This change can create a problem, however. It can make companies’ financial positions appear weaker, even though in reality, their positions may not have changed at all. Leases will need to be recorded as liabilities, which will make them look like debts that need to be paid off.
While there is some logic to this change, there will undoubtedly be some growing pains as it goes into effect. After all, if you lease office space, whether it be for one year, five, 10 or another period of time, you are obligated to pay it. In this way, it’s similar to a car loan or a mortgage, the difference being that when you are done paying those off, you then take title to property that has value (hopefully).
A lease, whether it’s for your residential living quarters or your office, is not an investment. When you’re done paying to lease office space, you must either agree to keep paying more or move to another location where you will also make payments.
So unless you own your own building, monthly costs for space will always be part of your expenses. The difference is how much and for how long.
Rules for Leasing Office Space
The FASB rules do not apply to short-term leases such as the ones you find in rental agreements with a temporary workspace. That’s because it’s not an obligation. You can end the agreement at any time. You can move to another location, smaller quarters, or your home.
This type of scenario wouldn’t be realistic for larger businesses with many employees. They would not be able to run a business that size from their homes or a coffee shop.
However, a larger business would be able to rent a suite of offices at a temporary location.
Another cost-cutting move larger companies are making is to give up their lease and have employees work from their homes. These businesses can rent temporary office space for different employees to come in and use at different times because, while some office space might be necessary, the businesses wouldn’t need it every day for every employee.
This type of arrangement saves not only the cost of a long-term lease, but the residual costs companies would have to face as a result of the new accounting rules. For-profit businesses may suffer because their bottom lines will not look as good when they have to start counting their leases as liabilities.
They may have trouble getting investors to come on board or getting banks to lend them money.
Extension Until 2021
These new accounting rules were scheduled to go into effect in January 2020, but FASB granted an extension to private companies and nonprofits. For them, the rule will not go into effect until January 2021.
Most commercial leases are longer than a year, so it is unlikely the industry will see companies re-signing due to this change. Those locked into leases that run beyond 2021 will rejoice in getting one more year with the old rules.
Those whose leases are up at the end of 2020 will benefit the most. They can use that year to plan ahead to minimize the blow of the change as much as possible.
They must weigh all their options and make predictions about whether their company is growing, staying the same, or downsizing. They must use this information to decide how to proceed in the decade to come.
Making such guesses can be nerve-racking. A wrong move can mean the end of a business.
Using Temporary Workspace
One way a business or nonprofit can reduce its risk is to move to a temporary or shared workspace. A business might be in a transitional stage, where it can be hard to tell what its space requirements will be in the future. Thus, signing a short-term agreement is the best strategy.
This can be true even if the accounting rules aren’t changing. Leases — especially long ones — are like marriages, and it can be stressful to make this type of commitment.
Making the switch for 2021 offers businesses another bonus though; short-term rental payments don’t have to go on the balance sheet. They’re exempt.
This extra year will allow private companies and nonprofits to continue keeping lease payments off their balance sheets and it will give them time to contemplate charting a new course for their business to avoid the potential hazard of the accounting change.
They can use the time to shop for new quarters if their lease will be up soon. They can also borrow money now, while they have a better chance of being approved. They can put off planned changes until their leases are up and they have more flexibility.