The Financial Accounting Standards Board (FASB) recently issued updates to revise the treatment of leases under the Generally Accepted Accounting Principles (GAAP). These updates impact commercial real estate firms that lease real property and other types of assets, and they require businesses to recognize the majority of leases on the balance sheet, which could inflate reported assets and liabilities.
Currently, lessees account for leases based upon its classification: capital lease or operating lease. Capital leases show on balance sheets as assets and liabilities for close to all of the useful life. Operating leases appear only on financial statements as a disclosure item and rent expense.
The new updates will require lessees to show all leases on the balance sheets for all leases with terms that exceed 12 months, despite their classification. Lessees must report a right-to-use asset and its related liability.
The recognition, presentation and measurements of cash flows and expenses that arise from a lease will depend upon its classification as an operating or a capital lease:
- For operating leases, the lessee recognizes a single overall lease cost, with the cost calculated on a straight-line basis over the term of the lease. They classify cash payments as operating activities on the cash flow statement.
- For capital leases, the lessee amortizes the right-to-use assets apart from interest on the liability using the comprehensive income statement. Repayments are classified in the principal portion within the financing activities of the lease liability. Interest on lease liability is reported in the statement of cash flows.
Other issues commercial real estate firms need to review with their accountant include:
- The impact on lessors
- Combined contracts
- Interplay with international standards
- Effective dates and transitions
These updates may have more repercussions for lessees. A business may incur additional costs to educate employees on the correct application of the new requirements in addition to educating users of the financial statement of the new impact of the updates. Most of all, although the new requirements have a relatively lengthy time prior to becoming effective, now is the time for companies to address the changes.
More more information on these updates or how the Menlo Group can assist you with your commercial real estate needs, contact us here.