Changes in the proposed lease accounting standards that the Financial Accounting Standards Board and the International Accounting Standards Board are working to converge are expected to have an impact on approximately half of public companies, but less than 10 percent will see a major impact, according to new research by the IASB.
Speaking at an International Financial Reporting Standards conference in Singapore, IASB chairman Hans Hoogervorst said Thursday that the IASB had conducted an analysis of the impact of the proposed leasing standard on 12,000 listed companies across Europe, Asia and North America and found some interesting insights.
“First of all, in the industrialized world, roughly 50 percent of listed companies report material operating leases,” he said. “That means that the other half will not at all be impacted by the upcoming standard. Secondly, the use of operating leases is highly concentrated. Out of the total of 12,000 entities that we analyzed, 1,000 companies, or less than 10 percent, accounted for 80 percent of all the operating leases. For these heavy’ users, operating leases are a very significant source of finance. We calculated that inclusion of the lease liability would lead to an increase of the long-term debt-to-equity ratio from 13 percentage points in Europe through 20 percentage points in Asia.”
He acknowledged that such substantial numbers could explain why many investors make adjustments to the balance sheet when they analyze the impact of leases, which currently are not carried on balance sheets under either IFRS or U.S GAAP.
The use of leases varies across industries, with some industries, such as airlines, keeping substantial sums of money from the airplanes they lease off their balance sheets. Hoogervorst’s predecessor, former IASB chairman Sir David Tweedie, often joked that it has always been his ambition to travel on an airplane that appeared on an airline’s balance sheet.
“We have also found that within economic sectors, the use of leases is very diverse,” said Hoogervorst. “In the transportation sector, for example, there are airlines that have operating leases for almost all their airplanes. Their hidden leverage is much higher than the numbers I just mentioned. Other airlines already carry most of their fleet on the balance sheet and will not be impacted by the new standard. In all, there can be no doubt that the leases standard will greatly enhance comparability between and within economic sectors.”
Hoogervorst said the IASB’s effect analysis clearly shows that the leases standard will only significantly affect fewer than 10 percent of listed companies. “However, in those economic sectors that are significantly affected by the leases standard, it brings much-needed insight in the true leverage of companies,” he added. “While only a minority of companies will be significantly affected by the lease standards, we are aware that this change will not be without cost to preparers.”
He noted that the IASB and FASB have already made some “pragmatic” decisions to keep such costs to a minimum, including the exclusion of short-term leases and variable lease payments. Last month, the boards also decided to include guidance on how to use a portfolio approach for leases.
However, he acknowledged that the two boards have some lingering disagreements over the leasing standards.
“While we have reached agreement with the FASB that most leases need to be put on the balance sheet, we have less agreement about how the lease liability should be run off in the income statement,” said Hoogervorst. “I will not bore you with the details, but more work needs to be done. In the next couple of months we should be able to finalize our work.”
Hoogervorst gave his speech only a day after the IASB and FASB jointly announced the release of their revenue recognition standard, which they have been working for over a decade to converge (see FASB and IASB Release Revenue Recognition Standard).
Hoogervorst called it the “jewel in the crown of convergence,” pointing out that it will affect every entity’s financial statements. He told the Singapore audience that the new rev rec standard would address most of the concerns regarding the “percentage of completion” method of accounting that is commonly used in the construction sector in some Asian countries, and he pledged to continue to work on the transition to the new standards through a transition resource group that the IASB and FASB are establishing.
“The new revenue standard replaces American standards that contain thousands of pages of application guidance and IFRS standards that provide too little guidance,” said Hoogervorst. “The fact that we managed to stay converged with our colleagues of the FASB is very important, and we intend to stay converged in the future. That is one of the reasons why we created a joint transition group, which will guide preparers in the implementation of the new revenue standard. We expect the transition group to answer the vast majority of the questions that inevitably come up with market participants. Should more fundamental questions be raised, they will be referred to the boards.”