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Do privately-owned companies need to use the new lease accounting? December 27, 2010

Posted by Bob Cook in Financial Planning & Analysis, Lease Accounting.

Would Scrooge & Marley have to use the new lease accounting?

This is a question I am often asked.  It’s a good one.  The accounting clearly applies to publicly-owned companies.  They are regulated by the SEC (in the U.S.) which requires the use of GAAP (i.e. generally accepted accounting principles) of which the new lease accounting will become part.  But, what about non-public companies?

Some private companies may choose to ignore the new lease accounting; in fact, some already ignore GAAP altogether.  A small family business … to the extent it keeps books at all … may choose to use any accounting rules it likes …. or at least as long as the family members agree.  For larger companies, though, particularly those with non-familial owners, accounting needs to be more sophisticated; many, perhaps most, will want to apply the new standard.

The reason: If the company needs to provide financial statements to anyone for any purpose, it probably needs to use GAAP in all its aspects, otherwise the party receiving the financial statements won’t be able to interpret the meaning of the financials.   To be more specific, if a company needs to show financials to a bank to borrow funds or to a customer to prove its ability to perform a contract or to partners to show how well the company is doing, then the company probably needs to apply the new lease accounting standard.

I stick in the word “probably” because there may be some companies that are thought to be so sound financially that they are able to be cavalier about how they prepare their financial statements. Also, some companies in some industries, notably real estate investment, feel that GAAP doesn’t really describe the financials of their business well and they use a modified GAAP.  In those situations, the new lease accounting will probably be ignored.   For any company that uses GAAP, though, they’re going to have to use the new accounting.

Person of the Year….. December 26, 2010

Posted by Bob Cook in Profession of Corporate Real Estate.
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This is the time of year when “Persons of the Year” get announced.  Time has anointed Facebook’s Mark Zuckerberg, Fortune crowned Netflix’s Reed Hastings.   They both are sound choices, both have changed the world.

I’m wondering this:  Might the “Person of the Year” ever be someone involved in corporate real estate? Might a corporate real estate professional ever change the world enough to be worthy?

This is not as crazy a question as you might think.  Thirty years ago, “Time’s Person of the Year” titles didn’t go to CEO’s; they went to politicians, artists, musicians, scientists.  (See note below.)  The idea that a CEO’s like Zuckerberg and Hastings (and Turner, Grove and Bezos before them) would be “Person of the Year” would have been thought, by many, to be ludicrous; CEO’s were still thought to be “robber barons”.  So it’s hard to tell what types of people will be capturing the awards in the future.  Why not a corporate real estate professional?

So, for those mid-career corporate real estate professionals who aspire to become a “Person of the Year”, let me offer three visionary roles that might spear the title.

Work-From-Home Revolutionary.   By most measures, employees love being able to work from home. Work-life balance and a sense of greater productivity are cited as the benefits and a revolution has already begun.  Work-from-homers are, though, still a minority of workers.  Might a leader come along who can push the revolution to what-some-think-is its logical conclusion: where the majority work-from-home?  What kind of leader might this be?  Perhaps it could be a corporate real estate exec of a major company (or his CEO boss) who willfully shuts all offices and gets his company to send everyone home to work.   Or better yet, someone who does this for the federal government (and in so doing balances the federal budget by selling off all the buildings that suddenly become unnecessary).  Or maybe it will be an entrepreneur who comes along and establishes a chain of drop-in offices that allow workers from any company to rent space and technology by the hour in office centers that become as ubiquitous as Starbucks.   Some have called the concept “Cloud Officing”.  Or maybe someone who takes Starbucks … which already offers a small form of this… but expands and augments the Starbuck’s mission to create the drop-in centers that truly transform how and where and the majority of people work.   Would not such a person be worthy of being anointed “Person of the Year”?  Isn’t how people go about working at least as important as how they watch movies?

Planet Saver

Or, how about someone who discovers some incredibly simple, inexpensive way to reduce the fossil-fuel consumption of buildings.  What might that innovation look like?   It’s probably not something like use of solar energy which is a technology that is sure to continue to advance but not in any revolutionary way; radical change is needed to be crowned “Person of the Year”.  So, think more radically.  Imagine a garage-tinkering facilities manager who finds a simple way to make electricity from the kinetic energy of workers walking around the office.   That’d, for sure, capture the title.   Get tinkering.

Civic Builder

And I have one last suggestion … maybe not quite so “out there” … that could capture the “Person of the Year” title.  Imagine a corporate real estate exec at a fast-growing company that suddenly needs large amounts of office space in major cities … somewhat similar to the situation tech companies like Cisco, HP and Oracle found themselves in at the height of the dot-com boom.  Now think about how a confident corporate real estate executive could use this building program to change the face of the cities where he’s building by constructing buildings with important public spaces, buildings that positively impact the civic life of the city.  It has been several decades since we saw companies building such “people places” as New York’s Citicorp Plaza,  Chicago’s First National Bank Plaza (now, JP Morgan Chase Plaza), and San Francisco’s Crocker Center.  Those tower-and-plaza forms might not be what would make sense today, but I’m sure that there’s some way to make a positive civic impact.

Target: 2020

Achieving great things in corporate real estate takes time, though, so set your sight on getting the “Person of the Year” award, not next year, but maybe a decade from now.  The year 2020 is a good round-number target.   Who out there is up to the challenge?

A Note on Time’s Person of the Year

The first Time “Man of the Year” (as it was originally called) was Charles Lindberg in 1927, and then the next two years the title went to business persons: Walter Chrysler of Chrysler in 1928 and Owen Young of RCA  in 1929.  Then, though, between 1930 and 1990, not a single business person received the title … a sixty-year drought.  Since then, the title has gone to Ted Turner of Turner Broadcasting (1991), Andy Grove of Intel (1997), Jeffrey Bezos of Amazon (1999) and now Mark Zuckerberg (2010).  Of eighty-one titles, only six have gone to business persons, although there have been four business persons named in the last two decades.

May the Christmas spirit be with you … and your company December 19, 2010

Posted by Bob Cook in Corporate HQ.
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My first experience with corporate real estate was when I was a child growing up in Pittsburgh.  Of course, I didn’t at the time think of it as having to do with corporate real estate, but in retrospect, I realize it was.

Every Christmas season my parents would take me downtown to see the Christmas decorations. My favorite displays were the animated scenes of Santa’s workshop in the windows at Horne’s Department Store.   I also, though, loved seeing decorations at all the big company headquarters.  I remember vividly a large Christmas tree in the big glass lobby of the Alcoa Building and a giant Christmas wreath over the gothic entrance of the Gulf Building.

I don’t get back to Pittsburgh at Christmas anymore so I don’t know if the Alcoa tree and the Gulf wreath are still traditions kept there, but I certainly hope so (… even though, I know, Gulf’s HQ isn’t in Pittsburgh anymore).  Those holiday displays were a way for the companies to give a present to the community each Christmas season.  It couldn’t have cost much, and it brought much wonderment.

I fear, though, that many, maybe most, companies have lost the Christmas spirit.  Few, today, contribute to holiday festiveness the way companies did in the past.   There are many reasons for this: multiculturalism, shareholder activism, bottom-line focus, suburbanization, globalization.   In this environment, it takes courage for a corporate real estate executive or any type of executive to authorize Christmas displays.   Those who do should be applauded.

I take heart in knowing that, in Pittsburgh, the Christmas spirit still seems to be alive.  This year, the community celebrated the 50th installment of Light-Up Night which kicks off the holiday season in “the ‘burgh”.  It’s now a two-day festival.  Downtown buildings keep all their lights on all night long, and yes, corporations participate: a 60-foot tree rises lit on PPG Plaza and the Pittsbugh Creche (a religious display, no less) sits prominently on U.S. Steel Plaza.

I hope the Christmas spirit is alive in your community …. and, if you have some authority, you do what you can to keep it alive in your company.   May the spirit be with you and yours.

We’ve Got Pop-Up Stores; How about Pop-Up HQ’s? December 15, 2010

Posted by Bob Cook in Corporate HQ, Financial Planning & Analysis.

T’is the season for pop-up’s. 

They’re everywhere.  Retailers have figured it out.  If you do most of your business at only certain times of the year … Christmas, Back-to-School, Summer Vacation … then why rent space all the other times?  There’s a lesson here for corporate headquarters.

The Pop Up Phenomenon

In early fall, Halloween stores appeared.   The chain of “Spirit Halloween” stores, for example, opened nearly 900 pop-up’s around Labor Day and kept them open through Halloween.   Then in November, Christmas gift stores began popping up.  Many examples here, but perhaps the most notable: Toys-R-Us opened over 600 “Express” stores this season and resurrected the “FAO Schwartz” name in the form of 10 pop-up’s in tony locations to serve the top (or you might say “over-the-top”) of the toy-buying  market.

Trendwatching.com takes credit for coining the term “pop up store” back in 2004.  As the examples on its website shows, the phenomenon isn’t just for Halloween and Christmas.  Pop-up’s pop up year-round.   They sell the gamut of merchandise … from designer clothes to gourmet food to cat snacks … and they’re run by all types of retailers … from small-time, one-timers like the Meow Mix Company … to big-time, part-timers like MTV … to big-time, full-timers like Target and JC Penny.  Pop up’s aren’t just for mom-and-pop’s anymore.

And they might not just be for retailers, anymore, either.

Entropy and the Corporate Headquarters

It used to be that all the folks “at headquarters” were, in fact, physically, at headquarters.   Not anymore.  In this day of specialization, getting the right person for a high-level position often requires ignoring geography.  If the best CFO-candidate is in Houston and he won’t move to headquarters in Atlanta, then give him a cell phone and VPN-access, and he’s good to go.  The same goes for middle-level managers and individual contributors where the competition for talent is strong.  As for the lower-end of the corporate hierarchy, those headquarters functions are more-and-more outsourced, off-shored, or near-shored.   When an employee calls “headquarters” to find out why his travel expense hasn’t been approved or what his HR benefits are or how he should connect his computer to the company’s main servers, those calls rarely go to anyplace one might think of as headquarters.   In fact, in the modern corporation, it’s often difficult to identify where headquarters is.  There’s no “there” there anymore.  “Headquarters” no longer has a physical connotation.

Where’s the center?

Yet, many think there is a need for some sort of center. … a place that symbolizes and embodies the company’s values, it’s soul.   If we’ve learned anything about corporate management over the last few decades, it’s that culture is important.  Read Good to Great.

For many companies, the center is now the company’s intranet.   That can work pretty well.  If you’re an employee, the homepage lets you know what’s happening around the company.  Video-on-demand lets you actually see the CEO talk about things he thinks are important.  And the use of social media … including that old-fashioned thing called “email” … allows employees at all levels engage in “water cooler” conversation, virtually.   This leads some to observe that the importance of physical place is dead.  But is it?

Different companies with different cultures answer this differently.   For some, a traditional corporate headquarters with “all hands on deck” might make sense.  For others, a totally virtual headquarters might be better.  For most, though, something in-between works.  But there’s a lot of terrain between the two extremes, a lot of room for different headquarters models and hybrids.

Why not a  Pop-UP HQ?

Consider a company that has headquarters personnel widely distributed  … perhaps globally.   It might have an address where some of the executive management and headquarters staff have offices, but it does not have anything like the traditional headquarters with most headquarters folks under one roof.  Company management feels a need for more face-to-face interaction across the headquarters staff.  Solution:  No need to lease a big corporate headquarters building; instead, have a pop-up headquarters a few times per year.

Now, many companies are already doing something similar.  Many have an “annual meeting” that takes place in a location like Las Vegas, where there’s an emphasis on building relationships via having fun.   It’s usually two or three days with a few convocations, maybe some training sessions, and a lot of golf and partying.

I’m talking, though, about something else.   I’m talking about creating a place, albeit temporary, that functions like a headquarters.  You don’t party at headquarters, and you wouldn’t at a Pop-Up HQ.  What happens at the Pop-Up HQ wouldn’t “stay there”.  What happens there … the sharing of stories, ambitions, insights, ideas … would build a culture that attendees would take back with them.

And the time at the Pop-Up HQ would not be structured around big presentations, training sessions, and the like.  That stuff can happen better on the intranet.  That’s not what happens at a headquarters.  Instead, attendees would meet with one another in groups of their own choosing.  Need to talk to the CIO?  This is your chance.  Need to know the real skinny on how a project is doing overseas, talk to the director in charge.   Need an impromptu meeting because of an issue that arose during a planning session earllier in the day, now’s the time to get all the folks together.

And the Pop-Up HQ would have to last a lot longer than a few days … and be more frequent than once-per-year.    You’d need at least a week; two would be better.  People need time to meet and then set up meetings based on the outcomes of those meetings.  As for frequency, quarterly feels about right.

Cost?  Certainly no more than renting and maintaining a headquarters building to house people who are rarely there.  Where?  Hotels, convention centers, and … if the phenomenon took root … empty (perhaps former traditional headquarters) office buildings that have been repurposed to serve as Pop-Up HQ’s.

Farfetched?  Maybe.   But two decades ago, the idea of loads of headquarters workers not being at headquarters would have seemed farfetched, too.

Few Comments from Lessees on New Lease Accounting as Comment Deadline Approaches December 13, 2010

Posted by Bob Cook in Financial Planning & Analysis, Lease Accounting.
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In August of this year, FASB and IASB jointly issued an “Exposure Draft on Leases”, outlining proposed new lease accounting.  This proposed accounting differs significantly from present accounting, most notably by putting all leases on balance sheets.  The new accounting will affect both lessees and lessors.

The proposed accounting is not without controversy.  While there is no strong, informed argument against putting leases on the balance sheet, there are such arguments against some of the details of the proposed accounting … for example, the requirement to capitalize “likely” lease payments, taking into account options to renew, as opposed to just capitalizing contractual obligations.  This provision, in particular, has elicited much outrage at real estate industry forums.

The accounting boards are receiving comments on the proposed accounting until December 15, just a couple days from now.  Comment letters received by the boards are posted on their websites.  So far, a little over 100 letters have been posted.

The surprising thing: very few of the letters come from big-name companies with large lease portfolios.    In fact, by my count, only three of the Fortune 500 companies have commented thus far; only one is in the top 400 and none are retailers, whose balance sheets will be hit significantly by the new accounting.

Now, it’s possible that more companies have submitted and the boards just haven’t posted them yet, but still … three letters from Fortune 500 companies is an incredibly small number to have been posted at this late date, given the controversy surrounding the proposal.  While a slew of comment letters might be forthcoming over the next few days, one would think that companies would have wanted to get their letters in early so other companies could follow their lead, by reiterating their comments.

It appears that the corporate real estate community, which has a strong stake in the outcome of the new accounting, has not been very successful in getting companies to raise the points of concern that have been the subject of industry forums.   Was it lack of true concern?  Inability to influence within the corporation?  Unfamiliar terrain?

To see my previous posts on the new accounting, including my recommendations for comment letters, click here.

Implicit Leases: The hidden bombshell in FASB’s new lease accounting December 5, 2010

Posted by Bob Cook in Financial Planning & Analysis, Lease Accounting.
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As we approach the December 15th deadline for commenting on FASB’s and IASB’s “Exposure Draft on Leases”, I thought I’d point out a far-reaching implication of the new lease accounting … an implication that has gotten surprisingly little attention.  It’s this: the new standard applies to not just explicit leases, but also to implicit leases.

Now it should be obvious that just because a contract explicitly says “Lease” in its title, does not mean that it is a lease … for any purpose, let alone accounting.  Also, conversely, a contract that does not say “Lease” in its title is not necessarily not a lease.  Under lease accounting, if a contract is or contains an implicit lease for accounting purposes, it’d have to be accounted for, in whole or in part, as a lease.

What-you-don’t-think-is-a-lease but which is a lease in terms of accounting, may surprise you.  The accounting definition of a lease does not conform to any layman’s definition or, for that matter, to any legal definition.  For  example: some types of licenses that give a company the right to occupy space, perhaps as part of a larger contract, are likely to be deemed to be leases for accounting and have to be accounted for as such.   In addition, the new accounting will also apply to service contracts involving equipment, such as photocopy machines.

The implicit-lease issue goes, though, far beyond licenses and equipment-based service contracts.  It will apply to some subcontracts and outsourcing arrangements … contracts that the contracting parties undoubtedly do not now think of as leases.

How’s that?

Appendix B of the Exposure Draft provides the proposed accounting definition of a lease.  It says, in essence, that each and every contract a company signs needs to be evaluated to see if it is or contains a lease.  If the following two characteristics are present, part or all of the contract must be accounted for as a lease:

(a)    the fulfilment of the contract depends on providing a specified asset or assets and

(b)   the contract conveys the right to control the use of a specified asset for an agreed period of time.

The document goes on to provide guidance in addressing these two tests, and you should read this guidance to understand the nuances.  Regarding these two tests as it relates to buildings, (a) a building would be deemed to be specified if the supplier was not able to relocate production to another facility without the customer’s approval, and (b) the building would be deemed to be under the control of the customer if the customer got all but an insignificant amount of the benefit from its use.  While contracts that call for payment on a unit-price basis would probably not be deemed leases, there will still be some types of sub-contracts and outsourcings that will be deemed to have implicit leases embedded in them. 

Consider a contract where Company A outsources logistics to Company B for a period of time and agrees to pay a certain amount each month for the service.  If Company A gets to say in which of Company B’s facilities this work is done and if the work Company B does in that facility is almost all to service Company A, then it is very possible that a portion of that contact will be deemed to be an implicit lease.  The obligation related to that portion would have to be capitalized and put on Company A’s balance sheet; Company B would account for that portion of the contract as a sublease.

This is going to take a lot of companies by surprise, and has an ironic twist.  One of the motivations for many companies who have outsourced work previously done in-house has been the ability to get assets (and related liabilities) off their balances sheets.  Well… surprise, surprise!  Those assets and liabilities may be coming back as a result of the new accounting.

The implicit-lease issue could even hit parts-supply contracts where conditions (a) and (b), above, exist and contract pricing is on a cost-plus-profit basis.  It also may hit energy contracts where a third party installs energy-saving or power-generating equipment, such as solar panels, on a customer’s site and then sells the power to the user.  This could have a big effect on the business models of such third-party suppliers of energy.

In truth, the need to evaluate whether a contract contains an implicit lease is not new; it already is an accounting principle.  Heretofore, though, unless an implicit lease met the conditions that made it a capital lease (which would then have to be put on the balance sheet), the identification of a contract as being or containing an implicit lease was non-material.  This is because operating leases and service contracts have been accounted for similarly … both off-balance sheet.   The “implicit lease test”, therefore, tended not to be applied rigorously.  Now with the new lease accounting putting leases on balance sheet, though, the test as to whether a contract is or contains a lease is far from immaterial.

The implication of applying the new lease accounting standard to implicit leases could be vast.  In theory, every contact signed by a company will have to undergo a “lease test”, just like today every lease needs to undergo a “capital lease test”.  Think of the process implications.  And beyond that, think about how your company might have to re-think strategies surrounding outsourcing and supply-chain management.  This is yet another reason that the new lease accounting has implications far beyond what most people think.

Lease accounting isn’t just for real estate, anymore … and it’s not even just for the-contracts-you-thought-were-leases, anymore.

Click here for more posts on the new lease accounting.