In an earlier blog, we highlighted that the retail industry is impacted by the FASB new lease standards, requiring a major overhaul in their financial statements. This post delves into the challenges for retailers in implementing the proposed changes to lease accounting as prescribed by ASC 842.
Challenges posed by FASB new lease standards:
- Data collection: ASC 842 calls for a wide range of information including lease commencement date, useful life, fair market value, borrowing rate, renewal/purchase options, space changes during the lease term, landlord allowances, initial costs and impairment charges. Since most retailers lease thousands of real estate for store locations, the sheer volume of data that needs to be collected can be overwhelming. US pharmacy chain Walgreens, for example, will have to bring in $33.7 billion worth of operating leases into its balance sheet.Compounding the problem is that lease data might be stored in various forms (spreadsheets, forms or paper documents). To track the fair market value of each store lease and calculate the impact, plan for additional time, cost, and resources. For instance, most retailers opt for “Full service Gross” leases wherein the rental income paid by the store to the lessor would include not only the basic rent but also other expenses such as maintenance, upkeep, repairs, property taxes, and insurance. ASC 842 explicitly states that only the lease portion be capitalized. So you must review your original lease document, get the exact lease rental details, consult the landlord as needed, and record accurate data. Further, expenses like property taxes will form part of the lease rental but maintenance or repair expenses will be excluded from the calculation.The time and effort involved in undertaking each of these activities is bound to have a substantial financial impact and it is imperative that retailers realize the enormity of the task ahead and start taking adequate measures.
- Accounting Impact: Retailers must recognize a right-of-use asset and a corresponding lease liability in the balance sheet for all off-balance sheet leases fulfilling the right-of-use principle criteria. While the balance sheet will show increased debt obligations (affecting your capitalization and coverage ratios), your income statement will result in a front-loaded expense pattern for finance leases. In addition, if you are a retailer with a presence in multiple countries, you will need to maintain two sets of books of accounts (IASB and FASB).
- Lease Negotiations: Longer lease terms require the addition of a large up-front future lease payment liability. Faced with the prospect of unfavorable financial ratios, retailers might consider negotiating a shorter lease term, with frequent renewals. Violation of loan covenants, especially with regard to balance sheet ratios and increased borrowing costs, could also be a possible fallout as ASC 842 explicitly prohibits grandfathering of leases.
- Revamping business processes and Internal Controls: Streamlining the store lease business process is of strategic importance to retailers and they will have to implement new processes, systems, and controls to account for current and future agreements. Moreover, Accounting, HR personnel and all related stakeholders need to be trained and made aware of the regulations in order to ensure proper compliance.
On a positive note, despite the huge challenges that retailers will face in achieving FASB lease accounting compliance, the new lease standards have provided them a good opportunity to re-evaluate and optimize their leasing strategies. This is where IWMS applications like IBM TRIRIGA can be of immense help as it provides you with a single, comprehensive system to manage your retail store assets across locations and geographies. It delivers seamless, predefined integration of all the various processes and helps you to manage the full facility life cycle of your real estate investments. Whether revisiting your lease versus buy decisions, lease data abstraction or scenario planning, or simplify your lease accounting process, IBM TRIRIGA will help streamline your compliance with both the FASB (GAAP) and the IASB (IFRS 16) guidelines.
The JLL Team