Financial Regulatory Forum

PREVIEW-Rulemakers plan global overhaul of lease accounting

By Reuters Staff
August 16, 2010

By Emily Chasan

NEW YORK, Aug 15 (Reuters) – U.S. and international accounting rule makers are planning to propose an overhaul of lease accounting as soon as Tuesday, in a move expected to affect some $1.2 trillion in leased assets.

Traditionally, accounting rules have given companies a lot of leeway in how they record leases for assets ranging from store locations and restaurant equipment to airplanes and machinery. As a result, only certain types of leases appear on the balance sheet, while a majority of a company’s leases can often be be kept off the balance sheet and hidden from an investors’ view.

But the Financial Accounting Standards Board, which sets U.S. accounting rules, and the London-based International Accounting Standards Board, which writes accounting rules for more than 100 countries, will aim to change all that this week by proposing to bring many of these assets onto corporate balance sheets.

“It’s something that needs to be done,” said John Hepp, a partner in accounting firm Grant Thornton’s professional standards group. “Lease accounting is broken.”

Lease accounting has hardly been changed in the last 30 years, so FASB and IASB have suggested that the changes would make accounting more consistent and better reflect the economics behind a lease transaction. It could also clear up some confusion between similar transactions that are accounted for as financings or leases.

Under the changes being contemplated, companies would likely have to recognize a liability for future rental payments and an asset for the right to use the asset they are leasing. Many of those leases now are classified as “operating leases” and exist off the balance sheet.

A FASB spokeswoman declined to comment on the final proposal, but said that the boards do expect to release it next week.

“Operating leases have long been considered one of the major off-balance sheet obligations, so there was this view that in an operating lease, the lessee has incurred an obligation and that it should be reflected on the balance sheet,” said Janet Pegg, an accounting analyst at UBS Investment Bank.

TO LEASE OR NOT TO LEASE?

Leases are used heavily in industries like retail, where retailers lease most of their stores and airlines, where carriers lease most of their planes.

Analysts at Credit Suisse estimated in 2006 that the total off-balance-sheet lease liability for S&P 500 companies was $396 billion, with the retail and restaurant industries facing the biggest liabilities.

While some investors may welcome the change to lease accounting because it will provide more clarity, many companies are fearful that the change will force their balance sheets to balloon overnight, and change all sorts of leverage and debt ratios, forcing them to renegotiate covenants with their lenders. Credit rating agencies, for the most part, already make calculations to compensate for off-balance-sheet leases, but they could also be changed.

“They’re trying to put the value of the lease on the books and the obligation of lease on the books,” said Jeffrey Taylor, an Arizona-based author of two books on lease accounting.

“It doesn’t really change net worth, but I guarantee its going to change return-on-asset formulas, return-on-equity formulas and debt servicing,” he added.

The FASB and IASB decided to address both lessee and lessor accounting as part of the proposal, so companies like CIT Group Inc  and Wells Fargo that operate leasing companies could also be affected.

“People in the leasing industry think if they can’t keep things off the balance sheet and operating leases disappear that its going to devastate not only equipment leasing, but also real estate leasing,” said Taylor.

“You’ll probably see a lot of people get out of the leasing business and I do see a consolidation of what kind of equipment might be leased,… but I can’t see in my mind how changing lease accounting is going to push a company over the edge.”

Taylor said he would expect lenders to work with companies affected by the change and that some companies may also want to restructure some leases due to the change.

The accounting proposal would be open for public comment and go through a revision process before becoming a formal rule. The new standard would likely not take effect for several years.

(Reporting by Emily Chasan; editing Bernard Orr) ((emily.chasan@thomsonreuters.com; +1 646 223 6114; Reuters Messaging: emily.chasan.reuters.com@reuters.net))

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