PROPOSED CHANGES TO LEASE ACCOUNTING

Transcription

1 PROPOSED CHANGES TO LEASE ACCOUNTING Reference Guide Lessee Perspective Based on Revised Exposure Draft Issued May 16, 2013 FOR INTERNAL USE ONLY BACKGROUND 1. WHAT IS BEING PROPOSED? a. Generally, all leases must be capitalized (i.e., recorded on the balance sheet) with an exception for Short Term Leases (see Glossary). b. The amount recorded on the balance sheet is equal to the present value of the lease payments to be made over the lease term discounted at the lessee s incremental borrowing rate (see Glossary). c. The lease term (see Glossary), for accounting purposes, takes into account any option periods (e.g., renewals, expansions, terminations, etc.) for which a significant economic incentive exists to exercise the option. d. A lease will be classified as either Type A or Type B (see Glossary). The main difference is how the lease expense is accounted for on the income statement. Both lease types must be capitalized. e. Percentage rent generally does not need to be taken into account. f. Any portion of the rent attributed to reimbursement of operating expenses is not included in the determination of the amount to be recorded on the balance sheet. g. At a minimum, each time there is a CPI increase in the rent, the tenant will need to reassess the asset and liability on their balance sheet. h. Initial direct costs (see Glossary) are to be included as part of the capitalized asset. 2. WHY DOES THIS MATTER a. More visibility/scrutiny for the client s real estate department from the C-suite, especially the CFO, and the potential for a longer lease approval process. i. May require a higher level of service and standardized processes and systems from both external service providers and real estate departments. ii. May require a greater number of sensitivity analyses to determine the balance sheet impact of alternative lease scenarios. iii. May provide an expanded opportunity for the real estate department to sit at the table in a company s strategic and operational decision-making processes. b. Heavy administrative burden on clients during pre-implementation preparation and post-implementation maintenance, including communication to key internal and external stakeholders. c. Opportunity for CBRE professionals to continue to provide clients with the highest possible level of service and enhance their role as trusted advisors. 3. WHAT LEASE TYPES WILL BE IMPACTED BY THESE CHANGES? a. Virtually all lease types (including commercial real estate), except biological, oil and gas, intangibles, etc. b. Short-term leases (see Glossary) will be excluded from this requirement. c. No grandfathering of existing leases. 1

2 4. WILL IT AFFECT ALL COMPANIES AND INDUSTRIES EQUALLY? a. Not necessarily. Leasing-intensive industries (e.g., retail) may be more affected, as well as companies that lease more assets relative to their peers. 5. WHAT IS THE TIMING AND HAS IT BEEN FINALIZED? a. These are still PROPOSED changes that have not been finalized. b. The 120-day comment period ends September 13, c. Clients should be encouraged to submit comment letters noting disagreement/agreement on the various sections of the proposal as the opportunity still exists to influence the final outcome. d. New standard expected to be issued in mid- to late e. Effective date will likely be no sooner than 2017, although any comparable periods presented in a company s financial statements must also reflect the changes. In the case of a public company, this typically consists of the two prior years. 6. WHERE CAN CBRE PROFESSIONALS AND CLIENTS GET MORE INFORMATION? a. All relevant and current client-facing information is on the CBRE Lease Accounting website at b. The website provides access to the CBRE Lease Accounting Task Force white paper, FAQ and a recording of the June 2013 joint CBRE/PwC presentation. c. Pay particular attention to sections in the white paper entitled What Companies Should Be Doing Now and Strategic Considerations to Address Prior to Issuance of New Standard. d. Contact CBRE Lease Accounting Task Force members directly with questions. PRACTICAL CONSIDERATIONS 1. WHAT IMPACT COULD THE NEW STANDARD HAVE ON LEASE TERMS? a. Some tenants may want to consider short-term leases to minimize the on balance sheet impact, but business objectives should continue to be the driver in the decision process. b. No free lunch landlords will likely charge a premium for short-term leases and/or reduce incentives, while tenants could incur additional renewal/relocation risk. c. A tenant opting for short-term leases may not achieve its desired financial reporting effect if they have a significant economic incentive to exercise its renewal option(s). 2. WHAT IMPACT COULD THE NEW STANDARD HAVE ON LEASE VS. OWN DECISIONS FOR CLIENTS? a. May have an impact on decision making related to some core assets. b. As on balance sheet treatment is a current disadvantage to ownership when compared to leasing, the requirement to capitalize leases will minimize this disparity. c. Business drivers and rigorous financial analysis should still be the key. 2

3 3. WHAT ADDITIONAL SERVICES OR BUSINESS DEVELOPMENT OPPORTUNITIES FOR CBRE MAY ARISE? a. Opportunity to reposition clients portfolios or sub-portfolios, especially with added C-suite visibility/scrutiny. b. Workplace strategy opportunities may receive greater focus to potentially mitigate the impact to the client s balance sheet by reducing their square footage requirements. c. Lease administration outsourcing opportunities, especially for clients who do not have robust systems in place. NOTE: Because the proposed changes have not been finalized, software vendors have not yet upgraded their systems. CBRE is monitoring our key software providers and can provide insight and consultation relative to the issues and concerns a client may have well in advance of the standard being finalized. 4. COULD THE NEW STANDARD IMPACT LEASES WITH CPI INCREASES? a. An additional administrative burden will exist for leases with CPI increases because, at a minimum, lessees will be required to reassess the amount on their balance sheet each time their rent increases. b. May create disincentive for the inclusion of CPI increases in clients new leases. 5. WHAT IMPACT COULD THE NEW STANDARD HAVE ON OPERATING EXPENSE CLAUSES? a. CBRE professionals will want to ensure lease language around operating expense clauses is clear to ensure that any amount associated with the reimbursement of operating expenses can be identified and carved out of the rent payment. SUMMARY It is important to note these are still PROPOSED changes to lease accounting. Therefore, clients should be cautioned that implementing any changes to their strategy or systems could be pre-mature as changes may still occur prior to the issuance of the final standard. However, clients should be aware of the proposed changes, potential implications and burden they could place on their financial performance, systems and personnel. Gaining an understanding of these changes should not be delayed. 3

4 GLOSSARY INCREMENTAL BORROWING RATE The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment. INITIAL DIRECT COSTS Costs directly attributable to negotiating and arranging a lease that would not have been incurred without entering into the lease. For example, this could include, but is not limited to, costs associated with preparing and processing lease documents, evaluating and recording guarantees, and leasing commissions paid by the lessee. LEASE TERM The non-cancellable period for which a lessee has the right to use an underlying asset, together with both of the following, if applicable: 1. Periods covered by an option to extend the lease if the lessee has a significant economic incentive to exercise that option. 2. Periods covered by an option to terminate the lease if the lessee has a significant economic incentive not to exercise that option. At the commencement date, an entity assesses whether the lessee has a significant economic incentive to exercise, or not to exercise, an option by considering all contract-, asset-, market- and entity-based factors relevant to that assessment. An entity s assessment will often require the consideration of a combination of those factors because they are interrelated. The following are examples of relevant factors to be considered: 1. The dollar amount of the lease payments in the option period. 2. The terms and conditions of any options that are exercisable after the initial option periods (e.g., the existence of an option to purchase at a below market rate). 3. Leasehold improvements expected to have significant economic value to the lessee. 4. Costs relating to the termination of the lease and the signing of a new lease, including negotiation costs, relocation costs, etc. 5. The importance of the underlying asset to the lessee s operations. The proposed rules provide a slight break to the commercial real estate industry by stating a change in market-based factors (such as market rates to lease a comparable asset) should not, in isolation, trigger reassessment. Thus, a lessee s option to renew at a below market rate will not by itself require the option period to be included as part of the lease term. RIGHT-OF-USE ASSET An asset that represents a lessee s right to use an underlying asset for the lease term. SHORT-TERM LEASE A lease that, at the commencement date, has a maximum possible term, including any options to extend, of 12 months or less. Any lease that contains a purchase option is not a short-term lease. 4

5 TYPE A LEASE For most leases of assets other than property (e.g., equipment, aircraft, cars, trucks), a lessee would classify the lease as a Type A lease, which considers the lease to be a type of financing and results in a front-end loaded expense pattern, and would do the following: 1. Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments 2. Amortize the right-of-use asset on a straight-line basis over the lease term with the rent payment allocated between interest expense and a reduction in the lease liability, much in the same manner as a traditional mortgage. However, the lease will not be considered a form of financing, and will therefore be classified as a Type B lease, if it is determined that one or both of the following applies: 1. The lease term is for an insignificant part of the total economic life of the underlying asset, or 2. The present value of the fixed lease payments is insignificant compared to the fair value of the underlying asset at the commencement date. TYPE B LEASE Leases of Property (i.e., land or a building; or part of a building; or both ) are presumed to be Type B leases, which are to be treated as follows: 1. Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments. 2. Recognize a lease expense in a pattern similar to the current accounting treatment for operating leases (i.e., straight-line expense pattern). However, the lease will be considered a form of financing, and will therefore be classified as a Type A lease, if it is determined that one or both of the following applies: 1. The lease term is for the major part of the remaining economic life of the underlying asset, or 2. The present value of the fixed lease payments accounts for substantially all of the fair value of the underlying asset at the commencement date. FOR MORE INFORMATION, PLEASE CONTACT: Jeff Beatty Senior Managing Director, Financial Consulting Group Director, Task Force on Lease Accounting jeff.beatty@cbre.com Ian Billenness Director, Global Corporate Services ian.billenness@cbre.com The CBRE Global Task Force on Lease Accounting is composed of the following members: Jeff Beatty, Financial Consulting Group (Task Force Director) Ian Billenness, Global Corporate Services Robin Ciskowski, Portfolio Services Finance, Americas Richard Hurst, Portfolio Services Judy Kinney, Client Accounting Services Xavier Menendez, Global Corporate Services Mike Nelson, Strategic Consulting Laura O Brien, Human Resources & Workplace Strategies Jennifer Pazzia, Global Financial Reporting Kyle Redfearn, Valuation & Advisory Services Jeffrey Shell, Corporate Capital Markets Andrew Steinberg, Global Financial Reporting Amie Sweeney, Corporate Capital Markets Nick Tansey, Global Corporate Services Len Tiso, Global Corporate Services 5