Paul Becht, partner of Margolin, Winer & Evens LLP, explained how the new lease accounting standards will impact real estate companies’ financial statements in his article published in the New York Real Estate Journal. Paul has over 20 years of experience in public accounting and is the vice president of the New York State Society of Certified Public Accountants’ Board of Directors. I recently had a conversation with Paul to discuss some of the findings in his article.
Bloomberg BNA: In your article you said that the new lease accounting standard will significantly change the way that leased real estate is reported on financial statements. Can you be a little bit more specific of how the real estate industry will be affected by the new rules?
Becht: The lease accounting rules are going to be effective in 2019. I haven’t heard that lessors are really going to be impacted by the new rules. But for lessee tenants, ASC 842 requires them to recognize a right-of-use (ROU) asset and a lease liability. The lease liability is calculated based on the present value of lease payments to be made over the lease term discounted at the rate implicit in the lease. Therefore, the shorter the lease term is, the smaller amount the lease liability is going to be, the less of an impact the new rules will have on the balance sheets. For example, the present value of lease payments for a two- or three-year lease will be much smaller than for a 10-year lease. Therefore, the impact of a two- or three-year will be much smaller than a 10-year lease on the balance sheets.
The change on the balance sheet will also impact companies’ financial ratios, such as the current and debt service coverage ratios. Banks often look at those ratios when approving loans, so lessees will probably start managing their balance sheets differently in order to meet those ratio requirements that banks look at.
Bloomberg BNA: Are you anticipating lessees to start negotiating for short-term leases rather than long-term leases?
Becht: In theory they will, but in reality, for the most part, it [the new lease accounting standards] won’t truly change their behavior. For lessee tenants, having a two- or three-year lease is just too risky for the business. From the prices-rise economic standpoint, tenants are more inclined to have a 10-year lease rather than a two- or three-year lease. The business department won’t be pushing for shorter term leases just because the accounting department told them that the numbers have changed. They may just tell the accounting department to “deal with it.”
So the answer is no, the new accounting standards won’t change companies behavior.
Bloomberg BNA: For investors and financial statement users, what do they need to be aware of when considering the impact of the new leasing standard?
Becht: Investors will just need to adjust their analysis.
Actually, investors drove the change of the lease accounting standards so that they will be able to compare companies with similar lease arrangements.
However, because all operating leases are going to be on the balance sheets, with exception of short term leases, companies will do whatever they can to avoid the impact. The lease liability is not currently reported on companies’ non-GAAP financial statements. Companies may start excluding it to show investors that the lease liability on their balance sheet is not relevant to their operations. If that is the case, analysts should change the way they analyze companies’ non-GAAP measures.
Continue the discussion at Bloomberg BNA Accounting LinkedIn.
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