A proposal to change how leases are accounted for on corporate balance sheets could have a widespread, detrimental impact on the U.S. economy, triggering a $10 billion reduction in gross domestic product (GDP) and 60,000 fewer jobs by 2016, according to the Equipment Leasing and Finance Association (ELFA). ELFA cited a new study, “Economic Impacts of the Proposed Changes to Lease Accounting Standards,” conducted by information and analysis provider IHS for the Equipment Leasing & Finance Foundation.
Most U.S. companies across a wide spectrum of industries lease equipment or real estate as part of their day-to-day operations. Currently, operating leases are not reported on companies’ balance sheets; they are reported in the footnotes to companies’ financial statements. The proposed lease accounting changes, from the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), would require companies to record virtually all leases on their balance sheets. The study’s analysis of financial data reveals that the proposal would depress company profits, economic growth and financial stability.
According to the study, many businesses do not object to having to record leases on their books. Rather, they object to how the proposal would require them to account for and report lease transactions, contending that aspects of the proposal are too complex, impose burdensome regulation on businesses and do not accurately reflect the economics of the lease transaction.
Because of concerns raised by private companies and not-for-profits, the FASB has added to its agenda a project to assess the feasibility of reducing or eliminating certain fair value measurement disclosure requirements for these parties. The decision by FASB Chairman Leslie F. Seidman to add the agenda project was based on comments received during private company roundtable discussions held in October.
The project will evaluate the need for existing disclosure requirements for private companies and not-for-profits for fair value measurements categorized within Level 3 of the fair value hierarchy. Level 3 refers to fair value measurements that are determined using significant unobservable inputs, such as expected future growth rates. The project will include conducting targeted outreach to private company and not-for-profit stakeholders, particularly investors, lenders, donors, and other users, to assess the relevance of existing Level 3 fair value measurement disclosure requirements.
IHS Study Findings
The Equipment Leasing & Finance Foundation’s study projects that under the existing lease accounting proposals being considered by the IASB and FASB:
• U.S. companies could add an estimated $2 trillion to their balance sheets—an 11% increase in total debt. Higher debt-to-equity ratios can increase volatility in corporate earnings and companies’ ability to secure financing, among other consequences.
• U.S. companies could experience a 2.4% reduction in pre-tax net income in the first year of the new accounting rule.
• The cost of debt could rise through higher interest rates—every 50 basis point increase would trigger a $10 billion reduction in GDP and 60,000 fewer jobs by 2016.
• The proposal could cause a permanent reduction of $96 billion in the equity—net worth—of U.S. companies, a sizable erosion of shareholder ownership value.
Call to Action for Businesses
ELFA proposes that FASB and IASB include four key considerations in their revised lease accounting rules. In a call for businesses to act, the association recommends they submit a comment to the Boards in support of the following:
• Recognize that there are at least two types of leases. Retain the time tested distinction between capital leases and operating leases and retain straight-line expense recognition for the leases that are now considered operating leases.
• Offer relief from the complexity and compliance burden of the proposal in areas such as transition, adjustment of estimates in the lease term, accounting for variable rents and disclosures.
• Preserve the netting in leveraged lease accounting that allows lease providers to reduce the cost to lease users by hundreds of basis points.
• Preserve sales-type lease gross profit recognition that allows captive companies to charge lower rates (as much as 100 basis points).
The FASB and IASB have announced plans to issue a new draft of their proposal by early April 2012, with a 120-day comment period. ELFA is urging the Boards to listen carefully to the feedback they receive on their proposal.