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New Lease Accounting Proposal Continues to Vex CRE Groups

Extended Effort to Draft Converged Rules to Improve Quality and Certainty Enters New Phase
May 29, 2013
The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) finally released a revised proposal to rules accounting for real estate and equipment leases.

The exposure draft, the latest revision to a proposal first released in 2010 that resulted in widespread complaints and dire predictions by CRE groups and other business interests about the effect of the changes on real estate markets and the economy, requests that public comments on the latest proposal be submitted by Sept. 13.

Under the current timeline, the joint boards could approve a final rule after weighing the comments by next year, with the new rules to be phased in by 2017.

The revised draft continues to require a lessee to recognize assets and liabilities as rights and obligations created by a lease, but it modifies the way of determining expense recognition and other reporting requirements introduced in the original draft.

Any progress in the rulemaking since 2010 aside, however, Real Estate Roundtable and its allies in Congress continued to register concern about the potential effect on property markets.

Fitch Ratings further weighed in last week with a long running concern -- that the proposed rules may encourage companies to shift to short-term leases or other accounting end-arounds, with fewer leases than originally expected brought onto the balance sheet once enforcement of the standard begins. Such a shift to short-term leases would be a credit risk for building owners, the rating agency said.

Real estate landlords and tenants will have to recognize rental income on their balance sheets on a straight-line basis, with costs recognized evenly over the term of the lease. Costs of leasing equipment or other items, by contrast, will be weighted more heavily in the early years of a lease.

While the dual-track approach remains controversial, it's "a clear improvement for real estate over the boards’ original (2010) proposal," Roundtable noted. That said, "We remain concerned about the potential impact of this new lessee requirement on tenant behavior," despite the shift to a straight-line basis landlords and tenants, the lobbying group said.

"We remain concerned that there has not been a release of a cost-benefit analysis of the lease accounting proposal" to guard against "unintended consequences" for property markets, according to a letter to FASB Chairman Leslie Seidman signed by 13 Republican members of Congress working in collaboration with Roundtable sent two days before the May 16 release of the latest draft.

Compromises in the latest version include an exemption allowing leases of 12 months or less to remain off the balance sheet. Arrangements assessed as "service contracts" can also remain off balance sheet.

The boards attempted to curb the shifting of long-term leases into short-term leases by specifying that terms of 12 months or less must include an option to extend. However, companies may still push for more short-term leases to keep them off the books, Fitch said.

"We believe short-term leases generally reduce the predictability of cash flows for a lessor and reduce the flexibility to align the duration of funding," Fitch said,

While putting information on many long-term leases in one place improves disclosure, the reporting requirements under the rule changes aren't comprehensive enough, Fitch said.

In a statement, Seidman said the latest proposal responds to the widespread investor view that leases are liabilities that belong on the balance sheet.

"The boards revised the original proposal to distinguish between different types of leases for income statement and cash flow purposes, in response to feedback received from stakeholders,” Seidman said, adding that the boards have worked together to develop a converged proposal to "address the inadequacies of current lease accounting and disclosures."

IASB Chairman Hans Hoogervorst noted that at present, investors must "take an educated guess" to determine the hidden leverage from leasing by "using basic disclosures in financial statements and applying arbitrary multiples."

"It is clearly not in the best interests of investors to expect analysts and others to guess the liabilities associated with leases," he said, adding the proposal will improve the quality and comparability of financial reporting.

Roundtable noted that the future of the proposed standard "remains ambiguous and has the potential to unravel."

Three of FASB’s seven board members dissented on the proposal and Seidman, who cast the deciding vote, will leave the board in June.

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