Practically lost in the brouhaha concerning the effects of the imminent changes in lease accounting has been the impact they could have on lessees’ relationships with their banks.
Bankers are warning that altering lease accounting could significantly change a borrower’s balance-sheet profile, possibly making it look more leveraged than it actually is. The changes could also worsen the financial ratios that govern a loan’s covenants, to the point where the borrower is in violation of its agreement with the bank.
With a final vote by the Financial Accounting Standards Board and the International Accounting Standards Board on lease accounting rules possible as soon as mid-March, the focus has been on their advantages for investors and the difficulty corporate finance and accounting departments might have in complying with the rules.
Following vociferous objections by senior corporate finance executives and others to the most recent plan delivered last May, the boards are now mulling new ways to proceed on lessee accounting. Whatever changes the boards do make, however, one thing is nearly certain: the assets and liabilities of what are now operating leases will henceforth be recorded on corporate balance sheets.
No matter how the boards decide to make that happen, the current apple cart of the relations between companies and their lenders is bound to be upset, experts say. That’s because the calculations of many of the key ratios governing bank covenants, such as earnings before interest, taxes, depreciation, and amortization (EBITDA), debt-to-equity (D/E) and return on assets (ROA), are bound to come out a whole lot differently for many companies.
Especially affected by a new system would be companies that retain the right to use equipment or real estate via operating leases. The assets and liabilities of such leases, which are tantamount to rentals, aren’t currently reported on corporate balance sheets. (Lessees are required to put capital leases, in which the lessee essentially agrees to buy the asset with financing help from the lessor, on their balance sheets.)
But under the boards’ lease accounting exposure draft, however, banks would likely see a whole lot more debt and assets on the loan applications of corporations bound by operating leases.