Effective 2013, new accounting standards will change the way companies record leases in their financial statements. These new rules will have far-reaching consequences for public companies and for the leasing market.
Currently, public companies describe their leases in footnotes to their financial statements. The new rules will require lessees to record a lease as a liability equal to the total amount of rent due under the lease and as an asset for its right to use the space.
The new standards provide incentives for lessees to invest in shorter term leases or to avoid leases altogether. Because the size of the recorded debt will be larger the longer the term of the lease, a company may prefer a five-year lease over a ten-year lease. Renewal options could also fall out of favor as they may increase the length of the lease and thus the size of the liability. More significantly for the leasing market, the new rules eliminate many of the differences between owning property and leasing it. This may prompt businesses to simply purchase property where they might once have leased.
The new standards could create unintended hardships for businesses. Higher debt ratios can affect credit ratings and impact debt covenants with lenders. Administrative costs are likely to be high, particularly for retail businesses that calculate rent on the basis of sales revenues. Retailers will have to estimate future sales and revalue such leases on an ongoing basis.
The proposed rules reflect the gradual merger of US accounting standards (GAAP) with IFRS financial accounting standards and attempt to limit off-balance-sheet financing activity.