March 9, 2016 | Rick Zelinsky
What will Lease Accounting Changes Mean?
For US public companies, the day has finally arrived. After almost 10 years of deliberations, 200 meetings and over 1,700 comment letters, Accounting Standards Update, ASU 842 – Leases has been released. This is the most significant lease accounting change in decades and understanding the impact is critical for all companies with significant lease portfolios.
Over US $1 trillion in off-balance sheet leases have been reported in lease footnotes for companies following the FASB/US GAAP standards. That’s about 6% of the US GDP – a staggering number. While there is consensus that moving all leases to the balance sheet will increase transparency, it doesn’t discount the fact that many organizations have a massive undertaking ahead.
Three key areas must be considered to properly measure the impact of this change: Approach, Systems & Standards, and Financials.
From a macro level, the approach and methodology to leasing needs to be reconsidered. With all leases on the balance sheet, buy-versus-lease decisions may need to be reevaluated go-forward. The benefits of sale-leaseback transaction have effectively been diminished and this option will likely not be used in the future. Lease term lengths, number of renewal options, structure of option rent and other lease conditions all will have an impact on future lease accounting. It’s important for companies to take action now to ensure current and future lease transactions align to their long-term strategy.
2. Systems & Standards
Six weeks ago IFRS released IFRS 16 Leases, a similar standard to FASB’s ASU 842 – Leases, intended for companies following IASB standards utilized outside the United States. While the timing for implementation is the same (first fiscal year beginning after December 15th 2018), the actual rules differ between the two standards. This will pose an additional challenge for multi-national operations that will force lease accounting compliance to both standards. Companies need to ensure their lease accounting system will provide functionality to track a lease by multiple standards concurrently. An additional consideration will be the transition from an operating lease to a capital lease and assistance with the automation of journal entries required to adjust for that impact.
While all companies are subject to the same impact, it doesn’t nullify the fact that concern is setting in. Moving leases to the balance sheet will cause companies to appear more asset-rich but also more heavily indebted. From a P&L standpoint, early in the term of a lease, interest will be greater, resulting in a higher lease expense initially, even if rental payments are consistent for the entire term. This will result in an initial reduction in earnings and will increase EBITDA. Investors need to be aware of these implications as this transition will have far-reaching impacts, including stock performance. Regardless of the concern, companies need to know their specific impact to educate all parties and determine their best path for implementation.
Retailers are disproportionally impacted by these accounting changes since leasing real estate is such a critical principle of their business. Of the top 20 US public companies with the largest operating lease portfolios, ten are traditional retailers and an additional seven have some retail store operations. Collaboration between operations, real estate, finance and technology will be essential to manage through the process.
Let us help. Our team has been building and implementing retail lease administration systems for more than 20 years which makes us uniquely positioned to help you develop the right approach, systems and standards to minimize impact while transitioning to the new standards. Tango’s Lease Administration solution is also built ground-up with the new regulations so compliance is guaranteed.