Hidden in Plain Sight

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

But the SEC wants to go further. Its report cites studies by the IASB suggesting lease accounting be based on contractual cash inflows and outflows. Under this method, both the lessor and lessee would report their economic interest in the leased assets, as well as assets and liabilities related to the lease payments. “Leases that are at present characterized as operating leases,” notes an IASB summary, “would give rise to assets and liabilities — but only to the extent of the rights and obligations that are conveyed by the lease.” This and similar approaches, the SEC report noted, “remain worthy of consideration.”

Fleming says the ELA is amenable to change, though it encourages an accounting treatment that is “workable and reflects reality.” But, he notes, “you can’t treat something on your balance sheet as an asset if you don’t own it.”

Yet Mulford thinks that’s probably exactly what will happen. “A lease on the balance sheet will not represent ownership, but the economic reality of commitment. It won’t say you own a [rented] storefront, but that you control it for a certain time, and that it is both an asset and an obligation.”

Both sides of any debate already agree on one thing: lease accounting may change, but leasing won’t go away. “There are benefits to having use of an asset without owning it,” says Geert Kraak, vice president of finance for Dutch Rabobank Group financing subsidiary De Lage Landen. “If you look at how much is financed by leasing companies in the United States and worldwide, that is not just going to disappear. There is a definite need for leasing.”

“The value proposition we offer is less and less dependent on the off-balance-sheet treatment of the leases,” says Kraak. “It is more about value added in terms of asset management, risk management, and the availability of point-of-sale financing.”

“Accounting treatment was the driving factor for leasing until now,” says Dan Sholem, an equipment finance-and-lease adviser. “The SEC’s [suggestions] are going to move the emphasis toward the operational benefits of leasing.”

Tim Reason is a senior editor at CFO.

Watch Those Terms

The Securities and Exchange Commission’s argument against operating leases is that the accounting often doesn’t reflect the true economics of the transaction. But others argue that overzealous pursuit of a favorable accounting treatment actually can cause economic damage.

“There is often too much emphasis on the off-balance—sheet treatment,” says Dan Sholem, an equipment finance—and-lease adviser. He warns that lack of focus on a company’s operational needs can ultimately force it to pay more for leasing an asset than for purchasing it outright. “A lot of times, companies will, at the end of a lease, get stuck with things they wish they’d bought,” he says.

Under FAS 13, a lease does not qualify as an operating lease if the company can purchase the asset at a price that is substantially lower than the expected fair value at the end of the lease term. Nor does it qualify if the present value of the lease payments equals or exceeds 90 percent of the asset’s fair value. A lease structured to avoid these triggers could cost a company far more than the original cost of the asset if the company later discovers that it needs to buy the asset or extend the lease, says Sholem.

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