The new regulations were issued through the FASB's accounting standards codification (ASC) Topic 842. Topic 842 substantially changes the accounting for leases primarily for lessees by requiring all leases with a term greater than one year to be placed on the lessee's balance sheet as right of use asset and a corresponding lease liability. In prior lease accounting for CRE space pursuant to the original lease regulation, FASB 13, the lessee was only required to record rent expense in the income statement and disclose the future minimum lease payments in the notes to the financial statements. According to financial firm, leaseaccelerator.com, U.S. corporations have more than $3.3 trillion in leased assets and the 10 largest of these companies are shown in the chart below.

All amounts per leaseaccelerator.com and the 2015 Fortune 500 report.

The devastating affects of this new accounting requirement will require all companies to include on the balance sheet a right of use asset (ROU) and a corresponding lease liability for these $3.3 trillion in leased assets. The ROU asset and lease liability are calculated as the present value of a lessee's lease payments at the rate implicit in the lease or the lessees incremental borrowing rate.

For example, Walgreens August 2016 10K balance sheet has $72.6 billion in assets and with these new lease accounting rules, the assets and liabilities will each be increased by the present value of the amount of their real estate operating leases totaling $34 billion. This will be the same for all public and SEC reporting companies. Many of these companies have thousands of locations that are leased and under the new rules will be required to keep detailed records and calculations of the ROU asset, present value of lease payments, discount rates, sub-leases, rate increases and other lease items, for each lease. This will significantly increase the accounting time and effort required to comply with these new rules.

The new accounting rules will have many negative impacts and the affect on business and financial metrics are as follows:

Balance sheet assets and liabilities will increase substantially.

EBITDA will increase (primarily due to no rent expense in a finance lease).

Loan covenants and credit terms may be violated due to the increase in liabilities.

Lease vs. buy decisions will be more critical and complicated.

Accounting and reporting time and complexity will increase (good for accounting and consulting firms).

May cause more companies, especially retailers, to shorten lease terms.

Financial ratio impact:

Total debt to equity will increase.

Interest coverage will decrease.

Return on assets will decrease.

Current ratio will decrease.

Asset turnover will decrease.

Return on enterprise value (net income divided by long term debt plus stockholder's equity less cash) will decrease.

Sale-leaseback transactions of CRE assets will also be affected by the new regulations as the seller-lessee will recognize gain only when control transfers to the buyer-lessor at time of the sale and will record a right of use asset and lease liability. The new regulations may force companies with a large number of leased real estate locations to shorten lease terms and acquire instead of lease the assets. The new lease accounting regulations will be effective for all public entities in 2019 and all other entities in 2020.

We here at Paramount Capital Corp. have racked our brains in trying to understand the logic behind the SEC's and FASB's purpose with these new rules. How is it possible that a 10-year operating lease of a restaurant by McDonalds, that is owned by a net lease REIT, is an asset of McDonalds that should be recorded on its books? Isn't this double counting of assets as the REIT will include the McDonalds restaurant on its books as an asset and McDonalds will also include it on its books as a ROU asset? If McDonalds signs a 10-year triple net lease for its restaurant locations and has full legal authority to operate its business in accordance with the lease agreement, why does McDonalds, in form, own the asset it leases? This new rule appears to place accounting form over substance. Accounting rules define assets as; things that are resources owned by a company and which have future economic value that can be measured and can be expressed in dollars. Does this sound like the definition of a lease?

WALNUT CREEK, CA—The Financial Accounting Standards Board with the Securities and Exchange Commission issued final regulations in 2016 on new lease accounting rules. According to Joseph Ori, executive managing director of Paramount Capital Corp., the new regulations will severely affect the entire CRE industry and specifically, any entity that has a lot of leased locations.

Ori addresses more about the new regulations in the commentary below. The below commentary's views are Ori's own.

This will include retailers, restaurants, banks and service companies. The current lease accounting rules have worked very well for over 35 years and the accounting was simple and easy to implement. Under the old rules, a lease was either an operating lease or a capital lease. Almost all real estate leases were accounted for as operating leases and some equipment leases were classified as capital leases.

A capital lease was required to be capitalized and depreciated if the lease met one of four requirements, which in substance meant, that the leased asset was owned by the lessee. If an operating lease, the lessee would have to record rent expense for its real estate locations and disclose in the notes to the financial statements the future minimum lease obligations.

The new regulations were issued through the FASB's accounting standards codification (ASC) Topic 842. Topic 842 substantially changes the accounting for leases primarily for lessees by requiring all leases with a term greater than one year to be placed on the lessee's balance sheet as right of use asset and a corresponding lease liability. In prior lease accounting for CRE space pursuant to the original lease regulation, FASB 13, the lessee was only required to record rent expense in the income statement and disclose the future minimum lease payments in the notes to the financial statements. According to financial firm, leaseaccelerator.com, U.S. corporations have more than $3.3 trillion in leased assets and the 10 largest of these companies are shown in the chart below.