Modifications to long-term land leases may trigger significant accounting consequences

U.S. companies that lease land, including property developers and retailers, are facing challenges and potential financial reporting changes under new lease accounting rules, as modifications to long-term land leases can trigger finance lease treatment, according to discussions at a recent advisory meeting with the FASB.

The introduction of the "90% test" under Accounting Standards Codification (ASC) 842, Leases, has significant implications for companies that lease land long-term. According to Michael Cheng, a National Professional Practice Partner at Frazier & Deeter LLC, modifications to land leases can trigger financing treatment, necessitating a reclassification as a finance lease. This test assesses whether the present value of lease payments exceeds 90% of the fair value of the underlying asset, in this case, the land. If the condition is met, the lease may need to be reclassified, potentially altering the company's financial reporting.

"It would be real estate entities, so they might lease land and then build a building on top of it that they plan to lease for a long time," Cheng said. "A lot of those are private companies, and then I think any retailer...restaurant-type business where again they lease the land and then build on top of it" would be affected.

Reclassifying a lease as a finance lease can have far-reaching consequences, impacting a company's balance sheet, expenses, and cash flow. This, in turn, can provide a more accurate picture of the company's financial health, although the extent of the impact varies depending on the company's specific circumstances. .

More study needed

Cheng's remarks, made during a Private Company Council (PCC) advisory meeting with the FASB on March 6, 2025, were part of discussions about implementation issues private companies are still facing to adopt ASC 842. The standard, which took effect for public companies in 2019 and private companies in 2021, aims to increase transparency and comparability in financial reporting. The standard requires companies to recognize lease assets and liabilities on their balance sheets for all leases with terms of 12 months or more.

A PCC working group has heard that companies are struggling with valuations from modifications, although not many companies with land leases have provided feedback thus far. David Finkelstein, director with SingerLewak LLP, said that it's an issue worth studying, particularly around agreements such as 99-year leases for undeveloped land, marinas, or other unique properties.

Finkelstein's mention of marinas highlights the potential impact on companies that operate in the maritime industry, where long-term leases are common. Marinas, in particular, often have complex lease arrangements that may be affected by the new accounting rules.

Douglas Uhl, director of corporate accounting policy at Chick-fil-A, Inc., also noted that companies are now required to perform more valuations, leading to increased costs and complexity. Historically, land leases without a transfer of ownership or bargain purchase option were typically classified as operating leases, he explained. However, with the new requirements, companies are now required to perform more valuations, which is leading to increased costs and complexity.

General survey to be issued

As part of its ongoing post-implementation review (PIR) of the leases standard, the FASB has been gathering feedback on the pros and cons of the implementation and ongoing application of the guidance.

Staff said that key findings so far include time-consuming and costly implementation efforts, ongoing application costs related to software or outsourcing, and improved communication, centralized processes, and better forecasting. Other challenges remain such as identifying lease populations, classification, and fair value, as well as difficulties with disclosures if software or systems do not support them. Despite these challenges, users have not requested additional information, suggesting that the standard is providing the desired level of transparency.

Jere Shawver, PCC Chair and CEO at Baker Tilly US, LLP, observed that private companies were initially resistant to the changes but now seem to be adapting, noting that "now that it's adopted, I'm not sure they want it to change, that would be my summary of what we've heard so far."

To gather further feedback on costs and application, the FASB staff plans to release a survey to financial statement preparers.

For in-depth analysis of the FASB's standard for lease accounting, please see Catalyst: US GAAP - Leases , also on Checkpoint.

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