Stephen Brashear/Getty ImagesA proposal would change the way companies account for leases, like those for aircraft, on their balance sheets.
10:37 a.m. | Updated
Rule makers around the world on Thursday issued a new proposal on accounting for leases that backs off from some of the most controversial aspects of an earlier version. But it would still represent a radical change in accounting by requiring many companies to report vastly larger amounts of assets and liabilities than they do now.
Under current rules, companies are generally able to classify virtually all leases as operating leases and keep them off their balance sheets, something that regulators and accounting critics have long criticized. Some airlines, for example, lease all their airplanes and show no airplane assets on their balance sheets and no liabilities for the money they are committed to pay for those planes in the future.
“The development of an improved standard for leasing is vital,” said Hans Hoogervorst, the chairman of the International Accounting Standards Board. “At present, investors must take an educated guess to determine the hidden leverage from leasing.”
Under the proposal, issued jointly by the international board, which sets rules for many countries around the globe, and by the Financial Accounting Standards Board, which writes the United States rules, an airline entering into a lease for a plane would show an asset of the right to use the plane and an equal liability based on the current value of the lease payments it has promised to make. That accounting would be similar to what it would show had it borrowed money to buy the plane.
“The proposal is responsive to the widespread view of investors that leases are liabilities that belong on the balance sheet,” said Leslie Seidman, the chairwoman of F.A.S.B., adding that the two boards “have worked together to develop a revised, converged proposal to address the inadequacies of current lease accounting and disclosures.”
There seems to be little doubt that there will be substantial opposition to the new proposal. “This is going to be one of the least popular standards,” Mr. Hoogervorst told reporters, “Companies like off-balance sheet financing.”
But some accountants said they thought the new rule could succeed where previous efforts had failed, “The F.A.S.B. has made an attempt to keep it as simple as possible,” said Rick Day, the national director of accounting at McGladrey, an American firm that primarily audits smaller companies. “While it will be controversial, I think it will fly.”
There were dissenting votes on both boards, with complaints made that the new proposal went too far to satisfy complaints about the earlier proposal, which was released in 2010.
Many accountants have agreed for decades that lease accounting needed to be reformed, but accounting rule making is a slow procedure, particularly when there is sharp opposition from companies.
In 1992, the Accounting Standards Board, which set British accounting rules, said it was considering changing the leasing rules, prompting howls of protest. The rule was not changed, and nine years later the board’s outgoing chairman, Sir David Tweedie, lamented that fact. “I would have liked to have gone into lease accounting, which is a mess,” he said. “Airlines have got hardly any aircraft on the balance sheets.”
Mr. Tweedie became the chairman of the I.A.S.B. in 2001, but it was not until 2006 that lease accounting was added to that board’s agenda, as well as to the agenda of the American board. That move came after the s Securities and Exchange Commission said in 2005 that action needed to be taken.
On Thursday, the two boards asked that comments on the proposed rule be made by Sept. 13. After those comments are analyzed, the boards will decide whether to issue a final rule, most likely in 2014 if they choose to move forward. There would probably be a considerable delay in making the new rules effective, probably until 2017, to give companies time to comply and, in some cases, to renegotiate loan agreements that put limits on borrowing by the companies — limits that could appear to be violated if leases are put on the balance sheet. If that is the timetable, the new rule would take effect 25 years after Mr. Tweedie first tried to take action.
In addition to making balance sheets larger, the proposed rule would also change income statements for many companies. Currently, a company that leased a piece of machinery for $1,000 a year for five years would show a $1,000 expense each year. Under the new proposal, that company would show a larger expense in early years and a smaller one in later years. That is because the accounting would be similar to what would be shown if the company had borrowed money to buy the asset, paying the loan in equal payments over five years. In early years, the interest expense would be higher than in later ones.
A significant change from the initial proposal is that most real estate leases would be accounted for differently. While they, too, would go on the balance sheet of the lessee, the value would be based on the expected lease payments over the life of the lease. Unlike in the 2010 proposal, the lessee would not have to assume that it would exercise renewal options, unless those options were at such favorable prices as to clearly give it a financial incentive to renew.
In cases where the lease payment was based on something that would vary — like a store lease where the lessee would pay a fixed rate plus a percentage of sales — the value would not reflect the expected additional payments. That would keep the asset value, and the related debt, lower than it might otherwise be. If the rent would vary based on an index — like the Consumer Price Iindex — the initial value would be based on the current level of the index. The values of the asset and liability would be updated every year as the index changed.
The split between the two types of leases is not quite that simple. Any lease that allows the lessor to use only an “insignificant portion of the underlying asset” could get the real estate treatment. Ruth Picker, an Ernst Young partner, said that provision “would require the use of greater judgment and estimates compared to current practice” and could be difficult to apply.In another concession to complaints, the boards said that leases with durations of one year or less could be treated the old way, with no asset put on the balance sheet.
The details remain controversial. At the I.A.S.B., the vote was 12 to 2, with two newer members abstaining. The two dissenters, Prabhakar Kalavacherla of India and Zhang Wei-Guo of China, said they opposed allowing real estate leases to be treated differently from other leases.
The American board approved the issuance of the draft on 4-to-3 vote, with one dissenter, Thomas J. Linsmeier, complaining that the rule “will result in financial reporting by the lessee that is so complex that it will hinder” the ability of investors to understand what is going on in part because there will not be enough disclosures of details.
Ms. Seidman said she thought the new rule would provide “a significant enhancement of disclosure for investors.”
The split on the American board could become important. Ms. Seidman will step down at the end of June, to be succeeded by another board member, Russell Golden. Mr. Golden backed the proposal, but his successor has yet to be named.
Ms. Seidman noted, however, that the three dissenters were not themselves in agreement, so there is no single alternative proposal available.
Marc A. Siegel, another dissenter on the American board, said the board had considered requiring much more detailed disclosures and should have done so. But Mr. Day, the accountant at McGladrey, said the failure to do that had provided much needed flexibility for companies.
Article source: http://dealbook.nytimes.com/2013/05/16/significant-changes-proposed-in-lease-accounting/?partner=rss&emc=rss