Ready or not, the new lease accounting rules are on the way and will result in companies with significant leases appearing asset-rich but also heavily indebted. Here are six things you need to know.
What is the change ? The new accounting rules will require operating leases (like an office lease) to be recorded on the balance sheet and the P& L statement. Previously only capital leases, which are essentially purchases were recorded.
Why is this change being made ? For transparency to enable investors, banks, regulators and other stakeholders to make balanced judgements about a company’s financial health. The changes made by FASB and IASB (the international accounting boards) are estimated to load trillions of pounds on to company balance sheets.
Does the total value of the lease need to be added to the balance sheet ? If the lease is longer than twelve months or the combined lease and any renewal option which the tenant is ‘reasonably certain’ to exercise exceeds twelve months, then yes the tenant must record the total value at the start of the lease.
When will the new rules take effect ? January 2019.
What will the impact be ? As a result some companies will exceed the debt-to-equity ratio required by their bank loan agreements. For example, a tenant leasing 20,000 sq ft in Clerkenwell at £65.00 per sq ft for 10 years will add £13 million of debt to its balance sheet (20,000 sq ft x 10 years x £65 per sq ft).
Are shorter term leases the best strategy for all tenants ? For many yes that could be the way to go, ie. the shorter the term, the smaller the liability but for others, probably not because the benefits will likely be offset by high construction costs amortized over the lease term, rising rental rates and the risk of being squeezed out by competing businesses prepared to sign up to a longer term.
If you’re anxious about the impact the new lease accounting rules could have on your business and would like to discuss how a move to more flexible term space could dramatically improve the look of your balance sheet, please call me on 07968 191 233 for a personal perspective on the benefits of transparent, objective and conflict-free tenant representation.
With all good wishes.
All information herein is from sources deemed reliable, but no warranty, expressed or implied, is made.