The Facts on FASB

Proposed changes by the Financial Accounting Standards Board to lease accounting rules could make record-­keeping a lot more complicated and lease negotiation more difficult, says Marc Betesh, president of KBA Lease Services and Visual Lease in Woodbridge, N.J.

What are the changes that the Financial Accounting Standards Board (the private-sector group that sets rules and reporting standards for ­accountants) is proposing for leases?

The fundamental change under FAS Topic 840 is that all off–balance sheet transactions involving operating leases, which includes most real estate leases, will be eliminated. Currently, companies don’t show operating leases for real estate on their financial statements, except in footnotes.

How will companies account for their leases if the new rules are adopted?  

Leases will appear on a company’s financial statement as though the company had purchased and financed the leased asset. The lease will be shown as a "right-of-use asset" with a corresponding liability for the rent payments and any direct costs like brokerage commissions. The actual figure used will be the net present value of the rent calculated at the interest rate it would cost the company to borrow money. The liability appears the same way, although direct costs are excluded. As the company makes rent payments, each payment is recorded as a payment of principal (a portion of the NPV of the asset) and interest. This amortization requirement could mean that a disproportionate amount of the rental liabilities will shift to the first years of a lease.

Why are the changes eliciting such controversy?

There is a lot of debate on two points—operating expenses and lease options. The right-of-use asset is supposed to cover only the pure use of the space, not the cost to service it. So companies will have to separate out service costs like common-area maintenance charges, taxes, and insurance from the right to use the space. Stripping out these costs will be easy with a pure triple-net lease since the tenant pays all those costs separately. It’s more muddled with a modified gross lease since the landlord pays these costs for the first, or base, year of the lease.

What is the issue with lease options? 

Under the new rules, tenants will have to consider how likely they are to exercise lease options from the first day they sign a lease. If they are likely to extend a lease, they have to include the option term and the option rent in their calculations. Making the option decision so early is very subjective and seems to undermine the purpose of the rule change, which is to provide more transparency and reliability in financial statements.

To make things even more complicated, the tenant also has to re-evaluate these probabilities on a regular basis and recalculate the amortization to reflect any changes.

How could these changes affect the overall leasing climate? 

Under the new proposal, tenants may prefer shorter leases, which will be problematic for landlords that need longer leases to secure financing or sell a property at a higher price.

When will the proposals be finalized? 

It seems likely that the proposals will be enacted sometime this year and go into effect a year or more later.