Wizard Watch

The potential changes in lease accounting rules coming in 2012 will have seismic consequences for the balance sheets of public companies. Operating leases will likely be replaced by capital leases, resulting in the shift of trillions of dollars to balance sheets of companies worldwide. With all leases for commercial real estate being capitalized in this way, the debt of most companies will increase dramatically.

The International Accounting Standards Board (IASB) and the U.S.-based Financial Accounting Standards Board (FASB) have made extensive changes to the exposure draft, released in August 2010. The boards said the changes would result in a more consistent approach to lease accounting and would improve the quality of financial information available to investors.

They released an Exposure Draft of the Proposed Accounting Standards Update on October 14th with an invitation for comments by Dec. 13th: “The Board invites individuals and organizations to send written comments on all matters in this Exposure Draft of a proposed Accounting Standards Update. Responses from those wishing to comment on the Exposure Draft must be received in writing by December 13, 2011. Interested parties should submit their comments by email to director@fasb.org, File Reference No. 2011-190. Those without email should send their comments to ―Technical Director, File Reference No. 2011-190, FASB, 401 Merritt 7, PO Box 5116, Norwalk, CT 06856-5116.‖ Do not send responses by fax.”

A schedule of the proposed Proposed Accounting Standards Update documents can be found on the FASB website.

Rest assured that we are closely monitoring this process and are working to make sure REportfolio will have the tools necessary to comply with the new regulations when they’re officially released next year.

According to the International Tenant Representative Alliance (ITRA), most commercial tenants will soon receive their 2010 expense reconciliation statements of operating expenses and taxes from their landlords. Typically, tenants have 30-60 days after receiving these statements to give notice to the landlord if they wish to perform an audit. If a company is leasing office space, industrial space, warehouse or other commercial real estate, now is the time to determine if the landlord is over-charging for expenses by performing a lease audit.

For many commercial real estate tenants, rent is the second largest operating expense after personnel costs. Auditing the landlord’s expenses provides confidence that these costs are being properly billed. Not all tenants need to audit lease expenses annually, but here are a few examples of situations that could trigger an audit:

1.    If a gross-lease was executed in 2010, the tenant will have only one opportunity to audit the base year (2010) expenses. If a tenant waives this right, they may be overbilled for all ensuing years due to a landlord understating the base year expenses. Even a tenant with a net-lease signed in 2010, while these don’t typically have a base year dollar amount, should consider an audit to verify they are only being charged for permitted expenses.

2.    Landlords of mixed-use properties routinely overcharge tenants for operating expenses and real estate taxes, because the landlord allocates expenses to the various components of the complex using methods which don’t reflect the actual usage of services by each component. Substantial operating expense increases often signals that a landlord has improperly calculated the expenses. A tenant should look at specific line items of expense when reviewing the year-to-year increases.

3.    Buildings in which landlords have expended major capital on building systems, exteriors or common areas certainly should be considered as an audit target. The lease should dictate if such capital expenditures are permissible.

4.    The gross-up of expenses is addressed in most leases and if applied properly is fair to both the tenant and the landlord. When a building has high vacancy, a landlord can make significant errors when applying this gross-up adjustment which negatively impacts a tenant’s share of the annual operating expenses, resulting in the tenant paying too much.

Paul Stevens, ITRA’s lease audit specialist recommends that, “tenants should protect themselves by hiring a professional lease auditor to review their lease and operating expenses to determine if they are being fairly charged. Many tenants have found, by being proactive, they have been able to save thousands of dollars over the term of their lease.”