CFO Magazine Updates Lease Accounting Changes to Come

With the December 15th deadline for comments on the lease accounting changes fast approaching many commercial real estate owners and tenants are wondering how the changes will impact them.Many would just as soon see the lease accounting rules stay the way they are. But it is clear that the way companies account for real estate leases on their balance sheets is headed for big changes. The experts agree on one thing- the time to prepare for these changes is in 2011 or sooner!

CFO magazine recently published an interesting article on the impact the lease accounting changes will have on commercial real estate buy vs lease decisions, the length of leases, renewal options and the end of net leases. An excerpt of the article is below:

By Marie Leone
CFO Magazine


Accounting-standards setters are under fire, again. The new leasing standard, proposed jointly by the Financial Accounting Standards Board and the International Accounting Standards Board, has been characterized as naïve, lacking value, and in need of serious reevaluation. The outcry comes not from a handful of opponents but from companies on both sides of common lease contracts — those that rent office space, copiers, or airplanes and those that own the assets.

At the center of the maelstrom is the "right-to-use" asset concept, the accounting mechanism that places leased assets and liabilities on the balance sheets of lessees, as if they owned the assets. That would essentially eliminate operating leases. Credit Suisse estimates that, within the S&P 500 alone, the volume of assets returning to balance sheets could surpass $550 billion.

At those levels, asset ratios could be thrown out of whack, potentially sending debt covenants — if not adjusted — into default, says Ross Prindle, a managing director with Duff & Phelps, while also requiring banks to increase their regulatory capital and wreaking havoc on compensation plans tied to the asset measures.In addition, the proposed standard (called Topic 840 by FASB) requires lessors to recognize assets and liabilities in a new way. A lessor must recognize an asset as representing its right to receive lease payments and, when appropriate, record a liability as representing the contractual right of others to use their equipment or real estate.

Then, based on how much residual value the lessor estimates it will retain at the end of the lease, it must also use one of two accounting approaches laid out in the draft: either the performance obligation or the derecognition model. If the rules seem complicated, that's because they are, says D.J. Gannon, a deputy managing partner with Deloitte. However, he says the proposed changes are well intentioned: rulemakers want to curb abusive leasing practices by companies that structure around the 90% ownership test that currently determines whether a contract is an operating lease and can therefore be removed from their balance sheets.

Be that as it may, in the year-plus since FASB issued its first discussion paper on the topic, more than 300 comment letters have been submitted, most indicating that stakeholders are not convinced that the intended benefits will be worth the additional cost and effort.The comment period is open until December 15, and two days later FASB and the IASB will hold the first of four new "outreach" meetings to get a better handle on what worries constituents. The boards plan to release a final rule during the first half of 2011.


Lessor Has More
What's interesting is that most critics are less concerned about the concept of capitalizing all leases than with how FASB and the IASB propose to treat the leases after bringing them back on balance sheets.
"The board is naïve if they don't think the same kind of structuring will occur under these rules as exists with the bright-line test," asserts Shawn Halladay, a principal at The Alta Group, a leasing-industry consultancy. Halladay says that lessees have only to structure leases for shorter terms to push more of the asset value from their balance sheets. That's because shorter-term leases require the lessor to retain a larger portion of the asset's residual value.

Lessor accounting gets more complicated if the company retains a "significant" amount of the asset's risk or benefit. At that point, a lessor is required to use the performance obligation approach, which forces the company to carry both the asset and the total lease payment receivable (at the receivable's present value) on its balance sheet, as well as a performance obligation liability. In contrast, current capital lease rules require the lessor to carry a lease payment receivable on its balance sheet, but not the underlying asset.
The other accounting model available to lessors is the derecognition approach, which is used when the lessor retains a low residual value on the asset. The impact of the two-method treatment is sure to create "a greater divergence in practice among lessors," says Michael Fleming, also a principal at The Alta Group.

Lessors that hold real estate for investment — most notably in real estate investment trusts — may get a chance to avoid leasing rules completely, says Mindy Berman, managing director at Jones Lang Lasalle, a real estate services firm. Soon FASB will issue a proposal that requires real estate investment holdings to be measured at fair value, testing periodically for impairment, instead of following lessor accounting rules.

to read the full article please visit www.cfo.com

National Real Estate Investor Covers New Lease Accounting Rules

From www.nreionline.com

Proposed new accounting standards have been drafted in order to push lease liabilities back onto corporate balance sheets. Such a change would represent a major shift for companies that have typically favored the off-balance-sheet treatment of operating leases, and it could have a significant impact on corporate decisions to lease or purchase real estate in the future.

The proposed guidelines are a joint initiative by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board to create a uniform global standard and greater corporate transparency in lease accounting procedures. The most recent draft issued Aug. 17 would establish one method of accounting that requires firms to recognize all lease liabilities and assets on their corporate financial statements.

Another key component is that companies would be required to record the lease value or rent commitment over the entire lease term, including renewal options. Although the intent is to stop off-balance-sheet activity, the changes would add significant weight to corporate balance sheets.

For example, a firm that pays $1 million per year in rent for its corporate headquarters would quickly see its liability multiply depending on whether it has a five-year or 15-year lease. Companies would appear more highly leveraged, which could affect factors such as corporate credit and existing debt covenants.

Crux of the matter
What makes commercial real estate industry professionals nervous is that it is not clear to what extent the new accounting guidelines would influence tenants’ decision-making process. Based on the universe of leased space, the potential impact is enormous.

Although FASB cites data that values leasing activity at $640 billion in 2008, other industry sources estimate that current volume as high as $1.3 trillion in operating leases for U.S. firms alone. Once the guidelines go into effect, which many in the industry believe will occur in 2013, both new and existing leases would be immediately affected.

One fear is that the new accounting practices could deter companies from signing long-term leases, or encourage firms to own rather than lease facilities. Both of those factors could be a detriment to the sale-leaseback and net-lease finance niche where leases typically extend 15 years and beyond.

Sale-leaseback transactions have accounted for $24.8 billion, or slightly more than 50%, of the $46.6 billion in single-tenant sales globally over the past 12 months from June 2009 through June 30, 2010, according to New York-based Real Capital Analytics.


Please visit www.nreionline.com for the complete article.

The lease accounting changes are expected to effect how companies view their real estate holdings and real estate asset management strategies in the future. Some analysts predict the changes will not be reflected on the balance sheets until 2013, but companies need to start the planning process now. Certainly there is need for a complete lease audit process to determine how many individual leases exist and how they could be impacted when they no longer are considered operating leases.

But important decisions will need to made on excess real estate space. In the past one option was subleasing the space to another tenant. Not a perfect solution but subleasing had some advantages. When the lease accounting rules change, subleasing will not remove the lease from the balance sheet and increases risk for the company in their new role as a landlord to the company that is subleasing space.

A better solution would be a Negotiated Lease Buy-Out or Lease Termination program. These are complicated transactions and you should employ someone with direct experience in corporate real estate finance and taxation. One company that has a long track record negotiating  commercial real estate lease terminations is Cambridge Consulting Group. They have saved companies such as Bank Of America and Ford Motor Credit millions of dollars by reducing their lease obligations. For more information please visit their commercial lease termination website- www.commercialleaseterminations.com.

Lease Accounting Rules Will Have Large Impact on Retailers

As reported in Retail Traffic

Proposed new lease accounting standards from the U.S. Financial Accounting Standards Board and the International Accounting Standards Board have the retail real estate world dizzy with worry as property owners and managers fear the new standards will cripple tenants and lead to shorter lease terms and more conservative expansion strategies.

Financial Accounting Standards 13 (FAS 13) would require all lease liabilities to be accounted for on corporate balance sheets as capital leases rather than as operating leases. That’s an important distinction because operating leases allow tenants to account for lease liabilities as they are incurred. In contrast, capital lease liabilities must be accounted for in their entirety every quarter.

In addition, the new standards would require corporations, including retailers, to account for the full potential liabilities of leases—including options and percentage rent, not just the base rental fee. They would have to provide estimates on all contingency-based payments built into the lease, including lease renewal options, rent based on a percentage of sales and co-tenancy kick-ins.

CFO Best Practice Sponsor: Cambridge Consulting Group was formed more than 10 years ago to help large organizations reduce their  costs by eliminating their leasing obligations for excess commercial real estate space. Founded by Dave Worrell, a former Corporate/Facility Director, Cambridge Consulting Group offers companies a better option than subleasing office space they no longer need or use. Using a newer financial strategy- Negotiated Lease Buyouts, Cambridge Consulting has saved Fortune 500 companies millions of dollars in commercial lease obligations. For more information please visit their website- www.ccgiweb.com   or call David Worrell at 888.472.5656


So, for example, a retailer would have to account for the entire potential 15 years’ worth of costs on a lease with a five-year term and two five-year options. As a result, retailers’ debt loads could appear to balloon up to ten times their current levels.

The Securities and Exchange Commission has estimated that more than $1 trillion in operating leases throughout the entire commercial real estate sector would need to be reclassified when FAS 13 goes into effect. As it stands, the two accounting boards plan to finalize the leasing standards no later than the second quarter of 2011.

The problem with this is that over the past few decades, retailers, more than any other type of commercial tenant, have become dependent on using various forms of contingency rents, says Vivian Mumaw, global director of lease administration with Jones Lang LaSalle Retail, an Atlanta-based third party property management provider.

The intricacies alone will make it difficult to comply with the rule. Retail leases today typically have five- to 10-year terms, with multiple renewal options. In addition, virtually all retailers pay a portion of their rents based on percentage of sales—meaning they pay more if sales exceed a certain threshold—while many also employ co-tenancy clauses, which trigger decreases in rental rates if other retailers move out of a shopping center.

All of that will make it difficult for retail chains to accurately estimate liabilities for the entire length of each lease, Mumaw says. In order to do so, they would have to forecast macroeconomic conditions, as well as the performance of their brand and the performance of each individual store many years into the future.

To read rest of article please visit :
http://retailtrafficmag.com/news/fas13_means_retail_real_estate_10052010/

KBA Lease Audit Saves Publishing Firm $ 57,000 by Auditing Their Commercial Real Estate Leases

Publishing Company Saves $57,000 per Year by Negotiating Lower Telecom Rates

Client
A publishing company with several offices in Canada.

Audit Discovery
Our client had negotiated an agreement with a major telecommunications company for the bulk of their services. Due to their large volume, the supplier assured them that they were receiving a very competitive rate. They also used three other companies for their telecom needs as each of their offices had its own particular choice of carrier.

After a thorough analysis of the client’s supply contracts and billing data, our team identified that many of the services were not being billed at the contracted rates. Moreover, the contracted rates were not competitive given the client’s substantial volume.

Resolution
Based on these findings, our team secured a credit from the existing supplier for the overcharges and recommended that significant savings could be gained by combining all of the client’s telecom traffic with a single supplier. The client implemented these recommendations and now has the benefit of centralized billing reports from the selected supplier as well as the negotiated lower rates. This is generating in excess of $57,000 per year in savings for the client.

For more information please visit www.kbalease.com