How the FASB will Impact Your Real Estate Initiatives Next Year
Starting a new business is always exciting. Choosing the perfect name… shopping for office space – so much hope and anticipation to see your baby succeed.
Well, the rules of the dream are changing — particularly when it comes to real estate.
The Financial Accounting Standards Board (FASB) has issued a new lease standard that impacts businesses who rent space. Taking effect in 2019, affecting both public, and private businesses, leases that will be longer than a year will need to be put on the balance sheet as both assets and liabilities.
Let’s explain this in simple terms.
Say you buy a computer. Undoubtedly, it loses market value after 5 years because it’s going to slow down, have little space left, and, will be generally outgrown. That 5-year computer lease is going to cost as much as if you had purchased it.
Under the new FASB standards, this concept is akin to buying the right to occupy a piece of real estate. At the end of the lease term, the space is used and may not have the value it once had in the marketplace.
When the new standard comes into effect, it will be mandatory to report leases as both assets and liabilities on the balance sheet — even if the intent is to return it to the lessor. This won’t just apply to real estate, but other assets like equipment and vehicles. The renting obligations these leases reflect will be recognized as debt — the kind that will impact your credit, loans and capital requirements.
FASB was asked to bring these new rules into effect in 2005, after seeing that upwards of trillions of dollars in future cash obligations weren’t cancelled under operating leases that are, today, only being mentioned in the footnotes of financial statements, instead of on the balance sheet to give investors and creditors an accurate picture of a company’s finances.
A Deloitte poll by Compliance Week, showed that over half the companies surveyed are planning to convert their processes toward the new reporting standard. But, many don’t consider themselves prepared for the transition. Why? Because, this transition will change the way businesses account for their strategies when it comes to leases in the short and long-term.
This change is the biggest we’ve seen in decades.
What this means for you is that you will have to be attentive to what gets classified as a lease. It will include the option to lease in the future, and, this will have to be put on the books. It will give you a reason to buy a building outright since it will be treated the same way as renting it — an obligation that must be put on the balance books once the standard take effect.