“REITs may think the lease accounting and revenue recognition standards won’t significantly impact them, but they may be surprised.” Angela Newell, BDO national assurance partner said in a report, 2017 BDO Risk Factor Report for REITs.
Among those companies surveyed, just 15 percent of real estate investment trusts (REIT) specifically noted lease accounting as a risk factor in their filings. “Applying the new standards can be complicated, and organizations that aren’t making headway on an adoption plan—establishing it and putting resources behind it—risk falling behind.” Newell said. Bloomberg BNA recently had a conversation with Newell to talk about some of BDO’s report findings.
Bloomberg BNA: What are the reasons that companies underestimated the impact of the new accounting standards? Is it possible that companies haven’t started implementing those standards yet?
Newell: Absolutely. A lot of the companies haven’t started looking at the lease accounting rules changes yet, because the rules are not effective for public companies in a year and half. The impact of the rules might be more significant once companies start adopting them. The new leasing standards, ASC 842, also reference to the new revenue standards, companies might not need to adopt the revenue rules immediately, but once they start adopting the leasing rules, they will have to look at the revenue rules too.
Bloomberg BNA: Do you expect companies to change their strategies in terms of negotiating lease terms and lease structures because of the new rules?
Newell: The rules for lessor accounting don’t really change a lot, the model is pretty similar to the current model. There are some changes, but not very significant. However, as lessees starting to understand the implication [of the new standards] to their businesses, their balance sheets in particular, they will be taking a hard look at their leasing strategy. Some of the lessees that we’ve talked to would really like to continue to keep their operating leases off the balance sheets, there are really limited opportunities towards that quite frankly. Lessors are facing the challenges that lessees might start changing their negotiation strategy.
Some of the lessees who have longer-term leases that are on the border [of the operating leases and capital leases] under the current guidance, because the lessees will have to put everything on the balance sheets, they may just go ahead and make the lease terms a little bit longer so that those leases will end up as capital leases. From the lessees’ perspective, capital leases are more preferable under ASC 842, because amortization and depreciation are fully expensed out the operating expense.
Bloomberg BNA: Do you expect lessees to take advantage of the practical expedient to negotiate short-term leases? Because leases with lease terms under 12 months don’t have to be put on the balance sheets.
Newell: When you start talking about bigger dollar leases, you can’t really economically justify leasing for less than 12 months. If you think about your headquarters building, or a special piece of equipment you need in your operation, limiting the lease terms for less than 12 months raises a lot of risk. Applying the 12-month exemption is not as easy as some people have thought.
Bloomberg BNA: Do you have any advice for companies who are just starting to implement the new leasing rules?
Newell: From the lessor perspective, my personal advice is—don’t underestimate and just say that there won’t be any impact. Because there are going to be changes, the changes might be relatively minor, but lessors should at least take a look at the standard and get an understanding of what the impact will be. Also, the biggest concerns are those leases that involve other types of payments, such as maintenance, insurance, and property taxes. The new standards specifically said that common area maintenance payments are not lease payments, they are services that need to be accounted for under ASC 606, the revenue standards. That requires lessors not only to think about the leasing standards, but also to think about if other standards will also be involved.
For lessees, what I’ve told people is that the FASB didn’t really change the underline principle of lease accounting. There are some changes around the edges, but for the most part, if they are leases today they are leases tomorrow. However, they need to pay attention at those arrangements or contracts that might have embedded leases, service contract that includes the use of identified property. Those arrangements might not have identified as leases historically. But it will be different under the new rules. There will have be a balance sheet impact.
Also, start thinking about the system. You might have already figured out the accounting part, but when it comes to IT, it takes time. It is surprising that many public companies are still doing lease accounting in spreadsheets. It is not possible to track the balance sheet impact for the new standard in a spreadsheet without hiring a small army of people. I think most of the companies will also need upgrade the existing lease management system to include an accounting module. If companies, especially those with international locations, don’t have all of their leases information stored in a centralized location, now is the time to get those data in one place, and get them into a system. Implementing a new system, my experience with IT is that it usually take 9 to 12 months. It’s not an easy quick process.
Bloomberg BNA: Are there any resources you would recommend for the leasing standards?
Newell: Right now there isn’t too many. It is going to be a problem. Some people said that the FASB might need to consider to form a Transition Resource Group (TRG) for the leasing standards. At this point they haven’t created one. However, there are some changes in the standards that are worth having that TRG conversation. Unfortunately, right now, there isn’t anything formal or organized—like the TRG or the AICPA task forces—that addresses the leasing standards directly. There are some industry groups, for example the Financial Executive International (FEI), that are looking at the lease accounting issues. But outside of those industry publications, there is nothing official.
Continue the discussion at Bloomberg BNA Accounting LinkedIn.
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