Hidden in Plain Sight

Leasing may soon have to be justified on economic terms alone.

Tweedie’s comment is significant: FASB is likely to work closely with the IASB — which has already done several studies on the subject —in developing any new lease-accounting standard.

Why Now?

Yet not everyone agrees that lease accounting is as serious a problem as the SEC suggests. ELA president Michael Fleming notes that the 30-year-old standard has long taken a backseat to more-pressing issues. “No investors are standing up and saying they have been misled because of lease accounting,” he says.

Indeed, under an SEC rule adopted in 2003, companies must disclose all contractual obligations — including both types of leases — in a table in the Management’s Discussion and Analysis (MD&A) section of the financial statements.

Dennis Hernreich, CFO and COO at Casual Male Retail Group Inc., says lease accounting is “very transparent,” and that changes are unnecessary. “To me, there’s more than adequate disclosure in the footnotes,” he says. Operating leases are, of course, common in the retail industry, where they generally reflect the sort of rental contracts standards setters had in mind. Casual Male’s total (undiscounted) future obligation for operating leases of $150 million is disclosed in a table of contractual obligations. (By contrast, Casual Male records $124 million in long-term debt obligations, which appears both in the table and on the balance sheet). Still, if FASB changes the accounting, he says, “we’d have a lot more assets and a lot more liability.” But he insists “that really wouldn’t be a problem.”

Critics of the current accounting acknowledge that off-balance-sheet leases are far less pernicious than the depredations that prompted the SEC report in the first place. But they argue that even sophisticated users don’t get all the information they need from the MD&A table, which lays out undiscounted payments for each of the coming five years and lumps the rest of the lease amount into a “thereafter” category. Charles W. Mulford, an accounting professor at the Georgia Institute of Technology, says even commercial lenders with whom he consults “routinely come up with overly conservative estimates of operating leases.”

That’s because to find the present value of an operating lease, a financial-statement user must estimate the discount rate, as well as the payment stream for the period beyond five years. (The labor involved is evident in the fact that the SEC itself did not attempt to discount the $1.25 trillion amount in its study.) Moreover, calculating the exact principal and interest for each payment is often complicated by the presentation of costs such as property taxes and maintenance as a lump sum.

“If companies themselves actually do the present-value calculation, it’s going to be much more accurate and consistently applied,” says Mulford, “than if every user does seat-of-the-pants calculations to figure out what should be on the balance sheet.”

What Now?

Lease accounting has already been under pressure in various ways — a recent clarification from the SEC’s chief accountant on how to account for certain aspects of property rental led more than 150 retailers and restaurant chains to restate results, while Fin 46 forced many companies to unwind synthetic leases and required companies such as Dell to consolidate vendor-financing arms that themselves issue leases.

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