Businesses urged to prepare for global lease accounting changes

Changes have been driven by a recognised need for greater transparency in leasing standards.

Jones Lang LaSalle is urging businesses across Asia Pacific to prepare for dramatic proposed changes to global lease accounting standards with significant impacts predicted on real estate portfolios in the first year of the new regime.

The International Accounting Standards Board (IASB), in conjunction with the US Financial Accounting Standards Board (FASB), has proposed sweeping changes to the accounting of operating leases. The exposure draft was released in August 2010 with final comments to be submitted by 15 December 2010, according to a Jones Lang LaSalle report.

David Brown, Head of Lease Administration Asia Pacific for Jones Lang LaSalle, points out that the accounting changes implicate any business that leases assets, including real estate and equipment.

“The changes have been driven by a recognised need for greater transparency in leasing standards by taking off-balance sheet obligations and presenting leases front and centre on company balance sheets. This new system demands a stronger long-term view of leases, factoring in future options, based on the balance of probabilities, and in doing so, generating considerable administrative burden,” he says.

According to Sylvia Koh, Head of Corporate Consulting for Jones Lang LaSalle in Asia Pacific, “Rent represents one of the largest operating expenses for businesses. So, the most substantial hit to businesses’ profit and loss statements will be in the first year of the rollout as companies report as much as 20% higher initial occupancy expenses for a 10-year lease”.

Under the new system, rent expenses will be replaced by diminishing leased assets on a straight line basis with higher front-end interest expenses.

Companies will be required to capitalise all lease obligations on their balance sheets – recognising their right to use leased property as an asset and their obligation to pay rent and other amounts as a liability.

The changes will potentially affect all current and future leases for both real estate and equipment, elevating the importance of real estate strategies capable of supporting the financial resilience of businesses.

Key industries set to face the greatest impact include commercial banks with large branch systems and retailers which typically lease the vast majority of their locations.

Ms Koh says, “We anticipate that under the new standards, companies will need far more information on their real estate leases than they have previously, and be prepared to make robust future projections, in order to accurately report their assets and liabilities for each reporting cycle. If you take retailers as an example, when they are operating on thin margins, the expenses from the first year of these changes have the ability to erase their profit margin entirely.”

“Companies should assess their real estate lease exposure and consider whether they need to develop a new strategy for resourcing their asset requirements,” she adds.

Mr Brown says, “Particularly for businesses that draw heavily on lease arrangements, we are encouraging them to start preparing now for the changes – even though the final guidelines are not due for release until the second half of 2011. They need to gear up for a level of detail that businesses have not had to comply with previously – leading to a significant shift in resourcing, data and information management and reporting. I can’t understate the adminstrative impact alone of managing leases at this level of detail.”

Mr Brown suggests that some of the key considerations for businesses include:

• Reviewing current real estate portfolios and lease arrangements
• Re-assessing the merits of owning assets outright compared to lease arrangements
• Re-evaluating lease tenure and strategies for negotiating competitive deals on shorter leases as well as preparing for possible shifts in lease structuring by landlords
• Improving organisational forecasting capacity in order to better predict space needs

“Ultimately, businesses need to understand the specific implications of these proposed changes to ease the adminstrative burden of compliance and be best positioned for managing the impacts,” he reiterates.

The proposed changes, likely to be effective in 2013, will impact companies reporting under either the International Financial Reporting Standards (IFRS) or US GAAP including all US-based companies, most European Union-based companies and in Asia Pacific, any company based in Australia, Hong Kong, India, Japan or Korea where conformity to IFRS is or will be followed.