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  • Alfred Erdmann CPA, CGMA, WithumSmith+Brown, PC

New lease accounting standard on the horizon

For several years now, the accounting standard-setting body in the United States, the Financial Accounting Standards Board (FASB), and the international accounting standard-setting body, the International Accounting Standards Board (IASB), have been working on various convergence projects in an effort to achieve more uniform accounting standards worldwide. Not surprisingly, lease accounting has consistently been among the topics in this initiative. It was – and is – among the most highly commented-upon topics in the overall project.

Several exposure drafts were issued, which garnered significant commentary and feedback from many sources. Ultimately, the IASB and FASB each issued new standards in the first quarter of 2016, with the FASB issuing Accounting Standards Update No. 2016-02, Leases.

Lessor accounting for leases is largely unchanged. The significant changes occur on the lessee side of leases. The following is a summary of the major points emanating from this new standard.For lessees, all leases will be accounted for by recognizing a right of use (ROU) asset and a corresponding lease liability at lease inception. On this point, the FASB and IASB agree. However, they do not on the subsequent recognition. Under the FASB standard, lessees will be required to classify leases as Type A or Type B. These classifications are not much different than the existing capital/operating lease classifications, with capital leases becoming Type A leases.

Under a Type A lease, lessees would recognize amortization of the ROU asset separately from the interest expense on the lease liability. Under a Type B lease, lessees would recognize a single lease expense. The IASB allows only the Type A lease designation for lessees. Leases of real property typically qualify as operating, or Type B, leases. Therefore, balance sheets for tenants will be required to reflect right-of-use assets and corresponding lease liabilities. The lease liability will generally be calculated as the present value of the minimum lease payments. The amounts to be included as rent under a lease should only include fixed payments, such as base rent and any minimum operating expense recovery, and variable payments based on an index (CPI, e.g.) or rate. This is calculated using the index or rate measured at the commencement date.In evaluating lease terms, lessees must assess the likelihood of options to extend being exercised. Extension options should only be included if it is “reasonably certain” that they will be exercised. Leases for terms of 12 months or less are excluded from the new standard and can be expensed currently.

Leases between related parties should be accounted for under the terms and conditions of the lease, but the parties must also apply the related party disclosure rules. Generally speaking, the lessor in a sublease (lessee in the original lease) should account for each lease independently of the other.It is important to note that these rules only apply to GAAP basis financial statements. Entities that report on an income tax basis will not be affected. For public companies, this new standard is effective for fiscal years beginning after December 15, 2018 (calendar year 2019 for many companies) and any interim periods within that year. For all other entities, it is effective for fiscal years beginning after December 15, 2019 (calendar year 2020 for many entities) and any interim periods within fiscal years beginning after December 15, 2020.

For these and all real-estate-related matters, it is always important to consult with a trusted advisor with a broad base of experience in the real estate industry. In addition to traditional accounting, auditing and tax services, a firm like Withum can help increase profitability while reducing operating costs.

Alfred Erdmann CPA, CGMA, is the audit services practice leader for Withum’s Real Estate Services Group.

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