Accountants to decide on $1 trillion leasing reform

LONDON (Reuters): Companies that lease planes, cars or property could be forced to swell their balance sheets by more than $1 trillion by global accounting changes that will be decided on this week.

Critics say the costly reform, which marks a second attempt at a deal as world leaders pile pressure on rulesetters for common global accounting rules by mid-2013, will backfire.

“It’s very clear that whatever they do they will upset someone,” said John Hitchins, global chief accountant at PricewaterhouseCoopers, one of the “big four” auditing firms.

Companies typically have many leases, such as for offices, shops, cars, PCs, phones and photocopiers. Past IASB chairman David Tweedie famously looks forward to crossing the Atlantic in a plane that is on the airline’s balance sheet.

Chang & Adams consulting say total reported debt liabilities of US companies alone would jump $1.5 trillion and bump up compliance costs by $10.2 billion a year under the reform.

Debt-to-equity ratios are set to balloon, which will require a re-writing of many loan covenants based on set debt limits. PwC’s Hitchins said most financial analysts already take into account off-balance sheet leases at the companies they cover, but there are likely to be some surprises.

The International Accounting Standards Board (IASB) and US Financial Accounting Standards Board (FASB) meet on Wednesday and Thursday to vote on draft changes for public consultation. Their rules are used in well over 100 countries and shape standards in many others.

There are currently two types of leases: operating, which are treated as a business expense noted disclosures; and capital, which are on the balance sheet.

The two boards have already agreed that all leases lasting a year or more should be on balance sheet to improve transparency, making companies appear more highly geared though with no change to cash flow or solvency.

The IASB and FASB faced so much opposition from companies to the first proposal they voted through that they were forced to go back to the drawing board.

People familiar with the situation say the second attempt is likely to back a dual approach that would treat property and equipment leases differently, with both on balance sheet.

The impact of an equipment lease, such as for a plane, could end up being front-loaded in the early years of the contract, while the hit from a property lease would be “straight line”, meaning it would be evenly distributed over the life of the lease.

The boards’ first proposal wanted to front-load the interest cost for all leases, raising hackles.

“They will struggle to get consensus on any model where you just have one type of lease. Two types of leases may be the most practical way of bridging the different views,” PwC’s Hitchins said.

A combination would help win over both boards as part of wider efforts to “converge” their accounting rules by a mid-2013 deadline set by the G20 world leaders.

They still need buy-in from a hostile industry. “In Europe our view is that the current lease accounting standard is not as broken as the boards say. It’s been very hard to get any true consensus in Europe on a new approach,” said Jacqueline Mills, director for asset finance Leaseeurope, which represents businesses that use leases.

“Our concern is that a new standard is going to be overkill. It’s taking so long to get anywhere, which shows it’s very difficult to get anything better than we have today,” she said. The bulk of leases cover property and Peter Cosmetatos, finance policy director at the British Property Federation said there were likely to be major unintended consequences from putting all leases on balance sheets.

“For some businesses it may make more sense to own property than to rent it, especially for the more blue chip end of the spectrum,” Cosmetatos said.

This could squeeze the steady rental income developers need to build new properties, and there could also be further momentum in a trend towards shorter lease terms to avoid big balance-sheet liabilities, he added.

Nigel Sleigh-Johnson, head of financial reporting at international accounting body ICAEW, said a dual approach would be disappointing and could encourage some gaming of the system. “You don’t want the accounting driving the transaction. We might see a pragmatic decision and we then have to look at what that means in terms of benefits. It’s undeniable that the costs of making these changes will be significant,” he added. The reform is unlikely to come in before 2016.