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Real Estate in a World Without Operating Leases: The End of Off Balance Sheet Financing

If your company engages in lease transactions—real estate, equipment, computers, etc.—then a new Joint Exposure Draft (Draft) by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) will likely impact business.  The Draft would affect almost all outstanding leases (there will be no grandfathering of existing leases) and require your company to recognize the leased assets and corresponding liabilities on its balance sheet. Such recognition will immediately affect certain financial metrics and could impair loan covenants (e.g, debt to income). In addition, accounting related expenses could increase because the Draft implements a more discretionary standard for determining the length of your lease obligation. If implemented, the Draft will also likely impact future decision making. Look for these potential impacts if companies are forced to recognize leases on their balance sheet:

  • Less Expansion: Unattractive balance sheets could make it difficult for companies to obtain the financing needed to expand.
  • Short-Term Leases: Companies might be more inclined to enter into short-term leases to avoid inflating the debt-to-equity ratio or impairing profitability ratios.
  • Shift to Purchase: No longer able to take advantage of the “off balance sheet” benefits of leasing, companies might choose to purchase assets (a decision that could tie-up capital and reduce investment in operating assets).
  • Sale-Leasebacks: Some believe that sale-leaseback transactions might disappear because under the Draft they would be recognized on the balance sheet, but others think that because the present value of a lease is almost always less than the full property value (and therefore less of an impact on the financial and leverage ratios), companies will still engage in sale-leasebacks.

Your company should be mindful of the Draft’s implications and take the necessary steps to ensure that you’re in a position to handle the change. We recommend that you:

  • Project new metrics and review loan documents to make sure that you won’t be in default of any particular covenants.
  • Develop management procedures that take into account the Draft’s new terms and language to help reduce or eliminate any future restatement costs.
  • Consider whether a short-term lease or an asset purchase would be more advantageous for your company.

For more information on the Draft and its implications see "A New Accounting Standard: How FAS 13 Could Impact Your Bottom Line." If you have questions please contact Matt Troyer at 317-968-5419.

  • Partner

    Matt Troyer counsels clients in numerous areas of corporate and real estate law. As corporate counsel, Mr. Troyer routinely advises owners of, and executives within, privately held businesses on a wide range of matters and ...

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