Impact of Changes to Lease Accounting

By Sarah Johnson-CFO Magazine

Leasing is one convergence project that some U.S. finance executives are eyeing very warily. All signs are that a revamped global standard, expected in 2011, would require companies to capitalize assets that have traditionally fallen under the operating-lease classification, and hence could be recorded off the balance sheet. The result: companies that lease would appear more highly leveraged.

"The ability to do any financial engineering, which [the Financial Accounting Standards Board and the International Accounting Standards Board] are very afraid of, will be severely diminished," says Bill Bosco, who consults for the Equipment Leasing and Financing Association and sits on the International Working Group on Lease Accounting for the two boards. "All leases will be on the balance sheet."

In a paper released earlier this year, FASB and the IASB indicated that, rather than distinguish between capital and operating leases, companies should instead think about their "right to use" a leased item, be it plant, property, or equipment. Lessees would record that right as an asset, and their obligation to pay future rental installments as a liability.

Lessors would, in turn, record a liability for their commitment to lend an item and temporarily give up their right to use it. The thinking is that lessors need to account for the item because they still retain control of it; their right to receive rental payments would be recorded as an asset.

Executives in certain industries, particularly airlines, railroads, and retail, may be heartened by the boards' recent decision to exclude certain leases from the final standard, an exception that many of those executives pushed for. Lease contracts that are effectively purchases — in which an item is financed for ownership — would be scoped out of the new standard. But the boards have yet to explain exactly how companies would determine how those leases are defined.

The changes apparently won't deter CFOs from using leases. In a survey of more than 800 CFOs and controllers in late September and early October, 59% of respondents told Grant Thornton they would continue to use leases or lease financing the same way they do now.