Professionals stress education as rule making effort advances
Financial reports for many North Bay organizations could seemingly worsen overnight after an expected change to lease accounting standards next year, and many North Bay accounting professionals are watching closely as an international effort to revamp the approach moves forward.
The Financial Accounting Standards Board and the International Accounting Standards Board, two major standard-setting bodies for accounting in the United States and abroad, announced this month that they have reached a preliminary agreement on the new standard, which seeks to provide clearer depiction of a company’s fiscal obligations by including the full duration of most leases with other assets and liabilities featured on a typical balance sheet.
When adopted, the new approach will appear to increase the financial liabilities reflected in the reporting of many companies, forcing lenders, investors and others to reconsider the calculations used to determine fiscal health and driving trends that could include a more competitive landscape between leasing and financing for property ownership.
“What this change does most significantly is that it removes the operating lease accounting model for most lease contracts, and puts most lease contracts under the capital model,” said Jim Perez, a partner at Pisenti & Brinker LLP and accounting lecturer at Sonoma State University.
Currently, many leases fall under the “operating” model, which depicts the expense as a month-to-month obligation on an organization’s balance sheet. To determine the full cost of paying the lease over its term, a reader must first determine the time left on the lease and match it with the reported expense.
While prudent lenders and investors would likely perform these calculations, Mr. Perez said that an increase in the role of leases for many organizations has driven a desire to make those obligations easy to interpret, prompting a revamp of the standard that began in 2010.
“Companies were structuring transactions to achieve a certain accounting result,” Mr. Perez said.
Under the new standards, which will undergo a public comment period before another draft is released later this year, leases would be treated more like financing that leads to ownership. The leased item, like a retail property or piece of equipment, would appear as a right-to-use asset, with a corresponding lease liability that would decrease as the lease reaches its end.
The changes stand to affect a broad variety of companies, though some will see their balance sheets appear to shift more than others, said Mark Rubins, a partner with Moss Adams LLP in Santa Rosa.
“Almost everybody has leases,” he said. “The more leases you have, and the bigger leases you have, the more of an impact it will have on the balance sheet.”
For many lessors of commercial space or equipment, the same changes would mean that lease transactions would appear as a long-term asset, decreasing as the term of the lease comes to a close.
Mr. Rubins noted that some of the common fiscal calculations that would be affected by the new standard included debt-to-net-worth and earnings before interest, taxes, depreciation and amortization known as “EBITDA.” While the underlying lease is still the same, the greater inclusion of liability could force a change in perspective for lenders, investors and developers of company performance-based perks for employees.
“The traditional multipliers of how to value a business will not work,” he said. “It’s going to mess with a lot of the traditional ratios people use.”
Some argue that the changes could inspire a broader consideration for property ownership, particularly at a time of convergence for low interest rates, low property values and increased limits on financing backed by the U.S. Small Business Administration and the California Small Business Loan Guarantee Program. Financing and leasing will be easier to compare in the new approach, increasing the competitiveness between the two options.
“Companies are saying, ‘Since we have to put this on the balance sheet anyway, let’s look at how much it will cost to buy it,’” said Mr. Perez.
The proposed rules are likely to exclude some entities and leases, Mr. Perez said. For example, leases of one year or less are likely to be excluded, and commercial lessors of retail property may be able to consider their leases under the current operating model. The final standard could also address concerns over the heightened initial liability that a new lease would reflect.
Amid the expected changes, which the boards plan for implementation in 2013, educating investors and others will be important, said Jon Dal Poggetto, managing partner of Dal Poggetto & Company LLP.
“I don’t think it changes the playing field. Everybody will just have to get used to looking at the balance sheet in a different way,” Mr. Poggetto said.
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