At its Nov. 11 meeting, the Financial Accounting Standards Board (FASB or Board) agreed on the effective date of the Leases standard (the Standard). 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. The Board plans to issue the Standard in early 2016. All leases with lease terms greater than one year will be subject to the Standard, including leases in place as of the adoption date.
As previously reported by NAREIT, the Standard will have little 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 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.
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 lessee’s/tenant’s balance sheet as a right-of-use asset. The Board preserved the dual lease accounting model for lease classification – operating leases and 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.
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 capital leases. Similar to an operating lease, the lessee will be required to recognize the present value of lease obligations as a liability. As a capital 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.
For more information, contact George Yungmann, Senior Vice President Financial Standards at email@example.com, or Chris Drula, Vice President Financial Standards at firstname.lastname@example.org.