CBRE, PwC: Few Executives Expect to Change Lease vs. Own Strategy Under New Standard

Few executives anticipate reducing the average term of their leases or trimming space leased because of new lease accounting standards, but many expect challenges around data collection and systems, reported CBRE Group and PwC US. 

On February 25, the Financial Accounting Standards Board completed its Leases project by issuing new guidance that establishes the principles to report transparent and economically neutral information about the assets and liabilities that arise from leases: 

–Lessees will need to recognize a right-of-use asset and a lease liability for virtually all of their leases (other than leases that meet the definition of a short-term lease). 

–The liability will be equal to the present value of lease payments. 

–The asset will be based on the liability, subject to adjustment, such as for initial direct costs. 

–This will balloon up the balance sheet of reporting entities who do a lot of leases presently accounted for as off-balance sheet operating leases.

–For income statement purposes, FASB retained a dual model, requiring leases to be classified as either operating or finance. 

–Operating leases will result in straight-line expense (similar to current operating leases) while finance leases will result in a front-loaded expense pattern (similar to current capital leases). 
–Classification as “operating” vs. “finance” will be based on criteria that are largely similar to those applied in current lease accounting, but without explicit bright lines in the current standard.

–Effective for fiscal years beginning December 15, 2018 for public companies; not-for-profits that issued bonds or securities that are traded, listed or quoted on an exchange or over-the-counter market; and employee benefit plans that file financial statements with the SEC.
–Other organizations: the new guidance is effective for fiscal years beginning after December 15, 2019.

CBRE and PwC surveyed real estate executives and reported that 56 percent of respondents lease more than half their real estate. In fact, nearly a quarter of respondents–23 percent–said they own no real estate at all and only 4 percent said they own all their real estate assets outright, implying that almost all companies will need to confront the new lease accounting standard head-on. But despite this fact, only 10 percent of the 500-plus executives surveyed said they would reduce the average lease term of new leases and only 2 percent said they would reduce the amount of space they lease. 

“The size and complexity of companies’ lease portfolios will determine the challenge of transitioning to the new standard,” said Jeff Beatty, Senior Managing Director of CBRE’s Financial Consulting Group. “We believe that after companies formalize the process of gathering the relevant data, they will be surprised to find that they may have more leases than they originally thought.” 

Some analysts say the new standard could make owning real estate more appealing than leasing it since one of the chief benefits of leasing real estate–keeping the lease liability off of the balance sheet–will go away. However, only 8 percent of executives surveyed said they expect to change their lease vs. own strategy, CBRE and PwC said.  

Many executives said the implementation challenges lie in managing lease information because management will need to accurately identify and account for all of their leases accurately on the balance sheet.

“Having the right leasing data is critical in companies preparing for future implementation considerations and staging for integration with longer-term solutions,” said Sheri Wyatt, Managing Director within PwC’s Capital Markets and Accounting Advisory Services practice. She said organizations should take a phased approach that starts with a current-state assessment that focuses on lease inventory, accounting process and data and system capabilities.

Wyatt said gathering and analyzing the information could take “considerable” time and effort depending on the number of leases and the variety and complexity of the lease portfolio. In many cases, original records may be difficult to find. Other factors such as identifying leases embedded in contracts will become more important as they will have to be recorded on balance sheet. 

Beatty noted that the new standard applies to all leases, not just real estate leases. “Prudent companies will plan to put time on their side by at least starting the transition process in 2016,” he said.