Are US Executives prepared for the proposed accounting changes

US Executives seem unprepared to deal with changes to lease accounting rules proposed by the IASB.  According to Deloitte research only 7% of respondents questions believed their company was prepared for the possible changes.  The firm questioned over 280 Executives throughout the US.  The suggested changes require more details to be included in financial reports, such as how to account for leases related to property and equipment. 

It is clearly evident that many US companies are concerned.  The compliance issues that would accompany the proposed changes would greatly impact financing, lease lengths and property strategy.  More than 40% of respondents believe the new standards would make it difficult to obtain financing in the future.

Companies Brace for Powerful Impact of Lease Accounting Changes

Proposed new accounting standards have been drafted in order to push lease liabilities back onto corporate balance sheets. Such a change would represent a major shift for companies that have typically favored the off-balance-sheet treatment of operating leases, and it could have a significant impact on corporate decisions to lease or purchase real estate in the future.

The proposed guidelines are a joint initiative by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board to create a uniform global standard and greater corporate transparency in lease accounting procedures. The most recent draft would establish one method of accounting that requires firms to recognize all lease liabilities and assets on their corporate financial statements.

Another key component is that companies would be required to record the lease value or rent commitment over the entire lease term, including renewal options. Although the intent is to stop off-balance-sheet activity, the changes would add significant weight to corporate balance sheets.

For example, a firm that pays $1 million per year in rent for its corporate headquarters would quickly see its liability multiply depending on whether it has a five-year or 15-year lease. Companies would appear more highly leveraged, which could affect factors such as corporate credit and existing debt covenants.

Although FASB cites data that values leasing activity at $640 billion in 2008, other industry sources estimate that current volume as high as $1.3 trillion in operating leases for U.S. firms alone. Once the guidelines go into effect, which many in the industry believe will occur in 2013, both new and existing leases would be immediately affected.

One fear is that the new accounting practices could deter companies from signing long-term leases, or encourage firms to own rather than lease facilities. Both of those factors could be a detriment to the sale-leaseback and net-lease finance niche where leases typically extend 15 years and beyond.

Sale-leaseback transactions have accounted for $24.8 billion, or slightly more than 50%, of the $46.6 billion in single-tenant sales globally over the past 12 months from June 2009 through June 30, 2010, according to Bloomberg Business.

Operating Leases and the Proposed Accounting Standards

The big question looming over the proposed accounting changes, is how will big business deal with the disappearance of operating leases? 
I'm not an expert, however I can tell you a few things for certain. First, most companies lessors and lessees are hiring accountants with heavy international experience in real estate. Second, the financial accounting impact is not going to result in competitive disadvantage since all companies must comply. Third, there will be differences in the overall adjustments experienced depending on how mature the leases are with respect to tenant occupying the space.

The valuation topic will pick up more steam and perhaps the number of options to renew included in the original lease will be reduced, basically the leases may be written differently. Overall there will be more transparency as to financing strategy in companies who have chosen to lease all locations rather than invest in capital assets - the wirelesss telecom industry generally leases all tower locations or builds to suit on leased land. There are many discussion brewing within this industry regarding how to move froward with new tower locations.

Most important at this moment is to prepare the shareholders for drastic changes in reported numbers. Applying the proposed changes will mean putting most of your leased assets on balance sheet, which will result in changes of businesses financial performance indicators, such as ROI. It will also affect the structure of earnings statement, as the expenses will be moving lower in your income statement. It is also important that some bank covenants may be affected. The preparation for such changes requires careful management of expectations, from both, shareholders and banks.

Bottom line, business will adjust and continue on, still exercising the option to pay cash or lease. The leasing industry will continue to grow and evolve with the changes likely to be put into effect (Mid- 2011).  New products and offerings will still add value for businesses and will continue to be a great option to keep operating cash clear, as well as other advantages.