A discussion paper on potential changes to lease accounting was released in March by the U.S. Financial Accounting Standards Board and the International Accounting Standards Board. According to the discussion draft all operating leases for real estate and equipment will have to be capitalized on corporate balance sheets and rent expenses will be dramatically altered. This would effectively eliminate operating leases, significantly increase costs and reduce flexibility.
Under this common standard, the contractual rights of a lease will be considered an asset and the rental commitments will be considered a liability. The rental payments will be split between capital and interest (similar to a loan) making the cost of the profit and loss account higher in the early years of a lease. Currently, leases are considered a straight-line operating expense.
While the stated purpose of the proposed new system is to create more transparency for company financial statements, it will cause balance sheets to balloon and cause significant reporting adjustments for contingencies. According to Jones Lang LaSalle, “If these proposals are adopted, they will change the way that corporations view their property holdings. They will inflate both assets and liabilities, affect profit-and-loss run rates, key performance measures including debt-covenant ratios, and change the overall make-up of corporate financial statements.” According to the Equipment Leasing and Finance Association, of the top 30 companies with outstanding off-balance sheet rent obligations, 15 are retailers.
Comments on the proposed rules are being accepted until July 17, an exposure draft is anticipated in 2010 and final rule issuance could come as early as 2011.