Media Release - 26 August 2010
Senior Communications Manager
Ernst & Young
+64 274 899 700
Proposals on lease accounting will impact the property market
Auckland, 20 August 2010 - The International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) yesterday released a proposal to improve the accounting for leases under both IFRS and US GAAP. The proposal seeks to align the accounting treatment of economically similar transactions for occupiers who choose to debt finance and buy real estate, versus enter long term leases. It is designed to provide a single model for lease accounting for both lessees and lessors – a “right of use” approach, and it could have a significant impact on the property market.
John Schellekens, Ernst & Young’s real estate advisory partner and Chairman of the New Zealand Valuation Standards Board says “the proposal represents a fundamental change to lease accounting. All assets and liabilities arising under lease contracts within the scope of the proposed standard would be recognized in the statement of financial position. The proposal is intended to address concerns about current accounting for leases including the classification criteria between finance and operating leases. Most property leases are operating leases and current accounting standards have been criticised as resulting in different accounting treatment for economically similar lease transactions, and not recording material assets and obligations in the financial statements. The proposals are intended to address these criticisms.”
Impact on lessees
Schellekens adds, “For lessees, the proposed changes would result in recording a liability for the obligation to make lease payments and an asset representing the right to use the leased asset. Rent expense would be replaced with interest on the liability and amortisation of the right-of-use asset. This would impact on performance measures like EBIT and EBITDA, and often would result in higher total expenses in the earlier period of the lease and lower expenses later in the lease. Estimates of the lease term, including renewals and contingent rents must be made not only at inception of the lease, but at every reporting date in order to determine the appropriate measure of the right of use asset and lease liability. This is a significant difference from current accounting requirements. Entities with numerous leasing contracts with contingent rentals, renewal options or residual value guarantees, such as retail companies, will be most affected. The likely impact of this will be a greater focus by lessees, when negotiating or restructuring leases, to consider the accounting impact of lease term, lease obligations, rent review structures and rights of renewal. Shorter leases and contingent rent clauses are likely.”
Impact on lessors
Schellekens says, “Lessors reporting under fair value (IAS 40), as is the case with New Zealand’s listed property sector, have had a lucky escape and will not be significantly impacted in an accounting sense as their reported values generally align with the value of their leases. The proposed changes will, however, mean that landlords will need to consider the impact of shorter lease terms on, for example, financing costs (which are tied to weighted average lease terms), property values and potentially costs associated with increased management time arising from more frequent lease negotiations.
The proposed lease accounting model will have a pervasive effect on the operations and financial reporting of entities engaged in leasing activity. The proposed standard is still subject to feedback, but is likely to come into effect in 2013/2014”
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