Lease Accounting: CFOs Are Missing a One-Time Restructuring Opportunity

by | 03 August 2017

Many companies are on the verge of missing a valuable chance to positively affect the financial statement treatment of their real estate leases. And that window of opportunity slams shut on January 1, 2019.

It’s not news that on that date all in-place real estate leases will be accounted for under the new FASB Lease Accounting Standard (Topic 842) based on the combination of the existing lease terms and company- and site-specific circumstances.

Prior to that date, the restructuring of material in-place lease commitments in a company’s portfolio presents a one-time opportunity to minimize and/or optimize the financial statement impact of the organization’s lease commitments.

MITIGATING THE FINANCIAL STATEMENT IMPACT

Many CPA firms are providing invaluable support in transitioning clients to the new standard. However, the scope of their work is limited. In a recent conversation with a Grant Thornton assurance services partner, he stated in a matter-of-fact fashion, “We can provide guidance and comment generically on hypothetical lease terms but not on specific transactions.”

The new standard introduces an opportunity for many lessees by providing an element of legitimate discretion to proactively mitigate the financial statement impact by restructuring these agreements. The accounting for a real estate lease is highly nuanced based on a host of factors including the organization’s business strategy, historical practices and the specific circumstances under which the property is occupied. As with most complex technical reforms of this nature, a great tendency exists to oversimplify both the impact and solutions.

Additionally, there is a widely held and mistaken notion that the new standards will uniformly impact all of a company’s competitors. Many financial leaders have accepted this belief too casually, which in part, has led firms to bypass the opportunity to evaluate alternative lease terms and structures.

Leasing is a corporate finance decision that is influenced by a company’s unique circumstances and business objectives. When a decision to lease is made, the period in which a company chooses to control the facility through the combination of lease term and option rights is influenced by factors including business growth assumptions, the level of investment made in a facility, a forecast of future local real estate market conditions, branding and image considerations, the impact on earnings and risk mitigation considerations.

TAKING ACTION NOW

Leveraging the window of time before January 1, 2019 necessitates meaningful engagement by a business with its advisors and real estate organization to understand the objectives and circumstances for each material lease commitment. A grounded understanding regarding a company’s historical practices is required as well. Finally, a tested and comprehensive model that can accommodate the multitude of inputs is needed to design optimal transaction structures.

Generalizations and speculation are pervasive around the impact of the new standard. But it’s clear that many corporate balance sheets will balloon. One report by financial services company Credit Suisse Group AG conservatively estimated that the S&P 500 companies presently have $600 billion of un-capitalized, off-balance-sheet real estate leases.

The most immediate and significant rewards will go to those firms that evaluate their in-place lease commitments and assess their options with extreme rigor and a proactive, cross-organizational approach over the next year.

Scott Daugherty is an Executive Vice President and a leader of Colliers’ corporate finance practice, which is exclusively focused on serving corporate real estate occupiers. He is both a former CFO and PwC CPA. He earned an MBA at the Kellogg School of Management and has a long association with Financial Executives International.