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New Lease Accounting Rules Remain Mired in Minutia

Companies Find it Difficult To Prepare as International Panel Has Moved Even Slower In Finalizing New Accounting Standards
January 29, 2014
We know sweeping changes are coming to how leases are treated under accounting rules. We just don't know their full scope, or when they will go into effect.

International rule makers have now set March 2014 as the next date for making a decision on sweeping accounting guideline changes that would require companies to capitalize and make extensive disclosures about their real estate and equipment leases.

However, nearly four years of public debate, outreach and changes to proposals that would for the first time require lessees and lessors to account for leases on their balance sheets have brought little clarity for companies.

The new standards will require companies to recognize on their balance sheets all assets and liabilities resulting from leases of more than 12 months in duration, based on the present value of the lease payments.

Not surprising given the delays and push back from industry groups, companies say they are unprepared to implement the new accounting rules, according to a recent survey released by Deloitte. Almost 80% of surveyed executives see difficulty in complying with the standard -- and companies are no more prepared for the new rules than they were two years ago when Deloitte conducted a similar study.

As proposed in the most recent "exposure draft," the standard will require both lessors and lessees to list the assets and liabilities resulting from all longer term leases.

Critics -- including members of the two panels charged with writing the new rules -- say the latest proposal to use a formula to distinguish between equipment and property leases is far too complex.

The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), acknowledged the concerns on Jan. 23, discussing the possibility of an approach that would scale back the requirements for companies which lease equipment or real estate to other companies, and refocus their efforts on simplifying the model for tenants that lease commercial property and other lessees.

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Such measures could include a possible exception for shorter term leases. CRE investment groups have fretted that as drafted, the standard could result in companies avoiding longer leases in favor of shorter terms in order to dodge the requirements.

A decision on changes to the current proposal, or "exposure draft," is scheduled for the next FASB/IASB meeting in March. The panels and their staffs are sorting through a litany of concerns from commercial real estate, equipment leasing firms and companies ranging from large multinational corporations to small businesses that would potentially be affected by the new reporting requirements.

Interestingly, the Deloitte survey indicates that while the boards are contemplating scaling back the rule changes for lessors, the accounting impact appears to be more severe for lessees.

More than half of responding executives, 58%, expect a significant impact on their balance sheet, and 53% expect an impact on financial disclosures. Nearly half cited an effect on their companies' financial ratios, with significant effects on debt-to-equity (71%) and return on assets (52%) cited by these respondents. Lessees were more likely to report these impacts.

"It's clear that lessees are increasingly forecasting difficulties complying with the new standard," said Scott Hileman, director, Deloitte Transactions and Business Analytics LLP.

The survey showed that just 1% of real estate lessees are "extremely" prepared to comply in 2013, down from 9% in 2011.

About 62% of large companies and 49% of smaller companies believe that the new rules would significantly challenge the adequacy of their IT systems, and 55% of large companies and 33% of small firms said that creating an electronic inventory of real estate leases would be a significant challenge.

"Large companies typically hold big, complex lease portfolios, which are going to present a significant data issue," said David Swanson, senior manager with Deloitte. "We are beginning to see more realism from companies on the scale of this challenge, but with roughly 40% of companies planning to employ a temporary IT solution during implementation, there remains a lot of work to do on upgrades or installing new systems for the long term."

More than half believe implementation will require more than one year, which is a significant 33% increase from the 2011 survey.

Hileman said the regression in some cases on compliance since 2011 is partly a result of the uncertainty regarding the new standard.

The good news, if there's any to be found, is that if the new lease accounting standard is issued this year, its expected effective date would be no sooner than 2017.
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