Real Estate Management in the True Cloud

When is the Proposed NEW FASB / GAAP Cheaper in Year 1 vs. Old GAAP?

Posted on: Monday, November 1, 2010

Lucernex real estate finance expert Jim Duport, after completing an upgrade to our core financial engine to support the new proposed FASB / GAAP rules, discusses an interesting finding – in certain circumstances, the new GAAP can be cheaper.

This is the first in a series of Blogs by Jim describing his findings during the process of developing the architecture within the core Lucernex financial engine to handle the new proposed FASB rules.

I started the substantial upgrade of Lx LseMod version 15, including changes to the core Lucernex financial engine, in July. After over 500 hours, it is virtually done. Since it includes a Transaction Date that can be different from the Lease Commencement Date (even exact days such as the lease starting on the 12th of the month), and Renewal Option Rent Calculations, I have been able to “test” a variety of real world scenarios under the Proposed New GAAP. Note: Lx LseMod provides for a 30-year lease term and 5 renewal options for a total of another 30 years.

Based on my understanding of the current and proposed GAAP (note the disclaimer), the results of my testing have been, to say the least, fascinating. In one case, without including a 5-year option to renew with a 3% increase, the P&L “rent cost” in Year 1 was 12.7% higher than under current GAAP; including the renewal option increased the percentage to 37.6% higher in Year 1 than under the current GAAP.

When is the Proposed NEW GAAP Cheaper in Year 1 vs. Old GAAP? Under the proposed NEW GAAP Lease Accounting, the “rent cost” charged to the P&L, i.e. Right-to-Use Amortization and Interest Expense, is to be applied when the lease is executed, the Transaction Date. Under current GAAP for Operating Leases, rent is straight-lined starting when the tenant takes effective possession, typically when Construction starts (Construction Start Date).

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ASSUMING the Transaction Date is the same as the Construction Start Date, assuming some Free Rent at the start of the lease, assuming no Renewal Options and assuming both dates are prior to the Lease Commencement Date, as is typical, the “rent cost” charged to the P&L will be lower using the New Proposed GAAP when compared to the current GAAP. We have performed numerous tests using Lx LseMod Corporate version 15 beta, and the results are consistent, the NEW GAAP is cheaper in Year 1 than the Old GAAP but only when the TD and CD are the same, there is free rent, and there are no renewal options.

However, this conclusion does not mean you should rush out and sign leases ASAP. Note the key assumption – the Transaction Date is equal to the Construction Start Date. In the real world, typically Construction does NOT start the same day the lease is executed, and may in fact, not start for weeks or months after the lease is executed (the Transaction Date).

However, the prudent real estate manager might want to identify the P&L rent impact under the proposed New GAAP taking into account the Transaction Date. In most examples I have seen, the Transaction Date was ASSUMED (there’s that word again) to be the same date as the Lease Commencement Date, again not typical in the real world. How many times have you signed a lease and moved in the same day?

Candidly, I do not know what others are using to test the ramifications of the Proposed GAAP; however, I seriously doubt anyone else has a financial engine as sophisticated. Lucernex is considering offering a free copy to FASB so they can see the impact of their proposed changes. I would also love to demo Lx LseMod Corporate v15 to anyone who might be interested.