Companies might be forced to boost the amount of debt they report on their balance sheets by hundreds of billions of dollars under a proposal announced to overhaul the accounting for leases

May 16, 2013, 1:05 p.m. ET

Accounting Change Could Boost Companies’ Debt

Proposed Rule Would Require Most Leases to be Treated on the Books as Debt

By MICHAEL RAPOPORT

Companies might be forced to boost the amount of debt they report on their balance sheets by hundreds of billions of dollars under a proposal announced Thursday to overhaul the accounting for leases.

If adopted, the changes could affect retailers and restaurant chains, which lease real estate at hundreds or thousands of locations. Other companies that may feel the impact are airlines and package-delivery companies, which finance aircraft through leases, and companies that lease printers, copiers and other office equipment.

The new proposal from the Financial Accounting Standards Board and International Accounting Standards Board, which set accounting rules for the U.S. and most of the rest of the world, respectively, would require companies to add all but the shortest leases to their balance sheets as obligations akin to debt. That could have a major impact, experts said, given the estimated $800 billion in new lease contracts world-wide every year.Current rules allow companies to keep many leases off their books. That makes them look less indebted than they really are, regulators and critics say, and doesn’t offer investors a true portrait of their financial health.

“Leases convey valuable rights and obligations that belong on the balance sheet,” said FASB Chairman Leslie Seidman. The proposal represents “a significant enhancement in disclosures for investors,” she said.

The proposal also would change how some companies reflect the costs from leases in calculating their earnings. It would set up a two-track system in which the costs of leasing real estate would be recognized evenly over the term of the lease, while costs of leasing other items would be more frontloaded toward the early years of a lease.

The proposal also would revamp the accounting for companies that lease out real estate, planes or equipment to those who use them.

The two boards are accepting public comment on the lease-accounting proposal until Sept. 13. They hope to issue a final rule in 2014, though changes aren’t expected to take effect until 2017.

“It’s mostly a good proposal,” said J. Edward Ketz, a Penn State University associate professor of accounting. “We get some transparency we haven’t had in the past.”

The proposal is likely to provoke some opposition from companies and their advocates, who fear the rules would be too burdensome and complex. The Equipment Leasing and Finance Association said the proposal “will not result in a significant improvement in the quality or reliability of financial information” and “will not faithfully depict the economics of equipment leases.”

“Obviously this standard is not a very popular one…. Generally companies like off balance sheet financing and this is going to put an end to a lot of that,” IASB Chairman Hans Hoogervorst said.

The move could force some companies to have to revise their debt agreements, which often are based on measurements that could be affected by the addition of leases to the balance sheet, said Rich Stuart, an accounting-standards partner at McGladrey LLP. Some companies have already started discussions with their lenders about the eventual need to adjust debt agreements, he said.

The proposal is the latest step in a long effort by the two boards to revamp lease-accounting rules. An overhaul has been in the works since 2005, when a Securities and Exchange Commission report identified lease accounting as an area that rule makers should address.

The two boards issued a previous proposal for a lease-accounting revamp in 2010. But the boards revised some aspects of that proposal after companies and others raised concerns, though the idea of adding most leases to the balance sheet was in the first proposal and remains there.

Global accountants stick to plan for leases on balance sheets

11:56am EDT

By Huw Jones and Dena Aubin

LONDON/NEW YORK (Reuters) – Company balance sheets could swell by trillions of dollars under an international plan issued on Thursday by two accounting bodies to show more clearly the cost of leasing everything from photocopiers to property.

If the revised draft from the International Accounting Standards Board and the U.S. Financial Accounting Standards Board is adopted, tens of thousands of firms worldwide will have to add leases of a year or longer to their balance sheets.

The proposals, out for public consultation through mid-September, signal the two board’s refusal to back down further in the face of opposition from companies, which fear that bigger balance sheets would make them look more indebted and bump up their borrowing costs.

Most leases are currently only mentioned in the footnotes of corporate financial statements.

“Obviously, this standard is not a very popular one,” IASB chief Hans Hoogervorst said in a conference call. “Generally, companies like off-balance-sheet financing” and the standard will put an end to a major part of it, he said.

At least one politician swiftly condemned the plan.

Representative Brad Sherman, a Democrat of California, who serves on the U.S. House of Representative Financial Services Committee, said the plan would “substantially harm small businesses and throw a real monkey wrench in the real estate economy.

Sherman, who spoke at a Securities and Exchange Commission hearing on a wide range of issues, urged the SEC to intervene in the accounting proposal.

The reform, which might not take effect until 2016 in view of the corporate opposition, is part of efforts to align international and U.S. book-keeping rules so markets can compare firms more easily and get a clearer view of their liabilities.

SLIM SUPPORT AT FASB

“At present, investors must take an educated guess to determine the hidden leverage from leasing by using basic disclosures in financial statements and applying arbitrary multiples,” Hoogervorst said in a statement accompanying the draft.

More clarity on lease liabilities could break some corporations’ loan covenants, which are linked to balance sheet size limits, or even trigger credit rating changes, accounting experts say.

The sums involved are huge.

In Europe, outstanding leases totaled $928 billion in 2011, according to Leaseurope, which represents over 90 percent of the European leasing market.

In the United States, companies have about $1.5 trillion of operating leases, according to a study commissioned by the U.S. Chamber of Commerce and real estate groups.

“Leases represent valuable rights and obligations that belong on the balance sheet,” FASB Chairman Leslie Seidman said on the call.

The standard passed FASB by a 4-3 vote. One question is whether that slim majority will hold after Seidman’s term ends in June. A seventh board member has not yet been named.

The two boards have backed down from their original plan to treat all leases in the same way, and confirmed on Thursday that they would pursue a “dual-track” approach to distinguish between property and equipment leases, as reported by Reuters.

Instead of the current “straight line” rental expense that stays the same throughout the life of a lease, the new standard would treat most equipment leases like loans, with the highest costs in the earlier years.

Property leases would still be treated as a straight line expense, but there is no change to the basic principle that all types of leases longer than a year must be put on balance sheets.

MORE CONCESSIONS WANTED

Industry bodies had been hoping for further concessions.

“The accounting has changed in a way that’s incomprehensible, so people are going to have to keep two sets of records,” Bill Bosco, a consultant for the U.S. Equipment Leasing and Finance Association, said in an interview.

Equipment leases will be lumped together, when legally they are not all the same, and some should have straight line expense, Bosco said.

The standard “will not bring about a sufficient improvement in financial reporting to warrant the cost and complexity of changing the existing approach,” Leaseurope said in a statement on Thursday.

Deloitte, KPMG and Ernst & Young, three of the world’s top four accounting firms, said the changes would be complex and costly to introduce. The top 50 companies in Britain alone disclose leases in excess of 100 billion pounds, Deloitte said.

“Most leases in the UK and United States will be captured by these proposals. Companies have thousands of leases and they will have to go through them lease by lease,” said Veronica Poole, Deloitte UK’s national head of accounting.

The big debate will focus on whether the rule change is needed at all rather than how to tweak the details.

The boards expect to issue a final standard in 2014, he said.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

One Response to Companies might be forced to boost the amount of debt they report on their balance sheets by hundreds of billions of dollars under a proposal announced to overhaul the accounting for leases

  1. Pingback: Debt Reform - What Would the Accounting Changes Mean for You? | Blog

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