Concerns Building for Pending Lease-Accounting Changes

Study finds proposal would raise costs, depress valuations, and increase volatility

Most machine tool builders and distributors, as well as U.S. machine shops and other domestic manufacturers, are wary about the start of 2012, as a series of federal tax law changes are due to erode the equipment-purchase incentives available to them for several years. But, the accounting changes may not be confined to purchases of production equipment: the Equipment Leasing and Finance Foundation has released a study (free download) of a proposal to change the way leases are accounted on corporate balance sheets, and said it “could have a widespread, detrimental impact on the U.S. economy, triggering a $10z billion reduction in gross domestic product (GDP) and 60,000 fewer jobs by 2016.”

The Foundation is an affiliate of the Equipment Leasing and Financing Association, a trade group for companies in the $628-billion equipment finance sector, which includes financial services companies and manufacturers. It commissioned IHS Global Insight to complete the study, “Economic Impacts of the Proposed Changes to Lease Accounting Standards,” as an independent source to substantiate how the complex proposal might affect an already fragile U.S. economy.

Here’s the concern: Currently, operating leases are not reported on companies’ balance sheets; they are reported in footnotes to companies’ financial statements. The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have proposed lease-accounting changes that would require companies to record virtually all leases on their balance sheets.

“Leases account for hundreds of billions of dollars in transactions annually, contributing not only to businesses’ success, but also to U.S. economic growth, manufacturing and jobs,” stated William G. Sutton, CAE, ELFA’s president and CEO. “It is essential that the Boards carefully consider comprehensive public input and comment before finalizing their proposal to ensure a workable lease accounting standard.”

FASB and IASB plan to issue a new draft of their proposal by early April 2012, to be followed by a 120-day comment period.

ELFA said the IHS study of financial data finds that the proposal would depress company profits, economic growth, and financial stability. It indicated many businesses do not object to having to record leases on their books, but they object to how the proposal would require them to account for and report lease transactions: their argument is that aspects of the proposal are too complex, impose burdensome regulations, and do not reflect the economics of the lease transaction accurately.

Among the specific points made by the IHS study, ELFA said the accounting changes would add an estimated $2 trillion to U.S. companies’ balance sheets (an 11% increase in total debt), and higher debt-to-equity ratios would increase volatility in corporate earnings, and impair companies’ ability to secure financing, among other consequences.

Also, it found that U.S. companies could experience a 2.4% reduction in pre-tax net income in the first year if the new accounting rule is instituted.

In addition, it said the cost of debt could rise because of higher interest rates (every 50 basis-point increase would trigger a $10 billion reduction in GDP and 60,000 fewer jobs by 2016, ELFA cited); and it predicted the proposal would cause a permanent, $96-billion reduction in the net worth of U.S. companies.

ELFA said several specific components of the proposal, including lower earning, reduced capital, and deferred tax assets for companies that lease because it would require companies that lease to front-load the costs of those leases rather than spread them over the life of the lease. It also documented that implementation would be costly; that the changes would eliminate many financing options now available, and depress credit ratings.

There would also be unintended consequences, ELFA said, including triggering existing debt and lease covenants, and increasing lease costs.

ELFA called on FASB and IASB to include four considerations in their revised lease accounting rules, and encouraged businesses that lease to submit a comment to the Boards in support of these considerations: recognize the different types of leases (capital leases and operating leases) and “retain straight-line expense recognition for the leases that are now considered operating leases.”

It also wants the Boards to offer relief from the compliance burden; to preserve the netting in leveraged lease accounting that reduces leasing costs; and to preserve “lease gross profit” recognition that allows captive companies to charge lower rates.

“There are many benefits to leasing, and the primary reasons to lease equipment will remain intact under the lease accounting proposals, from maintaining cash flow, to preserving capital, to obtaining flexible financial solutions, to avoiding obsolescence,” said ELFA chairman Crit DeMent, chairman and CEO of LEAF Commercial Capital Inc. “However, the financial burdens imposed by the standards under consideration are the last thing American businesses already struggling to regain their footing in a challenging economic landscape need. We urge the Boards to reconsider some of the more onerous and burdensome proposals under consideration to minimize the negative financial impact on businesses.”

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