How will the new lease accounting standard change real estate leases?

The new accounting standard will apply to real estate lease contracts for which rent should have been expensed on a case-by-case basis in the past. The new lease accounting standard will also apply to real estate lease contracts, for which rents were previously expensed as incurred, Many new journal entries will be required to be recorded. This will place a particularly heavy burden on companies that have a large number of operating lease transactions under the current standard. Furthermore, because subleases are classified based on the right-of-use asset recognized in the head lease rather than the underlying asset, not only the lessee, but also the lessor (intermediate lessor) of the sublease. This article is intended to provide an overview of the accounting treatment of real estate leases.

This article focuses on real estate leases. For a general overview of the background of the new lease accounting standard, timing of application, companies to which the standard will be applied, differences from the current system, and the impact on financial statements, please refer to the comprehensive explanation below.

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Complete Explanation] New Lease Accounting Standards Effective in 2027｜Outline, Changes, Impact, and Practical Responses

The new lease accounting standard effective from April 2027 is a major revision that, in principle, requires many contracts that were previously treated as off-balance sheet to be recorded on the balance sheet. Therefore, the scope of work to be performed by accountants will be broader than ever before, including inventorying of contracts, lease judgments, discount calculations, review of journal entries and notes, and system support.

1-1. Real estate lease contracts are also subject to the new accounting standard.

Under the new lease accounting standard, a lease is considered to be a lease if the lessee controls the use of the specified asset, even if the contract name is "rental" or "lease. Because the determination of the applicability of a lease is mainly based on the following three points, Real estate lease contracts are applicable and subject to on-balance sheet treatment in principle (1) The lease is a lease.

• Specified assets (no substantial right of substitution)
  An asset identified in the contract is indicated and the supplier has no substantial right of substitution.

• Enjoyment of the majority of economic benefits
  The lessee enjoys the majority of the economic benefits derived from the asset throughout the term of the contract.

• The right to direct the use
  The right of the lessee to determine the purpose and method of use of the asset during the term of the contract.

In addition, common expenses, maintenance, cleaning, insurance, taxes and public dues, etc. Service charges are not subject to on-balance sheet treatment. Generally, they are separated from lease elements (e.g., rent) and treated as expenses. In separating them, reasonable allocation criteria such as area, time, number of units, fixed price list, etc. should be established in advance and consistently applied to similar contracts. For example, if common service charges are not specified in a "lump-sum billing of rent + common service charges," rules are established for presumptive allocation based on the exclusive area ratio or the management association's prorata table.

1-2. Many journal entries are required.

Under the new lease accounting standard, a real estate contract, etc., for which lease payments should have been made on a case-by-case basis in the past, Many journal entries are required, including journal entries to be recorded at the time the contract is concluded and journal entries to be made at the time the contract expires. At the inception date, the present value of future rentals is recognized as a lease liability, and the amount adjusted for initial direct costs, incentives, restoration, etc. is recognized as a right-of-use asset. In addition, at the time of payment, the journal entry must be prepared taking interest into account and monthly amortization calculations are also required, which is expected to increase the workload of the accounting department.

Please refer to the following article for specific journal entries and accounting procedures along with practical scenarios.

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What journal entries and accounting procedures are required under IFRS 16 (new lease accounting standard)?

The new lease accounting standard (= IFRS 16) has begun mandatory application for companies that voluntarily apply IFRS. It is highly likely that it will be applied to Japanese GAAP in the not-too-distant future, and it is said that it may have a significant impact on the accounting treatment of all Japanese companies as well as IFRS-applied companies. What specific journal entries and accounting procedures will be required when the new lease accounting standards are applied? In this article, we will explain what journal entries will be required in line with actual business scenarios.

Lease terms must be estimated "in accordance with actual conditions

Under the new lease accounting standard, The lease term is estimated by adding or subtracting the expected exercise of extension/termination options to or from the term stated in the contract. For accounting purposes, even in the case of a real estate contract with an automatic one-year renewal, a lessee cannot expect renewal based on practice alone. Only to the extent that the extension can be supported by objective materials that are "reasonably certain" of an extension, the renewal period should be included in the lease term. The determination of the lease term should be documented by the commencement date, and the lease term should be revised if the assumptions change due to a formal decision to withdraw or a significant revision of the rent terms. The discount rate should be based on a reasonable estimate of the additional borrowing rate (IBR) consistent with the terms of the contract.

1-4. Increased burden of re-measuring/re-estimating

Under the new lease accounting standard, re-measurement is required according to changes or revisions during the period, and the difference is adjusted to the right-of-use asset in principle. If the reduction exceeds the balance of the right-of-use asset, the excess is recognized as a loss. In performing the re-measurement, In addition to the need to accurately obtain information on changes and extensions of contracts, detailed calculations that take interest into account are required. In addition, detailed calculations that take interest into account are required, which can be extremely burdensome.

2. what needs to be addressed specific to real estate

2-1. Free Rent and Phased Rent

In real estate leasing, free rent or step rent (step rent) immediately after occupancy is not uncommon. Even if the rent fluctuates during the term, the principle is to recognize income and expenses by leveling them over the entire term of the contract. The lessor recognizes revenue on a level basis, including the free rent period, and the lessee also factors incentives into the initial measurement and allocates expenses on a level basis over the term of the contract.

If the current accounting management system is based only on the simple posting of invoiced amounts, it will not be able to handle the automatic journal entries for the anticipation and advance payments required for free rent and step rent leveling, which will increase the operational burden and make it easier for input and posting errors to occur. It is a good idea to have a recording policy and system support in place in advance.

2-2. Security Deposit, Restoration, Short Term/Small Amount

For security deposits, the portion that is contractually clear that it will not be returned or the amount that is confirmed to be applied to rent is transferred to the cost of the right-of-use asset on the commencement date. The portion expected to be returned is transferred to the acquisition cost of the right-of-use asset at the time of payment.

If an obligation to restore the asset to its original condition is expected, the cost of removal, demolition, and restoration is estimated at the present value of the asset at the commencement date. The amount is recorded as an asset retirement obligation and the same amount is added to the right-of-use asset.

Internal criteria for short-term/minor amounts, along with the scope of application, should be documented in advance and consistent with audit and taxation. Short-term is usually 12 months or less, while small amounts are based on monetary criteria and the scope of assets to be excluded.

2-3. Subleasing also affects lessor's accounting treatment

In real estate lease contracts, there are many cases that fall under the category of "sublease," for example, when a property leased by the head office is subleased to a group company. Although the new lease accounting standard has limited impact on the accounting treatment of lessors, it may cause changes in the treatment of "subleases," which is an issue for many companies. Based on the right-of-use asset recognized in the head lease In addition, it is said that the number of cases that must be accounted for using the interest method will increase because the finance lease decision will be based on the right-of-use asset recognized in the head lease.

If the sublease qualifies as a finance lease, Lessee accounting for the head lease and lessor accounting for the sublease should be operated in parallel. At the date of commencement of the sublease, the lessee recognizes the extinguishment of the right-of-use asset and recognizes the difference as a gain (or loss). This results in the elimination of the depreciation base amount on the head lease side, which also affects the amortization calculation. Furthermore, when a termination occurs, the right-of-use asset that has been extinguished must be rerecognized and recognized in profit or loss, which affects not only the treatment of the lessor but also the lessee of the head lease. It is important to design a system that can automatically detect events such as term changes, rent revisions, and terminations of head leases and subleases in the ledger and process them consistently through to remeasurement and journal entries.

3. Summary: Preparing for the increased practical workload caused by the new lease accounting standard

In principle, real estate leases, regardless of the name of the contract, are also subject to on-balance sheet treatment. In considering the actual policy for dealing with this issue, it is inevitable that the final decision will be made for each individual contract.

Therefore, Free generated AI advisory chatbot for on-the-spot review of confusing issues. The following is a brief overview of the real estate lease contract. Based on highly reliable data supervised by a certified public accountant, we provide immediate answers to your practical concerns. We hope you will take advantage of this service.

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Masahiko Inoue, Certified Public Accountant / supervised by Masahiko Inoue / New Lease Accounting Standards AI Advisory Chatbot

Questions about contract judgments and accounting procedures are answered immediately according to your company's requirements. AI supervised by a certified public accountant will help you comply with the new lease accounting standards.

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In addition, whether to use a system or Excel for handling is also an important consideration. Accounting correspondence occurs from the time the contract is signed, and re-measurement during the term increases. In addition, subleases are based on the right-of-use asset recognized in the head lease, which affects not only the lessee's but also the lessor's accounting and increases the workload. Depending on the number and complexity of correspondence, there will be times when Excel will not be able to handle Therefore, we recommend that you consider a policy to deal with this issue, including the introduction of a system.

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We hope this article will help you to smoothly comply with the new lease accounting standards.

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