Just when our clients were becoming comfortable with the general premise of healthcare reform and the likelihood of declining medical reimbursements for years to come, enter the August 2010 Financial Accounting Standards Board proposed accounting rules for real estate and equipment. These changes have the potential of tremendous impact on equipment and real estate via the composition, execution and implementation of leases. In its current form, and depending on the breadth of an organization’s lease commitments, this has the effect of throwing tens of thousands to millions of dollars of lease commitments onto each balance sheet.
Speaking specifically to the healthcare industry, real estate and equipment leasing has been utilized extensively to assist with several business pressures, whether it be administrative, technological, competitive or regarding growth plans. This has been the preferred method, and a substitute to purchasing which requires significant cash outlays, among other prohibitive items.
Lease Accounting Changes
To explain where we are potentially going, we should address where we are currently. The Generally Accepted Accounting Principles (GAAP), which is code for how CPAs and businesses prepare financial statements for income and expenses, assets and liabilities, draws a line between an operating lease and a capital lease. Under the new guidelines, the difference in classification will be deserted.
It might surprise you, but, according to several sources within the accounting industry, the distinction should be abandoned. This is because the current trend has been where businesses place lease commitments off of the balance sheet, whereby financing new transactions without recording existing lease commitments as liabilities.
It has been suggested that the effect of adoption will add an estimated $1.3 Trillion onto balance sheets of businesses, significantly impacting both assets and liabilities of companies, which is to include private and non-profit organizations. Under the proposed standards, long-term real estate and equipment leases will be required to be disclosed, similar to that of a purchase.
The greatest impact would be that of dumping your equipment and real estate onto the balance sheet, but, even more complicated is that it would be necessary for lessees to calculate what is known as an ‘expected outcome analysis’. This can be defined as the present value of future lease payments. As each lease seems to differ from one other, under the rules it will be required by the lessee to determine potential financial outcomes within leases, including extensions, CPI adjustments and expense reimbursement items such as improvement amortization.
The new measures would require revisions at each reporting period. For each period, the changes stipulate that the income statement be revised to reflect the interest expense component, as well as losses to the asset.
Concerns are certainly mounting. Many are not sure how dramatic of an impact the shift will be, as well as their difficulty in determination of long-term forecasting models for relatively unpredictable financial outcomes. This uncertainty would create a deterioration of the use of lease term variables, to be explained further. Other criticisms include that of the time and costs transferred to real estate owners and businesses to implement such change.
As for impacts of leasing changes with regards to the healthcare industry, there are several as well. As was evident by medical real estate development growth that has occurred on and off the hospital campus, leasing has been a very effective tool for hospitals, now referred to as medical centers. These systems developed facilities to provide for favorable referral situations with physician groups to provide for and offset the enormous costs associated with operating a hospital. As for equipment leasing, most of these institutions have levered improving medical and technological advances by leasing equipment, so as to not become tied to the purchase of vital items, essential in patient satisfaction, that may become extinct within a short period of time.
The potential effects on real estate could have significant impact for systems and physician practices that have used lease transactions to add assets or expand in geography, now essentially having to make room on the balance sheet for all of it. Quickly, some will find themselves flirting with the line of allowable leverage that demonstrates necessary stability for the purposes of future investment. Arrangements such as ground leases or subleases have the potential to become negative consequences, rather than the opposite. It is no doubt that many healthcare providers are in their respective war rooms developing strategies designed for lease administration changes. MREA is currently working with hospital systems, large and mid-size physician groups to educate about such changes.
As for modifications to these proposed, monumental changes to accounting principals, please contact our firm. A new exposure draft is to be made public in the second quarter of this year.
MREA – Medical Real Estate Advisors was strategically designed to assist healthcare providers via our ‘healthcare business meets real estate’ mission statement. The firm’s owners are actively licensed CPAs, principals and real estate practitioners that, when utilized properly, have the ability to provide streamlined solutions to complicated business and real estate items that otherwise would absorb valuable time, multiple contacts and resources to remedy. Contact your representative today or go to http://mreausa.com.