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June 02, 2016

Changing rules for lease accounting; a bridge to a fair balance

The new rules for lease accounting will make a significant mark on the corporate world. In 2019 organizations reporting under FASB or IFRS will have to show virtually all their leasing contracts in their balance sheets. Sounds logical? However, worldwide only 15 percent of the $3.4 trillion in leasing currently appears on balance sheets, so the new rules will certainly have a significant impact. In fact, publishing a balance sheet and supervision by an accountant has not always been the norm.

FAQ - How new lease accounting standards will impact your business

Five frequently-asked questions about lease accounting and our answers to these questions.

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Looking all the way back to the 1850’s in the Netherlands, we find an almost provincial Rotterdam. The city is static, while Amsterdam, Antwerp, and even Vlissingen (historically called Flushing) are busy becoming the port epicenters of Western Europe. The city of Rotterdam finally catches up with all its competitors, and the entrepreneur Lodewijk Pincoffs plays a major role in this. Over a period of thirty years he works his way up to the highest rank in Rotterdam. Pincoffs plays a prominent role in the city council, holds a seat in the Upper Chamber, and has affluent friends.

Under his persuasion, more than $5 million is allocated to the port. A new waterway and a railway line are constructed to improve Rotterdam’s accessibility. There seems to be no holding Rotterdam back. However, this changes when people discover Pincoffs has been cooking the books; he has been listing debts as profits and in 1879 he flees to New York. Today a bust of Pincoffs and a small bridge at the city’s Poortgebouw, a national monument in Rotterdam, are the only reminders of this once-revered businessman.

It’s hardly a coincidence that the profession of accountant was born during this period. Without a balance sheet or supervision from an accountant, Pincoffs left Rotterdam’s investors penniless and the waterways, in which a huge amount of money had been invested, were in ruins. However, thanks to dredgers who made the route navigable once more, the municipality of Rotterdam was able to work its way back into becoming one of the world’s largest port cities.

Back in present time, many organizations now use off-balance leasing contracts, which includes major liabilities such as renting an office building. However,  premises and rental liability are not shown on the balance sheet, leading to ratios that appear to be more favorable. This will change with the new FASB rules in 2019, but large organizations will already need to introduce these drastic changes now. The accounting firm PwC has calculated what the introduction of the new rules would mean right now. For instance, within the retail sector, debt on the balance sheet would double, solvency would drop from 41 percent to 27 percent, and the debt ratio would rise from 1.1 to 2.5 times the operating result.

A threat? Some may see it that way. However, I would actually regard it as an opportunity, especially for property managers. It will become more relevant to consider your real estate critically and to apply alternative concepts, for example, by reducing the quantity of property and enhancing its flexibility. The new rules are also a driver for putting systems in order as the rental contracts and the liabilities they entail will soon be immediately visible in the balance sheet.

And it is precisely this transparency which is the positive note of the legacy Lodewijk Pincoffs left behind in 1879 in Rotterdam.

To learn more about the changes the new FASB standard has on lease accounting in the United States, check out the full white paper.

David Stillebroer
Director Product Management