David Kamen, Vice President, Global Portfolio Strategy, Global Workplace Solutions, Johnson Controls (Q1 / Winter 2013)
When preparing for the Financial Accounting Standards Board (FASB) new lease accounting rules, companies must assess the impact of these standards on the value of the their lease obligations on a capitalized basis. This can be done by calculating the total cash payments of leases, any anticipatory changes in the total lease term length and the imputed interest expense, and then repaying the costs over the anticipated length of the lease. This process can be completed in the following six steps:
- Calculate the impact on the company’s financial ratios, including profitability, liquidity, and leverage. Determine whether the company would be breaking any debt covenants it holds with lenders.
- Assess the impact on earnings before interest, taxes, depreciation, and amortization (EBITDA) and the company’s overall tax structure liabilities at the federal, state, and local levels. Analyze how any early lease terminations or cancellations would affect potential capital gains and losses for early write-offs of tenant improvements.
- Analyze the impact of U.S. generally accepted accounting principles (GAAP) and any related tax changes on the company’s deferred tax position. The change may result in bigger spreads between cash rent for tax and interest, and amortization for book values.
- For lessors, assess the impact on the company’s owned properties, including valuation issues. The change will result in possibly shorter leases but higher cap rates.
- Assess the potential impact on closing and transaction costs, such as money spent on attorneys, accountants, appraisers, and other specialists, as well as mortgage recording taxes and transfer taxes. Added time and additional analysis will all lead to more billable hours to be accounted for.
- Re-assess lease principles against the company’s own decision-making. The factors that should influence a company’s decision to lease or own equipment or property should be those that alter its underlying fundamentals. These include the net present value impact of cash flows, the value of the flexibility that comes with short-term leases, and alternate uses for the assets. The proposed accounting rule changes would alter none of these, so a well-planned asset ownership strategy does not need to be amended.
Once the final rules are announced this summer, there will not be a lot of time to prepare before they take effect in 2015 or 2016. Assessing the impact of the rule changes on the value of lease obligations on a capitalized basis is only one step that should be taken. To plan for the new lease accounting standards, companies should also consider the following tips....