New lease standard could destabilise corporate balance sheets

Proposed lease accounting rules could destablise the balance sheets of major
retailers and airlines which could be forced to bring billions of pounds in
liabilities on to their balance sheets.

The new rules, released today by the International Accounting Standards Board
(IASB), aim to demystify lease accounting and could force major lessees and
lessors to recognise greater liabilities in their published accounts.

The rules would likely hit the retail sector hardest with ten of the most
well known supermarket chains – including Tesco, Sainsbury’s and Morrisons –
holding an estimated £45bn in lease commitments, according to a study of their
published accounts.

Retailers are major lease-holders owing to the property they hold. Present
accounting rules however offer them flexibility in how they record lease
contracts.

The IASB hopes to tighten the rules and bring all leases on to the balance
sheet in order to provide investors with a more accurate financial picture.

For some, this could wipe as much as 25% off pre-tax profits according to
internally modeling cited by a Big Four auditor.

Julian Rose, head of asset finance at UK industry group the Finance &
Leasing Association said retailers will be significantly affected under the
proposed rules. He also cited airlines, rail operators and other transportation
businesses as others likely affected by the proposed rules.

“If there is a need to do this, it is very important that the rules companies
need to follow are as simple as possible,” he said.

Veronica Poole, audit partner with Deloitte said the standard could have a
knock on effect on company’s key performance indicators.

“The result could be lower asset turn-over ratios, lower return on capital
and an increase in debt-to-equity ratios which could impact borrowing capacity
or compliance with loan covenants,” she said.

“It would also typically raise the EBITDA (earnings before interest, taxes,
depreciation and amortisation) figure beloved by analysts.”

Giles David, chief financial officer, with high street retailer Brighthouse
said he does not expect his new-look balance sheet to affect the attitudes of
his investors.

“I’m not anticipating their view of the business performance to change,” he
said.

“We are a privately owned business we have a sophisticated investors. We
don’t broadcast our results, so there for we are able to have very decent
conversations and we work very hard in being transparent.”

Mark Venus, global head of accounts payable at BNP Paribas and also a member
of Leaseurope’s accounting committee, said the IASB had paid lip service to cost
-benefit considerations in its proposals.

“This is very visible in the draft standard that has just come out,” he said.

“The proposals are more than 100 pages in length only a handful of paragraphs
deal with cost – benefit analysis”.

Leasegroup estimated the European leasing industry was worth about €209 bn
(£134bn) in 2009.

David Tweedie, chairman of the International Accounting Standard Board, said
the proposals would result in better and more complete financial reporting
information available to investors.

Further Reading:

IASB
and US FASB publish proposals to improve the financial reporting of leases