February 26, 2016
FASB Issues Final Leases Standard
On Feb. 25, the Financial Accounting Standards Board (FASB or Board) issued a final Leases standard (the Standard). As previously reported by NAREIT, the Standard will not have a material impact on accounting for leases by lessors/landlords. Consistent with today’s accounting, lessors will account for lease revenue on a straight-line basis for most leases.
One change that will impact many equity REITs relates to the accounting for leasing costs. According to the Standard, only initial direct leasing costs that are incremental to the lessor will be capitalized. Generally, regular salaries and other costs of leasing staff or retainers for outside services will be expensed pursuant to the new Standard.
Another change that will impact lessors relates to the accounting for taxes, insurance, and common area maintenance. Under the standard, tenant payments to the landlord for taxes and insurance will be considered lease revenue. However, tenant payments to the landlord for common area maintenance will not be considered lease revenue, and will be accounted for under the FASB’s new Revenue from Contracts with Customers standard.
All lessees/tenants will be required to recognize a liability measured at the present value of lease obligations. An equal amount will be recognized on the lessees’/tenants’ balance sheet as a right-of-use asset. The Board preserved the dual lease accounting model for lease classification that drives the pattern of expense recognition in the income statement – operating leases and finance leases (formerly capital leases). Most leases in the real estate industry will be classified as operating leases. For operating leases, lessees/tenants will report lease expense on a straight-line basis over the term of the lease. For finance leases, lessees will record interest expense in a similar fashion to amortizing debt.
Another change that will impact some equity REITs relates to accounting by lessees under long-term ground leases. Under today’s accounting, lessees treat ground leases as operating leases. Thus, under today’s GAAP, there is no recognition of a lease liability on the balance sheet, and ground rent expense is recorded on a straight-line basis on the income statement. Under the new Standard, long-term ground leases will generally be classified as finance leases. Similar to an operating lease, the lessee will be required to recognize the present value of lease obligations as a liability. As a finance lease, this ground lease will not qualify for straight-line expense recognition in the income statement. Instead, payments made on the ground lease will be recorded in a manner similar to accounting for amortizing debt. The result will be that the combination of decreasing interest expense and straight-line amortization expense of the right-to-use asset will be higher in the early years and decrease over the term of the lease.
Public companies will be required to apply the Standard for all accounting periods beginning after Dec. 15, 2018 – for REITs this means application required beginning Jan. 1, 2019. The Board decided to permit early adoption upon the issuance of the Standard.
For more information, contact George Yungmann, Senior Vice President Financial Standards at email@example.com, or Christopher Drula, Vice President Financial Standards at firstname.lastname@example.org.