Five Tips on ASC 842 and IFRS 16 Lease Negotiations

Some recent accounting changes have been turning leasing, a long-understood aspect of CRE financial and contracts, into potential new legal sand traps. For example, there may be implications for corporate real estate strategy under Financial Accounting Standards Board’s Accounting Standards Codification Topic 360, or ASC 360.

The Financial Accounting Standards Board’s Accounting Standards Codification 842, known as ASC 842, would be the controlling standard. According to Deloitte, ASC 842 lease modification guidance is new to US generally accepted accounting principles (GAAP).

The proper legal and accounting issues, while a big aspect, are only one part. Another is how to negotiate

Commercial real estate software provider Quarem recently offered tips to negotiating leases under the new ASC 842 standard. 

“There are two phases of ASC 842 compliance: the initial implementation, and the ongoing process of maintaining compliance,” Quarem president John Rice said in prepared remarks. “Accounting departments must be in the communication loop of lease negotiations and subsequent execution to avoid being months behind in amortizing leases that were executed months prior.”

The five tips are to simplify lease accounting and to avoid potential complications further down the line:

1. “Renewal Options: Push landlords to define rent schedule for renewal option terms.”
2. “CPI Increases: Avoid variable rent increases tied to CPI (substitute explicit percentage increases instead).”
3. “CPI Increases: If CPI unavoidable, negotiate a percentage cap on the CPI increase.”
4. “European and APAC Leases: Try to eliminate the traditional “market review” for rent adjustments during the term of the lease.”
5. “Lease Agreement Execution: Timing is vital. Don’t wait for the fully executed lease to be returned to you before sending the lease for abstraction and amortization. Have the lease abstracted and amortized immediately after lessee execution.”

The reasons are the complications that can arise under the new rules. For example, modifications in a lease are treated differently if a contract is new or the modification is a change to an existing agreement. An early termination might mean that the company immediately vacates the space. Otherwise, it could be considered a change in lease term only. Take 60 days to leave the premises and it might be that the lease term changes from the remaining portion to those two months.

Often, implications of new standards are viewed by companies as exercises in compliance. In the case of ASC 842, it’s not just following new rules, but understanding the impact they will have on regular operations. There are multiple software packages that can help with compliance, but it might be a good idea to also sit down with an expert to understand how you might need to change regular business practices to protect yourself.