July 18th, 2011, By Dana Haugh
Are you ready for the new FASB rules? If you’re like 99% of us, the answer is probably no. But the deadline is fast approaching and we are all running out of time to get organized and prepared. As most of you have probably heard, the new FASB is designed to make companies more transparent—especially important if you own a public company. The duration, options and borrowing rates will all change as well as the frequency with which leases are reviewed. The volume of real estate data, as well as reports, will also increase substantially and it is expected that lease executions will be met with incredibly complex calculations. All your real estate commitments will need to be recorded differently and entries will have to be present on both your income report and your balance sheets. And these are just some of the changes FASB has announced. The second quarter is quickly coming to a close and the start of the third means that the last of the changes will be revealed. That gives us about a year to get ready.
Part One of this article is going to address the main changes in leases, lease rates, terms and reassessment options. This is by no means an exhaustive list (though it may feel that way) and if you would like a more detailed and dense description stay tuned for our white pages.
WARNING: This is not for the faint of heart. This is some pretty heavy stuff– a bit more involved than your basic lease rules.
For now, brace yourself.
So, new lease regulations. Firstly, it’s important to realize that FASB is still in the process of distinguishing a lease from a service contract, and is still seeking feedback on that matter (if you feel so inclined, your opinion is needed). Right now, the distinction is made based upon assets: specified or inseparable. Specified assets are defined as assets controlled by the customer (physical access), the customer’s participation in the design and arrangement of the asset (customer-specific) and the customer’s right to obtain all economic benefits of the asset—therefore, such an asset would be classified under a lease term. Inseparable assets are defined as “uncontrollable” holdings, where the customer has none of the aforementioned entitlements and thus does not have the right to “control” the asset. This would then be considered a service contract. So what this basically means is that fewer contracts, including current leases, will actually be considered leases.
But, if you happen to be one of the few whose contract is considered a lease, we have some changes for you to look forward to—namely that your lease term will start when you sign the contract. So no more “hidden” properties or signing contracts but avoiding lease agreements until the actual move-in date. Now, your lease term will start when your contractual agreement is made.
Lessee rates will now need to adjust for changes in lease term estimates depending on new incremental borrowing rates.
And your reassessment options just got a little less accommodating—the initial and subsequent evaluations for lease reassessment options will contain thresholds for extending and terminating a lease or purchasing an underlying asset—and you (the lessee or lessor) can’t consider any changes in the market for your evaluation after the lease begins. Way to be, FASB.
Check out Part Two for more info on the fun FASB changes…!
All information gathered from FASB and Leasing 101