NEW ACCOUNTING RULES requiring all leases with terms of over 12 months to be brought onto the balance sheet could result in companies changing the way lease deals are structured to keep them off their books, rating agency Fitch has warned.
In May, international and US accounting rulemakers published proposals that will require companies to account for the assets and liabilities arising from all but the shortest leases on their balance sheet. While the new rules will better reflect the economic substance of lease arrangements, Fitch believes there are several ways that companies might try to structure arrangements to keep leases off the balance sheet.
These include switching to lease term with less than 12 months, and/or replacing leases with contracts that provide access to a desired service without giving them rights over a specific asset. Under the rules, service contracts and leases of 12 months or less will remain off-balance sheet, though they attempt limit the appeal of the exemption by including renewal options within the 12 month period.
Since leases are defined as providing an identified asset that the lessee controls, these service contracts could remain off-balance sheet, which could be simply achieved by giving the lessor the right to substitute an asset at will for a similar one.
“If companies did manage to keep any leases of longer-term assets off the balance sheet, robust disclosure will be essential so that analysts can still adjust key metrics,” Fitch said in its special report: New Global Proposals to Reshape Lease Accounting.
The project to bring all long-term leases onto company balance sheets has been rumbling on since August 2010, when the IASB, responsible for IFRS, and US standard setter FASB, put forward original proposals that were rejected by constituents. These have since been refined with much of the complexity taken out, though there is still some dissent from the profession over the shape of the rules.
One concern held by the rating agency is that information relating to lease contracts may not be consistently disclosed. Disclosures of non-lease components of a contract containing a lease appear to be optional, while short-term leases are omitted and contracts deemed not to be leases at all will be similarly excluded.
“Some disclosures, such as the terms and conditions of extension options, while clearly useful for material leases, may prove impractical to provide for entities with heterogeneous smaller lease balances. In response bland, “boilerplate” text might be given,” Fitch said.
“There is a risk that transparency is impaired. Indeed, not all of the rentals currently shown in the operating lease table may appear in the new lease disclosures. If significant, this could make analysis more difficult.”
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