From the December-January 2011 issue of Treasury & Risk magazine

Leases on the Books?

Half a trillion dollars. That's how much Goldman Sachs analysts claim could be added to corporate balance sheets if a proposed change in lease accounting is approved by the Financial Accounting Standards Board. The proposal involves the accounting for some $640 billion worth of leases at companies worldwide, but it has received surprisingly little attention considering its likely impact, both on companies that lease substantial amounts of equipment and on equipment leasing firms. The International Accounting Standards Board is considering a similar change.

Currently, most leases are classified as operating leases and do not show up on balance sheets. For example, airlines don't record leased aircraft as assets on their balance sheets, and oil companies don't include leased oil rigs. Nor do companies list lease payment obligations as liabilities. They provide data on leases in footnotes to the balance sheet.

The FASB wants all assets and liabilities arising from lease contracts to show up on balance sheets.

Under the FASB proposal, companies would include operating leases as a separate asset, along with property, plant and equipment. Lease payment obligations would be recognized as a liability and carried at amortized cost, with both the asset and liability amounts based on the present value of expected payments over the term of the lease.

The impact of the change, which if approved by the board would go into effect sometime in 2011, would be widespread, since virtually every major company leases equipment.

"Even though in some ways the proposed rule change is just catching up with what is happening already as companies explain these leases in footnotes," says Michael Moran, vice president of the Goldman Sachs Global Markets Institute, "the numbers involved are so huge, it's not clear how less sophisticated investors will react to seeing the much higher liability figures on balance sheets."

Sue Liu, manager for financial and management accounting at Hong Kong-based Cathay Pacific Airways, says that requiring airlines to account for operating leases in the same manner as they do financial leases would give investors a false picture.

"Management does not necessarily enter into operating leases as a means of financing, but as a means of managing exposure to residual value and to benefit from the flexibility that these operating leases provide," Liu says.

Instead of clarifying a company's financial picture, the change would force analysts and banks to "strip out" the impact of leasing to determine an airline's real leverage, she adds.

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