In March, the working group assembled by the Financial Accounting Standards Board and the International Accounting Standards Board will meet in London for the first time to make a comprehensive review of lease accounting rules.Because transparency has been seriously compromised under the current rules, Grant Thornton believes that this review is critical and comes not a moment too soon.
The problem is that existing lease accounting rules permit assets (and the related financing liabilities) to be kept off the books, regardless of economic substance, as long as the form of the transaction stays within the bright lines of the rules. Those rules have expanded over the years to include 16 FASB statements and interpretations, 11 technical bulletins and staff positions, and at least 30 Emerging Issues Task Force abstracts. Only specialists can hope to navigate such complexity.
The "magic" that causes both the asset and the liability to disappear begins by arguing that property, plant and equipment must be "owned" to be an asset. If there is no asset, then there can be no liability. Because existing leasing rules allow this type of accounting hocus-pocus, a mindset has evolved that any financing transaction can be structured so that the assets and liabilities are off-balance-sheet.
That's a mindset that needs to change.
Although there are legitimate tax and legal advantages to lease financing, too many transactions are structured for the purpose of arriving at a desired accounting treatment. The resulting balance sheet does not present a complete and transparent financial picture. Basic analytical tools like return on investment and debt-to-equity ratios are useless when neither the investment nor the debt is on the books. Before conducting even elementary financial statement reviews, users must look to the notes, and then make their own adjustments to published accounts based on what is, in many ways, incomplete information.
The dollars-and-cents implications are stunning. The Securities and Exchange Commission has estimated the undiscounted value of future lease payments among SEC registrants at more than $1.25 trillion, an amount that is greater than the gross domestic product of many countries. And that figure does not include leases to private entities not filing with the SEC. The rapid global growth of lease financing has made accounting for leases an international issue.
The way forward would seem simple. Both the Chartered Financial Analyst Institute, in its Comprehensive Business Reporting Model, and the SEC, in its report on off-balance-sheet financing, conclude that lease assets and obligations should be on-balance-sheet. Strong support for lease accounting changes is coming from chief financial officers and senior comptrollers. When asked in a national survey conducted by Grant Thornton if lease accounting rules should be revised to give investors more transparency, 63 percent agreed that they should.
Change is never easy. But our common goal should be high-quality decisions based on high-quality, transparent information. Anything that brings us closer to that goal is in the public interest in both the short and the long term. A principles-based standard that improves the accounting for leases would increase transparency and accessibility, and decrease complexity in preparing, auditing and using financial information.
Everyone will benefit from that.
Edward Nusbaum is the chief executive of Grant Thornton LLP.
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