On Monday at what seemed to be one of the more popular breakout sessions: “FASB Lease Accounting Changes and the Bottom Line: What Corporate Real Estate Needs to Know” Kenneth Rudy, Managing Director, Corporate Solutions, Jones Lang LaSalle moderated a panel of experts including Mindy Berman, Managing Director, Jones Lang LaSalle, Brad Homant, FASB Practice Fellow and Erik Lange, Partner - Transactions & Restructuring - Transaction Accounting Services, KPMG LLP.
Under new accounting rules proposed by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) slated to be issued in 2011, companies could receive a massive shock as all leases of real estate and equipment will have to be capitalized on a company's balance sheet. According to Jones Lang LaSalle’s Perspectives on Corporate Finance released in March of 2010, “The pressure to revamp the three-decade-old leasing standard is driven by the perceived lack of transparency around off-balance sheet obligations and the complexity of current lease accounting. When the project on lease accounting was adopted in 2006, U.S. companies were estimated to have a capitalized equivalent of $1.3 trillion in operating leases. A common rule of thumb is that 70 percent of operating leases represents real property.” With an estimated release of the final standard expected by mid-2011, our industry could be affected by as early as 2012 which as you can imagine caused a great deal of grief throughout the room as 2012 is when the CMBS market is expected to be facing its most difficult challenges.
A recent survey conducted by Jones Lang LaSalle (JLL) and CoreNet Global found that 99% of corporate real estate executives are substantially unprepared for a proposed major change in national and international accounting treatment of real estate lease obligations. 66% of respondents said the changes would have a significant or major impact on the size of their company's balance sheets.
According to JLL, the expected effects from the new standard will be significant and include:
• Substantially larger balance sheets from reporting leased assets and lease obligations
• Higher reported initial occupancy expenses, as much as 20%, as straight-line rent expense is replaced by amortization of the leased asset and high front-end interest expense (see figure 2)
• Pressure on existing borrowing agreements related to covenants for leverage ratios and earnings
• Greater complexity in reporting and investment in information systems—need for more data and judgment applied in evaluation; continuous periodic reassessment of estimates and potential remeasurement required
• Higher reported cash flow (EBITDA) as rent that was previously “above the line” is changed to interest expense and amortization
Mindy Berman, one of the expert panelists, made the following comments in a
blog from the Summit: Wake Up Call on Lease Accounting:
Capital MarketsThe CoreNet Global Summit session on FASB lease accounting changes was standing-room only, with well over 100 professionals showing up to find out how this change will affect their businesses. The moderator, Jones Lang LaSalle’s own Kenneth Rudy, asked for a show of hands to determine how many people were familiar with the rule change, which essentially will turn operating leases into capital leases for accounting purposes.
When CoreNet Global and Jones Lang LaSalle surveyed CRE directors a year ago, two thirds were unfamiliar with the change, and virtually no one was engaging other stakeholders in their companies. At yesterday’s session, about one third were still unaware of the basic information and less than a third had engaged stakeholders. With release of the exposure draft containing the new rules expected in June or July, this slow movement is cause for concern. And many people in the room expressed alarm that the rule change would cause them to break financial covenants that could send their companies into bankruptcy or exacerbate the trauma in the commercial real estate market —concerns that are exaggerated, to put it mildly.
"In between the extremes of panic and complete indifference to this issue lies the course I have recommended to CRE directors for several years. First, get educated. Second, take the basic steps to prepare for the change. At a minimum, that is going to mean engaging your corporate finance team and business unit leaders. At some point, the corporate treasurer is going to come to CRE looking for information. It won’t be good if the CRE is unaware of the rule change when that happens."
- Mindy