Tuesday, November 13, 2012

IASB Chair Calls for Transparency in Lease Accounting

IASB Chair Hans Hoogervorst called on securities regulators and national accounting standard-setters to support the IASB’s joint efforts with FASB to bring transparency to lease accounting. In remarks at the London School of Economics, Mr. Hoogervorst highlighted the extent to which lease arrangements have become one of the greatest sources of off balance sheet financing for many companies. Companies favor off-balance sheet financing since it masks the true extent of their leverage

Specifically mentioning the earlier battles over stock option expensing and bringing pension liabilities on balance sheet, he explained how efforts to bring greater transparency in financial reporting often met strong resistance and lobbying from vested interests, but that in time those enhancements became accepted as normal business practice. He emphasized that the efforts of the IASB and FASB to shed light on hidden leverage should be warmly welcomed around the world. This is an ongoing and uphill battle for accounting standard setters, he added.

The vast majority of lease contracts are not recorded on the balance sheet, noted the IASB Chair, even though they usually contain a heavy element of financing.  For many companies, such as airlines and railway companies, the off-balance sheet financing numbers can be quite substantial. In addition, the companies providing the financing are more often than not banks or subsidiaries of banks.  If this financing were in the form of a loan to purchase an asset then it would be recorded, he noted, but calling it a lease means that it miraculously does not show up on the books. 

Currently, most analysts take an educated guess on what the real but hidden leverage of
leasing is by using the basic information that is disclosed and by applying a rule-of-thumb multiple. In the view of the IASB Chair, it seems odd to expect an analyst to guess the liabilities associated with leases when management already has this information at its fingertips. This is one reason why it is urgent that the IASB create a new standard on leasing, in close cooperation with the FASB.

In June 2005, the SEC submitted a prescient report to Congress regarding the use of off-balance sheet arrangements. Arguing for a change in lease accounting, the report said that the fact that lease structuring based on the accounting guidance has become so prevalent will likely mean that there will be strong resistance to significant changes to the leasing guidance, both from preparers who have become accustomed to designing leases that achieve various reporting goals, and from other parties that assist those preparers.

The SEC turned out to be quite prophetic, said the IASB Chair. As the financial crisis was caused by excessive leverage, he continued, the IASB-FASB efforts to shed light on hidden leverage should be warmly welcomed globally. National accounting standard-setters, regulators such as the SEC, and investors must stand by their beliefs and help bring much-needed transparency to this important area. Their vocal support will be needed to counter what is a well-funded lobbying campaign.

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