The Spirit of Accounting

One of us hates admitting that he remembers when the Financial Accounting Standards Board tackled leases in the 1970s. The board's noble goal was to eliminate off-balance-sheet financing by forcing lessees to capitalize more leases. However, its efforts evoked preposterous propaganda from opponents who predicted higher interest costs, fewer sources of financing, and annihilation of the leasing industry. They just didn't grasp that the issue at stake was whether financial statements are more useful if they're complete and truthful, instead of deficient and misleading.

Unfortunately, FASB compromised and produced bright-line criteria, including one that requires capitalization if the lease term equals or exceeds 75 percent of the property's predicted life. Instead of forcing more liabilities onto balance sheets, the criteria are actually guidelines that help lessees, lessors and auditors keep them off. By caving in, FASB allowed OBSF to flourish for 40 more years.


Once again, FASB wants to implement substantive reform to eradicate this transparent deception. Like actors in a remake of a really bad old movie, another generation of champions for deceit is already rolling out the same discredited arguments that are just as ill-conceived and unpersuasive as they were four decades ago. One example is a vacuous May 2012 letter from a 60-member bipartisan group in Congress who didn't even wait for an exposure draft.

As near as we can tell, the two ringleaders and the 58 others are in the hip pockets of lessors and lessees who fear that truth will put them in the tank.


Brad Sherman, D-Calif., and John Campbell, R-Calif., two House members from the Los Angeles area, are taking the lead. Their release trumpets that they're both CPAs, as if that fact guarantees that their arguments are sound. It doesn't.

We believe CPAs should be trusted protectors of the truth. In contrast, we have learned to trust members of Congress to spin the truth mercilessly. It appears this pair has been in Washington long enough to turn to the dark side. You'll soon see what we mean.

Specifically, they sent a letter in May to Leslie Seidman, FASB's chair, with copies to the International Accounting Standards Board's Hans Hoogervorst and the Securities and Exchange Commission's Mary Schapiro (carelessly omitting the "c" in Mary's last name). We're focusing on four obvious falsehoods that are flaunted on Sherman's Web site.


Their first salvo repeats this forty-year old cliche: "If enacted, [the new standard] could have disastrous consequences for American businesses and the real estate industry." False!

We find no disaster in a standard that shuts down illegitimate businesses that have prospered while engaging in or facilitating deceptive financial reporting. Instead, the real disaster is that so much OBSF is taking place.

We would applaud a new standard that would encourage managers to analyze their lease-or-buy decisions the old-fashioned way, by using expected cash outflows, instead of blindly paying any price to avoid reporting lease-related assets and liabilities.

As for the real estate magnates the congressmen are fronting for (see below), their opposition is based on the fear that they'll have to compete for tenants using lower rent and better customer service, instead of helping them commit financial reporting fraud. That, too, would not be disastrous.


Sherman proudly claims: "An independent study estimated that ... [capitalizing leases] will add over $1.1 trillion in leased real estate assets and liabilities onto balance sheets." Balderdash.

Of course, the best response to this finding (which was pinched from an SEC report from several years ago) would acknowledge that today's horrible accounting standards allow managers to avoid recognizing $1.1 trillion of real-estate-related liabilities (and another $0.4 trillion for personal property leases) on their balance sheets. That's 1.5 trillion reasons for FASB to press ahead with reform, instead of freezing the status quo.

Beside that point, the allegedly independent report (produced by a small Sacramento firm, Chang & Adams Consulting) openly declared it was sponsored by these entities: the U.S. Chamber of Commerce, the Real Estate Roundtable, the National Association of Industrial and Office Properties, the Commercial Real Estate Development Association, the NAIOP Inland Empire Chapter, the NAIOP Southern California Chapter, the National Association of Realtors, and Building Owners and Managers Association International.

No one, absolutely no one, with a lick of brains or a gram of integrity would hope to get away with characterizing this report as "independent." As the congressmen surely know, it lacks credibility because it was paid for by lessors who want to continue helping lessees employ OBSF. We suggest there would be more independence in a report on the positive effects of dietary cholesterol sponsored by bacon makers and egg farmers.


Sherman disingenuously claims: "Capitalizing ... leases will throw off debt-to-capital ratios, ruin credit ratings and force many companies to pay higher interest rates." Bullfeathers!

For this damage to occur, these two outrageous premises would have to be true: Nominal capital ratios are taken at face value by investors, creditors and credit rating agencies, and higher interest rates are bad.

The bald-faced spin is sickening. Instead of using their CPA status to build trust, Sherman and Campbell are besmirching their reputations (and yours and ours) by making obviously indefensible statements.

For starters, OBSF through leasing is the financial world's worst-kept secret. Because any banker or investor worth their salt already factors in the omitted lease debt, actually reporting it will simply reduce their effort and risk, thus encouraging them to invest or lend more comfortably.

Further, any credit ratings based solely on reported liabilities would be woefully deficient and undependable. Therefore, actually recognizing lease obligations would not "ruin" them, but make them easier to prepare and more useful to boot.

As for rates, we spot a paradox. First, interest expense for borrowers (lessees) is interest income for lenders (lessors). If today's rates are low because lenders are innocently unaware that borrowers' balance sheets don't include all liabilities, then they aren't adequately compensated for their credit risk. Second, at their behest, these 60 members of Congress are advocating a public policy that deliberately misleading financial statements should be used to keep lessors' interest income artificially low. We're inclined to think the lessors who supported the study haven't figured that one out.

In contrast to Sherman's simplistic claim, capitalization should actually encourage interest rates to go down, not up, because lenders will face less risk. In addition, managers who would otherwise acquire assets by leasing won't be tempted to pay higher interest rates to avoid recognizing debt on their balance sheets.


Sherman tries to paint this scary picture: "Most companies will naturally try to reduce the size of their leases by shortening leasing terms, which will increase costs for real estate owners and managers forced to renegotiate complex leases every six or eight months." How revealing!

First, Sherman assumes that a new standard would have a loophole that would allow ultra-short-term leases to produce OBSF. Although FASB and the IASB started to go there a year ago, we don't think it's going to happen.

Second, we notice with grave disappointment that Sherman considers the unethical act of publishing intentional misrepresentations to be "natural" and worthy of preserving.

Third, his lament on behalf of his sponsors is crocodile tears. Lessors and lessees are engaged in repugnant and reprehensible behavior. Who cares how much it costs these crooks to commit their crimes?


Will duplicitous congressional support and these phony dire forecasts cause FASB to cower and allow another weak standard to contaminate financial reports for two more generations? Good grief, we hope not! But we're not just crossing our fingers. There are two good reasons the board will be strong.

First, Sarbanes-Oxley reformed FASB's funding to eliminate vulnerability to threats from corporate managers. Lessors and lessees can huff and puff all they want, but they won't prevail.

Second, the current board is more sophisticated in understanding the relationship between reality and spurious financial statement representations. Consider these words: "The role of financial reporting in the economy is to provide information that is useful in making business and economic decisions, not to determine what those decisions should be. While new accounting standards may change the way companies report their financial condition, the standards do not create or change the underlying condition itself." This higher calling was not uttered by two radical accounting profs in a column. Instead, it was proclaimed by FASB chair Leslie Seidman in a speech on June 4, 2012.

As a result, we're confident that the board members won't swallow these and other bogus claims that capitalizing all leases will damage the economy, because they understand that the capital markets already know that large lease liabilities exist. Members also comprehend that they are responsible for compelling statement preparers to reveal the truth so users aren't forced to guess.

The board gets it: Lease debt is debt and should be reported for all to see.


Although we hope this column will somehow shock the 60 congressmen and their sponsors into realizing that their letter did nothing but put their unethical behavior on full display, we didn't write this column just to refute them. We have hit them hard because they are merely the early birds among a large flock of unscrupulous hucksters. Let them all know that FASB will dismiss these comments and others like them as irrelevant and insignificant because they are biased and untrue.

Bottom line, we're confident bullying won't work like it did 40 years ago. Heaven help the capital markets if we're wrong.

Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at paulandpaul@qfr.biz.