Company balance sheets could swell by trillions of dollars under an international plan issued on Thursday by two accounting bodies to show more clearly the cost of leasing everything from photocopiers to property.
If the revised draft from the International Accounting Standards Board and the U.S. Financial Accounting Standards Board is adopted, tens of thousands of firms worldwide will have to add leases of a year or longer to their balance sheets.
The proposals, out for public consultation through mid-September, signal the two board’s refusal to back down further in the face of opposition from companies, which fear that bigger balance sheets would make them look more indebted and bump up their borrowing costs.
Most leases are currently only mentioned in the footnotes of corporate financial statements.
“Obviously, this standard is not a very popular one,” IASB chief Hans Hoogervorst said in a conference call. “Generally, companies like off-balance-sheet financing” and the standard will put an end to a major part of it, he said.
At least one politician swiftly condemned the plan.
Representative Brad Sherman, a Democrat of California, who serves on the U.S. House of Representative Financial Services Committee, said the plan would “substantially harm small businesses and throw a real monkey wrench in the real estate economy.
Sherman, who spoke at a Securities and Exchange Commission hearing on a wide range of issues, urged the SEC to intervene in the accounting proposal.
The reform, which might not take effect until 2016 in view of the corporate opposition, is part of efforts to align international and U.S. book-keeping rules so markets can compare firms more easily and get a clearer view of their liabilities.
“At present, investors must take an educated guess to determine the hidden leverage from leasing by using basic disclosures in financial statements and applying arbitrary multiples,” Hoogervorst said in a statement accompanying the draft.
More clarity on lease liabilities could break some corporations’ loan covenants, which are linked to balance sheet size limits, or even trigger credit rating changes, accounting experts say.
The sums involved are huge.
In Europe, outstanding leases totalled $928 billion in 2011, according to Leaseurope, which represents over 90 percent of the European leasing market.
In the United States, companies have about $1.5 trillion of operating leases, according to a study commissioned by the U.S. Chamber of Commerce and real estate groups.
“Leases represent valuable rights and obligations that belong on the balance sheet,” FASB Chairman Leslie Seidman said on the call.
The standard passed FASB by a 4-3 vote. One question is whether that slim majority will hold after Seidman’s term ends in June. A seventh board member has not yet been named.
The two boards have backed down from their original plan to treat all leases in the same way, and confirmed on Thursday that they would pursue a “dual-track” approach to distinguish between property and equipment leases, as reported by Reuters.
Instead of the current “straight line” rental expense that stays the same throughout the life of a lease, the new standard would treat most equipment leases like loans, with the highest costs in the earlier years.
Property leases would still be treated as a straight line expense, but there is no change to the basic principle that all types of leases longer than a year must be put on balance sheets.
Industry bodies had been hoping for further concessions.
“The accounting has changed in a way that’s incomprehensible, so people are going to have to keep two sets of records,” Bill Bosco, a consultant for the U.S. Equipment Leasing and Finance Association, said in an interview.
Equipment leases will be lumped together, when legally they are not all the same, and some should have straight line expense, Bosco said.
The standard “will not bring about a sufficient improvement in financial reporting to warrant the cost and complexity of changing the existing approach,” Leaseurope said in a statement on Thursday.
Deloitte, KPMG and Ernst & Young, three of the world’s top four accounting firms, said the changes would be complex and costly to introduce. The top 50 companies in Britain alone disclose leases in excess of 100 billion pounds, Deloitte said.
“Most leases in the UK and United States will be captured by these proposals. Companies have thousands of leases and they will have to go through them lease by lease,” said Veronica Poole, Deloitte UK’s national head of accounting.
The big debate will focus on whether the rule change is needed at all rather than how to tweak the details.
The boards expect to issue a final standard in 2014, he said.