Will new lease accounting rules destroy the economy?

Two authors submitted similar articles about lease accounting at around the same time, so I felt compelled to publish both:


Smile0523 writes:

http://www.accountingtoday.com/news/Lease-Accounting-Changes-Economy-61071-1.html

According to this article, FASB has proposed new changes to lease accounting that could have a detrimental impact on the U.S. economy. Current findings show that if these new lease accounting standards are passed, it could trigger a $10 billion reduction in gross domestic product and 60,000 fewer jobs by 2016. 


The proposed changes attempt to account for all leases on the balance sheets of companies, while currently operating leases are only disclosed in footnotes. The study conducted by the Equipment Leasing & Finance Foundation also notes that due to this change, companies would trigger about $2 trillion in debt on their balance sheet. They worry that this higher debt-to-equity ratio will hurt many companies by making them appear more volatile. 


What do you think?


Is this an issue that could greatly impact our economy, therefore, they should not change a thing? 


Or is this proposal just adding debt and volatility to the financial statements that already exists, it was just not as apparent because it was previously masked in footnotes? 


Spfahey writes:

In a recent study, conducted by information and analysis provider IHS, they look at the implications of what would happen if we switch our accounting standards to include leasing activity on the balance sheet. Some of the key concerns that were raised were that:
“U.S. companies would add an estimated $2 trillion to their balance sheets–an 11% increase in total debt. Higher debt-to-equity ratios can increase volatility in corporate earnings and companies’ ability to secure financing, among other consequences.”
“U.S. companies could experience a 2.4% reduction in pre-tax net income in the first year of the new accounting rule.”
“The cost of debt could rise through higher interest rates–every 50 basis point increase would trigger a $10 billion reduction in GDP and 60,000 fewer jobs by 2016.”
“The proposal would cause a permanent reduction of $96 billion in the equity–net worth–of U.S. companies, a sizable erosion of shareholder ownership value.”
Currently lease activity is disclosed in the footnotes section of the financial statements and the reasoning to get them on the balance sheet would be to get a clearer understanding of the entity, but I think this is a problem with the footnotes in general that the information provided is not generally accessible and comparable.
Personally I think this may be an unnecessary move. Making the footnotes section more transparent is the goal of XBRL reporting and ultimately accounting for leases that don’t hit the balance sheet would be tagged and easy to understand without having to have a large impact of adding trillions to U.S company balance sheets. 
Is there are a strong argument to implement the change? 
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About Mark P. Holtzman

Chair of Accounting Department at Seton Hall University. PhD from The University of Texas at Austin. Worked at Deloitte's New York Office. BSBA from Hofstra University.

2 comments

  1. I think all this would do is to expose an underlying existing issue rather than create one. In other words, it’s the equivalent of exposing all the dirt and dust that been hidden under the rug for years rather than “creating” new dirt. I see something positive and something negative coming out of this:Positive aspect:Lease accounting is a touchy and complex issue which has been on the discussion table for years (I believe that under IFRS, lease activity will have to be included in the balance sheet section anyways). Assuming that US companies will adopt IFRS in the near future, including lease activity in the balance sheet section will actually help with the transition.Negative Aspect:Current interest rates and terms for loans are calculated based on existing debt-to-equity ratios and pre-tax net income which does not include lease activity in its balance sheet and P&L. If all the sudden, those ratios change because of the way things are calculated –including lease activity in a balance sheet for instance, then interest rates and loan terms would get affected by an artificial adjustment, while in reality nothing has changed. Since the US economy is not at its peak, this may not be the best time to implement such an artificial adjustment.This is a complicated issue without an easy answer, and I see benefits in both changing the rules and keeping them the same. I think that for now, the best solution would be to make footnotes should be more transparent and include more detailed information. That sort of adjustment would have less of a ripple effect on interest rates and loan terms.

  2. I agree with blackswan87 if this issue will be brought up through the implementation of IFRS standards in the near future, why not implement these changes? I can understand the concern for an increase in debt and the negative impact on companies' financials, but shouldn't this be exposed anyway? Especially if internationally companies are already required to follow this method of lease accounting if they follow the IFRS standards. More transparency in footnotes could be a temporary solution, but shouldn't we be aiming to permanently improve our methods of accounting? I think we should favour a permanent solution, even if it might not be the most favoured one.

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