- From 1976 through 2018,
the accounting for leases was among the most deceptive
accounting practices in existence.
For example, in 2016 alone,
these lease accounting standards allowed
publicly traded companies around the world
to avoid reporting three trillion dollars in obligations
under non-cancelable lease contracts.
The lease accounting rules were changed starting in 2019.
Let's discuss the old bad rules, the new better rules,
and the financial statement impact of both.
Now, before we go any further,
let's define what we mean by a lease.
A lease is a contract specifying the terms
under which the owner of some property
transfers the right to use the property to someone else,
without transferring legal ownership.
Here's an example.
Let's say that I am a package delivery company, like FedEx.
I need the use of an airport warehouse
for the next 10 years.
Rather than buying the warehouse from its legal owner,
I can lease the warehouse under a contract
that gives me exclusive right to use that warehouse
for the next 10 years.
I don't legally own the warehouse,
but I do have the legal right to use the warehouse.
That seems simple enough,
but the incredibly controversial
accounting question is this.
During the 10 year period of the lease,
should I, the user of the warehouse,
report the warehouse as an asset on my balance sheet?
And when I sign the 10 year non-cancelable lease contract,
should I report on my balance sheet the value
of the obligation to make those future contractual payments?
Historically, a major challenge for accountants has been
to establish accounting standards that prevent companies
from using the legal form of a lease
to avoid recognizing future payment obligations
as a liability.
This is called off-balance sheet financing.
The phrase itself sounds pretty unsavory.
Off-balance sheet financing.
The very purpose of the balance sheet
is to report the sources of a company's financing.
In 2016, the FASB in the United States,
and the IASB in London,
adopted a new lease accounting rule mandating
that all longterm leases be reported on the balance sheet.
Both the leased assets and the associated obligation
to make the lease payments.
This rule eliminates the off-balance sheet financing aspect
of the old controversial lease accounting.
This rule goes into affect in the United States
starting in the year 2019.
The impact?
Trillions of dollars in lease obligations
previously excluded from the balance sheet
will now go on the balance sheets
of companies around the world.
This new lease accounting rule treats the lease arrangement
exactly the same as if the company had gone to a bank
and borrowed the money, which was then used to purchase
the exclusive right to use the asset
during the length of the lease.
So lease financing is now on the balance sheet.
In July 2018, LeaseAccelerator,
a leading provider of lease accounting software,
published a list of the publicly traded US companies
with the largest unrecorded lease obligations
that the new lease accounting rule
will now put on the companies' balance sheets.
Because retail companies have historically leased
many of their store and distribution facilities,
there are many retailers in the top 20.
The large banks are in the top 20,
because they usually lease their locations.
Another industry with a long history
of leasing important assets is the airline industry.
For American Airlines, the new rule will put
on the balance sheet an additional nine billion dollars
in facilities, airplanes and other equipment
used under previously unreported lease arrangements.
Yep, the new lease accounting rules
will substantially impact the reported financial numbers
and resulting financial ratios for many, many companies.