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.
[caption id="attachment_56550" align="alignright" width="377" caption="Jim Perez, Mark Rubins, Jon Dal Poggetto"][/caption]
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.”