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Few Companies Prepared for New Leasing Standards

February 16, 2011

A new survey by Deloitte found that only 7 percent of companies are well prepared to comply with the new lease accounting standards that have been proposed by the Financial Accounting Standards Board.

That’s not such good news, because the new proposed draft standards, which were originally distributed last August, may be finalized as soon as this June, Deloitte pointed out. That doesn’t mean they will take effect in June, of course. FASB is still trying to agree on the leasing standards with the International Accounting Standards Board, and enough companies have issues with the leasing standards that they probably would not take effect for several years anyway.

Plus, in order to comply, lessees (and possibly lessors) would have to fundamentally change how they account for real estate and equipment leasing transactions, providing more extensive financial statement disclosures than ever before, Deloitte noted.  The new standard would effectively eliminate all operating leases and require them to be capitalized on the company's balance sheet, a major change from the way many companies are used to doing business.  For lessees, the new standards would also replace rent payment expense reporting with interest and amortization expense reporting.

"These changes will have an immense impact on many companies that lease commercial property," said Josh Leonard, a leader in Deloitte's real estate consulting practice, in a news release. "Beyond the major changes involved, companies need to start looking at their lease portfolios now for adequate lease information, technology capabilities, and resources to implement and monitor the new standard, expected to be final by mid-year 2011." 

From a financial perspective, more than 80 percent of respondents believe that the lease accounting standards will place a significant burden on financial reporting for tenants as well as property owners, Deloitte pointed out.  More than 40 percent of the respondents to the survey believe the new standards would make it more difficult to obtain financing.

Not only that, but 68 percent of respondents said it would have a material impact on their debt-to-equity ratio; and, roughly 40 percent thought the new lease standard would lead to shorter term leases.

Only 35 percent of the respondents to the survey said they are extremely or very confident in the integrity of their company's lease data needed to comply with the new standard. That’s not so good.

On top of that, to accommodate the new leasing standards, major technology investments would surely be needed. That may be good news for computer and software companies, but not necessarily for the companies that would have to buy all that new equipment.

One-quarter of respondents said their companies are likely to have to make a major upgrade to their information technology systems, while 20 percent said they are likely to acquire a new system.  Among companies with 1,000 or more leases, the need for IT investment was even greater—39 percent of these respondents expect the new standards will lead to a major technology system upgrade, while 27 percent expect to acquire a new system. In addition, just 21 percent of respondents are extremely or very confident in the capability of their companies' information technology provider to comply.

Half the respondents at companies with 1,000 leases or more expect that implementation would take one year or longer, according to Deloitte.

"For the real estate industry, the impact of the proposed new lease accounting changes will impact both the balance sheet and tenant strategy and execution. For owners and operators, the big shift will be in what their tenants demand. Shorter-term leases may be in high demand along with an increased tenant appetite to forego renting in favor of buying," said Bob O'Brien, vice chairman and real estate services leader for Deloitte LLP, in a statement. "In addition to changing how they do business, real estate companies are going to have to make changes in how they operate. The proposed new leasing standards will require a re-examination of capital expenditures on new leases, enhanced lease administration and forecasting systems, and careful consideration of the balance sheet and income statement impacts on existing loan covenants.  The changes may be sweeping."

No wonder FASB and the IASB have been on the receiving end of negative comments from leasing groups who want them to slow down the transition to any new standards. FASB Chairman Leslie Seidman recently said that FASB and the IASB are aiming to complete their convergence efforts on the leasing standards by the end of the third quarter (see FASB Reverses Course on Fair Value). She said the board has mainly been evaluating changes to the lessee mode, and it would then take a step back and see what appropriate changes need to be made in the standards for lessors. Whatever changes are made, a long transition period will be needed if so few companies are prepared for the new standards.

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