Accounting changes could escalate occupier debt

10 December 2009

A joint US and European proposal to standardise the way occupiers’ operating leases are treated in company accounts will dramatically increase the level of corporate debt held by many FTSE companies.

The proposal by the European wide International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) will see balance sheets balloon dramatically as operating leases will cease to be off-balance sheet. The principal reason for the proposed changes is the classification between finance leases (on-balance sheet) and operating leases (off-balance sheet). Depending on the classification adopted, very similar transactions can be accounted for very differently. This reduces comparability for users of financial statements.
According to Ian Howarth, Head of National Business Advisory Services at Lambert Smith Hampton (LSH), the proposed changes will remove some of the benefits enjoyed by undertaking some transactions such as the sale and leaseback of assets. If the proposals are introduced, both historic and future sale and leaseback transactions will be shown on balance sheet. This may impact financial performance measures such as return on assets, debt to equity ratios and possibly loan covenants.
Howarth said: “In the future, occupiers will need to assess how the proposed changes will impact the way they hold and occupy real estate. The decision on whether to lease versus buy; the preferred length of leases, and whether to incorporate breaks, should be carefully considered as the proposed Standard is currently planned for 2011.”
LSH's 'Operating leases' briefing note highlights the proposed changes and identifies what the potential impacts may be, particularly for corporate occupiers of real estate.
To download LSH’s latest briefing note on the proposed accounting changes for operating leases go to http://www.lsh.co.uk/images/cms/operating_leases_corporate2.pdf