Fitch Ratings is warning that proposed changes to the international rules on accounting for leases could give companies an incentive to change the way lease deals are structured so they remain off balance sheet, making it harder to provide accurate comparisons for credit rating purposes.
The new proposals, which are part of a converged project on leases between the International Accounting Standards Board (IASB) and US Financial Accounting Standards Board (FASB), will remove the advantageous off-balance sheet treatment that operating leases currently offer.
Instead, the new standards require that all leases with terms of over 12 months are brought on-balance sheet. The boards issued a revised exposure draft on the changes to the accounting rules earlier this year which is open for comment until 13 September 2013.
Fitch says the new standards will give a better indication of the economic substance of leases, and will make analysis easier as the ratings agency views longer-term leases as debt-like obligations and routinely adjust debt metrics to enable comparison of different financing models.
However, Fitch cautions that some companies may seek to re-arrange leases to avoid including them on the balance sheet in this way. Options include switching to a lease with a term of less than 12 months, although the rules attempt to address this by including renewal options within the 12 month period. Companies may also try to replace leases with contracts that give them access to a desired service without giving them rights over a specific asset.
Fitch says it is vital that information about cash rentals and the nature of leased assets remains available to ensure adjustments can be made if necessary. If companies do succeed in keeping any leases of longer-term assets off the balance sheet, it says robust disclosure will be essential so that analysts can still adjust key metrics.
The new standards are not likely to become effective before 2017, and Fitch has published a special report New Global Proposals to Reshape Lease Accounting explaining how it assess leases in its analysis and how it will approach the proposed changes.
For full coverage of reforms of international lease accounting rules, see related articles below.
