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Structuring Strategies for Off-Balance-Sheet Treatment of Real Property Leases
The Financial Accounting Standards Board (FASB) released a new set of lease accounting standards, known as Accounting Standards Codification (ASC) 842, which went into effect earlier this year. Most significantly, publicly traded companies are now obligated to list all leases of 12 months or longer on their balance sheets as both assets and liabilities. Large private companies will follow suit in 2020.
Traditionally, such leases have been condensed into the footnotes of company's accounting disclosures as off-balance-sheet operating expenses. Altering the categorization of such leases as debt rather than operating expenses will result in trillions of dollars to be transferred onto company books and, consequently, significant increases in company leverage, a key measure when evaluating a company's risk.
Under the new standards, companies are required to record all "leases" (except those with terms of less than one year) on their balance sheets as a right-of-use (ROU) asset and a lease liability. Whether a contract is a lease rests on two issues: whether the contract depends on the use of an "identified asset" and whether the contract conveys the "right to control the use of the identified asset for a period of time in exchange for consideration." FASB, ASC 842-10-15-3. If either element is missing, the contract is not a "lease" for financial accounting purposes. If a contract is not deemed to be or contain a lease, such contract will be deemed off-balance-sheet. Therefore, determining whether a contract is a lease under the new standards demands closer analysis.
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