Time passes

Accountants gain new life on leases

Leases may finally be going on balance sheets. If all goes well, an draft proposal, jointly published on Thursday by American and international rule-making bodies, will lead to mandatory standards by the end of 2014. This latest effort to improve accounting for leases officially began in 2006. As bad as it sounds that it took almost a decade to purge financial statements of an obvious economic fiction, the saga is actually much longer-running. The first official suggestion that leases are much more like purchases than rentals dates back to 1949.

The basic issue is that legal ownership can be a poor description of economic and financial reality. A leased airplane may not technically belong to an airline, but the airline uses it as if it does. In practice, the airline has an asset and a corresponding financial liability. Lease payments include some implicit interest expense.

Accountants are trying to look through the contract terms to the economic substance, but it's not easy. The rules currently in place require financial leases to be treated as capitalised assets, but allow companies to treat many leases as "operating", although analysts often use footnotes to do their own capitalisation.

The new rule recognises more leases as actual loans, so some companies will look more leveraged. It also divides leases into two types, either property or equipment, recognising that the value of land does not depreciate with use. Despite its 339 pages, the new draft marks a retreat from earlier ambitions. Plans to capture the precise economic reality of variable payments and renewal options were abandoned.

Why has is taken so long for accountants to do something so obvious, and even then not to do it completely? For one thing, many accountants feel uneasy interpreting the economic meaning of contracts. Also, while the principle that leases are often debt-financed assets, not rentals, is straightforward, it is not clear how to calculate what these assets are worth. Finally, accountants have had trouble standing up to clients who want to show low debts to lenders and equity investors. Considering the obstacles, a decade, or seven, is not that long to wait.