“You don’t need us to tell you that big changes in lease accounting rules are afoot. And if you’re looking for technical analysis of the new rules, you’ll find tons of it online. The problem is that without an accounting background, you’ll have a hard time digesting it. And what you won’t find on the Internet is a plain English explanation for non-accountants. So we decided to create one. Here are the eight things that tenants of commercial real estate need to know about the proposed new accounting rules and their impact on leasing.”
1. What’s at Stake
Accounting rules require companies to keep two basic financial statements:
A balance sheet listing assets and liabilities showing what the company owns and owes, with recorded assets equaling, or “balancing,” recorded liabilities plus equity; and
An income statement (a.k.a. P&L) listing the company’s revenues and expenses, which makes it possible to calculate the company’s profits and losses.
These financial statements aren’t just a technical exercise in bean counting. They directly affect a company’s ability to attract investors and get bank loans, and even affect how much it pays in taxes.
2. How Current Lease Accounting Rules Work
A lease is one of the transactions that a company must account for on its financial statements. How the company does that depends on the kind of lease. There are two possibilities:
Operating leases are transactions in which the owner (a.k.a. “lessor”) gives the tenant (a.k.a. “lessee”) a right to use land or another asset. The tenant doesn’t own the asset and must return it to the owner after the lease ends. Most standard commercial real estate leases are operating leases.
Capital leases are essentially purchases in which the tenant acquires an ownership interest in the leased asset. Examples include leases that transfer ownership of the property to the tenant at term’s end, give the tenant an option to purchase the property at less than its fair value and/or last for as long as the asset’s remaining economic life.
Accounting-wise, the most important difference between the two kinds of leases is that tenants aren’t required to record operating leases on their balance sheet.
3. Why the Rules Are Changing The new accounting rules propose to change how leases must be recorded on the balance sheet and P&L. The biggest change: elimination of the rule that tenants don’t have to list operating leases on their balance sheet. From now on, all leases will have to be …