You may have heard that there will be a new leasing standard applicable for financial reporting (ASU 2016-02, Leases (Topic 842)), but what does it really mean to you, the lessor?
First, here are a few facts:
- For private companies, the effective date of this standard was recently pushed back to fiscal years starting after December 15, 2020 (calendar 2021 year-ends).
- Lessees will be required to recognize a lease liability (lessee's obligation to make lease payments) and a right-of-use asset (lessee's right to use the asset for the lease term) for all leases, not just financing leases (previously known as capital leases).
- Lessor accounting will be largely unchanged.
If lessor accounting will be largely unchanged, you can stop reading, right? Wrong! There are some items lessors will need to consider in the upcoming year(s) related to this new accounting guidance. Below are some of the main items that should be considered.
ASU 2014-09 - Revenue from Contracts with Customers (Topic 606) is also newly effective. Key aspects of the leasing standard were set to align with the revenue recognition standard, therefore, you will need to obtain an understanding of the revenue recognition guidance as well. For example:
- Lease vs. non-lease components (e.g., CAM services, trash removal services) will need to be considered. The lease will be divided into the lease (lease accounting), and other services (revenue recognition accounting applies).
- Contract consideration would be allocated to the separate lease and non-lease components based on the relative standalone selling price basis.
- Fixed consideration to non-lease components will be recognized as lessor provides services ("transfers control").
Note that payments for property taxes or insurance would most likely be considered part of the lease component because they do not transfer a separate good or service to the tenant.
- Lessees will now have to record all leases on their balance sheet, so tenants could have problems with debt covenant compliance, which could also impact their borrowing capacity.
- Since leases will be recorded on balance sheet, it could change companies lease vs. buy strategies.
- Tenants could potentially desire to negotiate different lease terms. For example:
- Tenants may want to ensure the contract is specific as to lease vs. non-lease components as non-lease components may be left off the balance sheet.
- Tenants may explore variable lease payments, as this could decrease the right-of-use asset and lease liability.
- Tenants could consider entering into short term leases (12 months) without renewal options, as this may scope them out of the need to record the lease on the balance sheet - depending on the terms and likelihood of renewal.
- Shorter term lease could mean higher rental rates.
Sale and leaseback transactions:
- In general, there will no longer be off-balance sheet benefits for the seller-lessee related to a sale and leaseback transaction. There may still be other benefits to sale and leaseback transactions related to cash flow and legal obligations.
- Determining whether a sale has occurred, and the seller-lessee has transferred control within the new lease and revenue recognition standards has become more complex. Further, additional consideration should be made with regards to deferred gains on these transactions. Upfront discussions with your accounting and tax professionals will be pertinent in order to structure transactions appropriately.
Without a doubt, as with most new accounting guidance, there will likely be more disclosures required on both the lessee and lessor financial statements.
So, while you may have heard that the new leasing standard won't apply to the lessor, special consideration should be given to the effect of the leasing standard on the lessee since it may ultimately impact your business. Contact our experts at The Bonadio Group today to learn more.