With the world’s leading accounting standards setters on the verge of voting in a new lease accounting regime beginning at a meeting on Tuesday, questions remain about whether all leases can be regarded as debt.
Regardless of how that question is answered, it’s most likely that at long last the Financial Accounting Standards Board and International Accounting Standards Board will soon be putting forth a standard that would require all lessees and lessors to record all operating leases on their balance sheets, rather than scattering them in the footnotes of financial statements as they have done until now. As they are today, capital leases would continue to be reported on corporate balance sheets.
Recently, CFO reported that 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.
The issue of how leveraged companies would appear to their bankers as a result of the proposed standard triggered a bevy of vigorously worded comments from readers, largely circulating around a central question: Are leases debt?
The debate began with a laugh. It was ridiculous that the boards’ proposal would make borrowers’ balance sheet look more leveraged than it is, because all leases already are debt.
That comment triggered further mirth from another reader, who noted that FASB started to curb the ability of borrowers to hide debt via the use of leases with a 1976 standard.
A third reader, apparently agreeing with the first two, responded with a definition:
Relying on the notion that an operating lease is an “executory contract,” a fourth reader, apparently representing the lessor side, argued strongly that operating leases aren’t consider debt for the purposes of bankruptcy. “The simple definition that debt is everything owed is too simplistic,” he shot back:
The argument heated up. Leases are, in fact, “loan shark financing that drives companies toward bankruptcy,” one of the earlier commenters declared.
Finally, two temporizing readers tried to strike a balance between the two extremes.