial reporting processes," comments Avison Young Chief Financial Officer Gary Hubbard, based in Chicago. "By planning and starting early, companies can more effectively manage the process and minimize the surprises."
According to Avison Young Principal Sean Moynihan, based in Atlanta, "the rules may seem far off, but putting together a team of experts now to analyze leases is critical to minimizing the balance sheet impact before it's too late. Even a renewal option in a single lease contract could reduce shareholder equity by millions of dollars. Many companies will be blindsided in 2018 if they don't prepare now."
A brief summary of Avison Young's observations, with respect to the new lease accounting rules, follows below:
Major Changes for Lessees
For lessors of real estate, the boards of the FASB and IASB are generally leaving in place a model similar to today's operating lease accounting requirements, with income statement and balance sheet treatment similar to how leases are accounted for today.
The same does not hold true for real estate lessees; the new lease accounting standard is expected to create significant changes to the presentation and measurement of the financial position and results of operations for companies with significant lease obligations.
Under the proposed lease accounting standard, leases with terms longer than 12 months will be capitalized, resulting in the overwhelming majority of real estate leases moving onto corporate balance sheets. Under the FASB's model, leases will be evaluated and categorized as either Type A (similar to capital leases today) or Type B (similar to operating leases today). Under the IASB's proposed model, all leases will be classified as a financing lease (similar to capital leases today). Under all models, the leases will be capitalized onto a firm's balance sheet, but with very different effects on shareholder equity, EBITDA (earnings before interest, taxation, debt and amortization) and overall profitability. Additionally, seemingly insignificant factors, such as lease renewal options, will have important implications for financial statements.
All Leases Will Be Impacted
Existing leases will not be grandfathered under the new rules. As a result, every lease in a company's real estate portfolio could negatively impact its financial statements. Public companies, 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 stay compliant with Security and Exchange Commission (SEC) regulations.
"One of the key challenges for real estate decision-makers is that using discounted cash flow to analyze lease deals, which is the common practice now, doesn't work under the new rules," adds Moynihan. "Executives should take a much more active role in the negotiation process and engage with their colleagues in finance at a deeper level to ensure the impact is fully understood – before signing a lease."
Getting Ready for the Changes
Avison Young is striving to prepare top executives for the changes, providing recommendations that include identifying the optimal lease arrangement under the new rules. The firm's risk-mitigation strategy includes four recommended actions:
- Identify the right team to help transition to the new standards, especially finance and real estate specialists. Often, those in finance are not familiar with how real estate leases are structured, and real estate professionals do not appreciate the accounting impact of leases.
- Conduct a strategic evaluation of the existing lease portfolio, starting with the largest leases, and assess how they will be accounted for under the new rules. Assess the impact on EBITDA and other key financial ratios and evaluate whether there is any potential impact on loan covenants.
- Consider renegotiating leases now, even if they are not up for renewal, in order to mitigate some of the less favourable impacts that would otherwise occur. Throughout the negotiation process, work closely with your tenant advisor to address areas of concern with an eye toward protecting financial statements.
- When negotiating new leases, reduce the spread between a lease's liability and the corresponding right-of-use asset. The more the two items are out of balance, the greater their potential negative impact.
Over the past six years, Avison Young has grown from 11 to 67 offices and from 300 to more than 1,900 real estate professionals across Canada, the U.S. and in Europe.
Today's announcement comes on the heels of Avison Young releasing its inaugural Global Citizenship report on June 15, 2015.
Avison Young has produced such white papers as "FASB planning sweeping changes to GAAP rules – An in-depth analysis of what the new standards will mean for your business and how companies can prepare" and "IFRS changes cause concern for Canadian companies – An in-depth analysis of what the new standards will mean for your business and how companies can prepare" in previous years.
Avison Young is the world's fastest-growing commercial real estate services firm. Headquartered in Toronto, Canada, Avison Young is a collaborative, global firm owned and operated by its principals. Founded in 1978, the company comprises 1,900 real estate professionals in 67 offices, providing value-added, client-centric investment sales, leasing, advisory, management, financing and mortgage placement services to owners and occupiers of office, retail, industrial and multi-family properties.
For further information/comment/photos:
• Sherry Quan, Principal, Global Director of Communications & Media Relations,
Avison Young: 604.647.5098; cell: 604.726.0959 [email protected]
• Gary Hubbard, Chief Financial Officer, Avison Young: 312.448.7955
[email protected]
• Sean Moynihan, Principal, Avison Young: 404.865.3679 [email protected]
• Mark Rose, Chair and CEO, Avison Young: 416.673.4028
Avison Young was a winner of Canada's Best Managed Companies program in 2011, 2012 and 2013 and has demonstrated its commitment to the program and successfully reapplied for the designation as a Gold Standard winner in 2014.
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SOURCE Avison Young Commercial Real Estate (BC)
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