Revising long-term leases

Many companies are unaware that leases may have to go on the balance sheet from 2012, warns Christian Roelofs

Changes to lease accounting will be finished early next year and are expected to have implications for businesses that are heavily reliant on leases. The changes will require businesses to move all but short-term leases on to the balance sheet - an alteration that could have more impact than any other global accounting changes in the past decade.

Our international team recently did some research globally to see how many businesses are aware of the imminent switch. Worryingly, our survey revealed that about half (47 per cent) of tech-business respondents were unaware of, and are therefore unprepared for, the changes. What we found even more concerning is that the technology businesses aware of the changes being proposed by the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) are not wholly convinced that the impact will be positive or useful.

Just under a third (31 per cent) believed the change would increase cost and complexity. A mere seven per cent thought it would increase transparency. Eleven per cent of those technology businesses polled indicated that they would alter the way they structure leases in the future.

The IASB and FASB are set to re-present their latest proposals for lease accounting early next year and it is vital that businesses assess the impact of the potential changes. It is also key that investors consider whether the new proposed model will actually deliver the transparency for which they are rightly calling.

Our findings should give those two boards pause for thought, as firms are seeing costs and complexity in the proposals but are questioning whether or not there is any improvement in transparency.

We have seen alternative proposals that could create a different set of incentives to structure leases and achieve desired accounting outcomes. Change for the sake of change is not the goal, and a rush to a new standard could actually make things worse.

There is no question that a global review of lease accounting is long overdue. The lack of transparency concerning leases has festered for years, but a major change to lease accounting is a once-in-a-generation event and needs to be effective. As such, we welcome the boards’ decision to consult publicly on their latest thinking as it is essential that any new standard is practical for business, avoiding undue complexity and excessive estimation uncertainty.

Investors need transparent, comprehensible information about leasing obligations and the related revenue and costs. The boards have a difficult task, but we encourage them to look closely at whether or not the leasing proposal is sufficiently aligned with the ongoing review of revenue recognition - these areas are interrelated.

Second, we ask them to look closely at whether or not they have adequately distinguished leases from other types of contract (so-called executory contracts) which, under current standards, are not generally recognised in financial statements at all. The most critical thing now is that affected businesses and investors engage with the process to help ensure these goals are achieved.

The US Securities and Exchange Commission has estimated the undiscounted value of future lease payments among US listed companies alone at more than $1.25tn (£792.3bn) - an amount larger than the gross domestic product of many countries. Globally, the value is far higher. There are certainly legitimate tax and legal advantages to lease financing. However, too many transactions have been structured for the purpose of arriving at a desired accounting treatment.

Currently, balance sheets do not present a complete and transparent financial picture. Basic analytical tools such as RoI and debt-to-equity ratios are useless when neither the investment nor the debt is on the books. Before conducting even elementary financial statement reviews, users must look to the notes, then make their own adjustments to published accounts based on what is, in many ways, incomplete information.

Christian Roelofs is associate director of recovery and reorganisation at Grant Thornton