LegislativeUpdate
ASSOCIATE (CONT.)
Article written by ERIN STACKLEY
who monitors and analyzes federal
legislative developments affecting the
field of commercial real estate, and
lobbies the U.S. Congress to make sure
that their interests are addressed. Prior
to joining NAR, she worked for the
House of Representatives and had a legal
fellowship with the National Federation
of Independent Business (NFIB).
LEASE
ACCOUNTING
UPDATE
In 2006, the Federal Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) commenced a project to develop compatible accounting
standards that could be used for both domestic and international
financial reporting. This followed a 2005 Securities and Exchange
Commission (SEC) report recommending changes be made to
lease accounting practices to ensure greater transparency in the
system. FASB and IASB’s goal for the project was to develop a
global rule to bring leases onto corporate balance sheets in both
the U.S., Generally Accepted Accounting Principles (GAAP) and
the International Financial Reporting Standards (IFRS). Four
years later, in August 2010, they released their first exposure draft;
after extensive public comments, three years following the release
of the first exposure draft, they released the second in May 2013.
Under the current exposure draft, companies would be required
to change to a “right-of-use” accounting model. Under the current
system, many leases are classified as “operating expenses,” which
do not appear on balance sheets. The “right-of-use” model being
proposed would change to listing leases as assets and liabilities,
which are reflected on balance sheets. The FASB and IASB
believe this will improve transparency and provide investors with
more consistent and concise financial reporting. Leases that are
less than twelve-months in length would continue to conform to
the current standards and be classified as operating expenses.
WHAT DOES THIS MEAN FOR COMMERCIAL REALTORS®?
The current exposure draft would bring nearly $1.3 trillion
in leased assets back onto companies’ balance sheets, about
70 percent of which are real estate leases. This “bloating” of
balance sheets may have serious effects for commercial real
estate practitioners, especially for those who have heavy debt
loads or who are still recovering from the recession. Among other
potentially detrimental side effects, this balance-sheet bloating
could cause companies to see their debt-to-equity ratios increase,
making it more difficult to obtain credit. It could also complicate
compliance with debt covenants or agreements between the bank
and borrower, which usually prohibit companies from borrowing
more than they are worth. Finally, it could also have the effect
of incentivizing shorter lease-terms, as leases that are less than
one-year in length would continue to be considered “operating
expenses” under the proposal. Under the new system lessees may
prefer shorter leases without renewal options, which could reduce
the borrowing capacity of many commercial real estate lessors
who rely on leases and the value of the property as collateral when
obtaining financing.
WHAT IS NAR DOING?
Since the first exposure draft was released in 2010, NAR has been
very involved in the deliberations over the FASB and IASB’s
lease accounting proposal. Along with sending letters of its own to
the agencies asking for a cost-benefit analysis of the proposal and
explaining its concerns regarding the detrimental effects it would
have on commercial real estate practitioners, NAR has worked in
coalition with other industry groups to advocate for real estate’s
best interests on the issue. NAR has also engaged with Congress
on the issue. In 2013 NAR successfully urged thirteen lawmakers
to send a “Dear Colleague” letter to the FASB expressing concern
once again over the lack of a cost-benefit analysis of the current
proposal. Additionally, in September 2013 NAR sent a comment
letter to the FASB on their second exposure draft (it sent several
comment letters on the first Exposure Draft as well).
NEXT STEPS
It was predicted that the IASB and FASB would finalize their lease
accounting proposal in 2014, but as the year comes to a close and
they have not done so yet, it seems more likely that it will come
out in 2015. If that is the case, it is probable that the proposal will
not be put into effect until the year 2018. While the FASB and
IASB debate the final rule, NAR will continue to work with both-groups, other industry stakeholders, and key lawmakers to ensure
that the final rule does not detrimentally affect commercial real
estate practitioners or the economy.
