M id A tlantic Real Estate Journal — Thriving Over 50 Spotlight — November 18 - December 22, 2022 — 9A T hriving O ver 50


By Laura Riso, Audit Senior Manager at Withum ASC 842 Lease Accounting for Tenants and Landlords


he new lease account- ing standards under ASC 842 were effective

executed or not. Under the new standards, these costs will be expensed as incurred. One scenario that could have a significant effect on land- lords is accounting for ground leases, in which the landlord is actually a tenant who is leasing the land upon which the building they own is situ- ated. Accounting for ground leases will require the tenant to record the right-of-use asset and lease liability, which for ground leases could be a term as long as 99 years, resulting in a significant asset and li - ability recorded on the balance sheet. For most landlords, this

could be the only right-of-use asset and lease liability on their balance sheets. Another challenge that could affect both landlords and ten- ants is debt covenants. The significant increases in assets and liabilities from leases could result in lower liquidity and performance ratios and higher leverage ratios, which may result in failed debt cov- enants. Borrowers and lenders should begin conversations early to come to an agreement on how these metrics may im- pact their covenants. Real estate landlords and tenants should also consider

the effects of the lease ac- counting standards while negotiating their leases. The COVID-19 pandemic and remote work environment have already begun a push away from long-term leases. ASC 842 may be another push towards short-term leases. With an accounting policy election, lease terms of 12 months or less can be excluded from these lease accounting standards. The new lease accounting standards only apply to finan - cial statements reported under Generally Accepted Account- ing Principles (GAAP). Many

real estate companies report their financial statements on the income tax basis of ac- counting and, therefore, do not need to apply the new lease accounting standards. Laura Riso is an Audit Se- nior Manager in the Princ- eton, NJ office of Withum. She has over 12 years of experience providing au- dit and attest services to various types of clients, with a focus in the areas of real estate, employee benefit plans and financial services. She is a certified public accountant in the state of New Jersey. MAREJ

for private companies beginning January 1, 2022. These new stan- dards re- quire compa- nies to record substantially all leases on

Laura Riso

their balance sheets and will affect real estate leases for both tenants and landlords. There will be a significant change for tenants, who under ASC 840 had mostly recorded their leases off balance sheets. Landlords will not be as sig- nificantly affected by these standards, but there are in- tricacies of which they should be aware. Real estate leases have tra- ditionally been recorded as operating leases, under which tenants record their rent pay- ments as expenses and land- lords record their rent receipts as revenue on a straight-line basis on their income state- ments. Under the new stan- dards, tenants will record a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, on their bal- ance sheets. Tenants will then calculate interest on the lease liability and amortization of the right-of-use asset on their income statements to arrive at a straight-line lease expense. The accounting for landlords will not substantially change under the new standards, ex- cept for accounting for some of the costs associated with obtaining a lease. Under ASC 840, costs associated with obtaining a lease were capi- talized to the balance sheet and amortized over the life of the lease. Under ASC 842, the definition of initial direct costs changes. Initial direct costs are now defined as ex - penses that would not have been incurred if the lease had not been executed and will continue to be capitalized and amortized over the life of the lease (a commission to a broker, for instance). Initial indirect costs that are incurred whether the lease is executed or not are now just expensed as incurred. For example, legal fees incurred to negotiate a lease are going to be incurred whether the lease is ultimately

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