Starting a business is an exciting time. From coming up with the name to window-shopping for office space, it’s the epitome of the American Dream.
Well, the rules of that American Dream are changing – at least, in terms of real estate.
Last year, the Financial Accounting Standards Board (FASB) issued new lease standards that will impact every business that rents space. It will take effect after December 15th, 2018 (for public companies) and Dec 15, 2019 (for privately held companies). Leases longer than 12 months will need to be listed on the lessee’s balance sheet as both an asset and a liability.
Ok, why is this important?
“Think about it like buying a computer,” said Howard Ecker, CEO of Howard Ecker + Company and the pioneer of tenant leasing. “A leased computer doesn’t have a lot of market value after five years. Maybe it’s slow or it doesn’t have enough space. Whatever the issue, you’ve outgrown it; it no longer serves your needs. But that five-year computer lease has cost you almost as much as if you purchased it.
“Under the new FASB standards, you’re essentially buying the right to occupy a piece of real estate. At the end of your lease term, the space is used and may not have the value it once had in the marketplace – a marketplace full of diverse choices,” Ecker pointed out.
In short: The new FASB lease standard disrupts the status quo by turning office spaces into used PCs.
The changes mean companies will have to report their leases as both assets and liabilities on their balance sheets – even if the tenant’s intent is to return the asset to the landlord. The standards apply to real estate as well as tangible business property, such as equipment, vehicles and more. And the rent obligations these leases reflect are essentially recognized as debt – the kind of debt that will impact a company’s credit, loans and capital requirements.
The Securities and Exchange Commission (SEC) asked FASB to craft these new rules in 2005, after seeing that “approximately $1.25 trillion in non-cancelable future cash obligations committed under operating leases” were basically living in the footnotes of financial statements instead of holding weight across the actual balance sheet – the kind of weight that gives investors and creditors a true picture of a company’s financial health.
According to a recent Deloitte poll by Compliance Week, over half the companies surveyed will be working hard to convert and work toward this new financial reporting standard. However, the biggest concern is that only 14% consider themselves prepared to make the transition. Think about it. This shift is going to change the way all CFOs account for leases in both their short and long-term financial strategies.
This is the biggest change to hit business owners in decades.
According to an analysis by Deloitte, businesses will have to look far more closely at what they classify (or do not classify) as leases. This includes options to lease for future expansion, which will need to be treated as if they will be executed and reflected on the books right away. This will give tenants reason to buy their buildings outright since it will be treated the same way as renting – namely as another obligation on the balance books.
More significantly, companies’ paperwork tracking leases may multiply exponentially. Some companies may need to keep multiple sets of books. This will be a significant challenge for small or struggling companies.
Bottom line, when you start a business (especially a small business with a brick-and-mortar storefront), loans are typically involved. With this change in the FASB rules, rent obligations will no longer be considered an expense reported off the balance sheet. As a result, more companies will struggle to build credit since debt ratios will appear inflated.
Now is the time to start examining what these changes mean for you and your business.
Brian is an international speaker and coach.