Sox First

Of all the issues and scandals in the accounting world, none are likely to be as big as lease accounting. The fallout from lease accounting will make the issues over fair value look like a picnic. The International Accounting Standards Board and the Financial Accounting Standards Board now plan to bring leases on to the balance sheet, and that will create a problem for many companies.

According to the World Leasing Yearbook, the total amount of items leased globally in 2007 amounted to a massive $US760 billion ($A919 billion). However, many lease contracts did not appear on balance sheets because international and American accounting rules have two categories of leases: finance leases and operating leases with only assets and liabilities arising from finance leases recognised in the statement of financial position.

Leases are off the balance sheet, that's why companies love them.A company, for example, might buy a piece of equipment and set up a long-term payment lease plan. Under the plan, it pays for that equipment over time. Ownership of the equipment, however, is in the hands of a leasing group so the transaction does not appear on the company's balance sheet. The lease payments appear as operating expenses instead. If it's a public company, the leases would be disclosed in the footnotes of its accounts.

The problem with lease accounting is that is it is out of date. It came from a different era, a period long before financial innovation and engineering, one based on the notion of who owns the asset rather than who controls the risks, benefits and obligations. According to the rule makers, lease accounting should recognise that all leases give rise to liabilities for future payments and assets. They say this means leases need should be incorporated into the company's statement of financial position, The lessee's obligation to pay a lease fee, the equivalent of rent, needs to be recognised as a financial liability and should be acknowledged as such. That said, the rule makers concede that leases are not like other financial liabilities because they give the entity the right to use an asset. This means the lease would have to be presented separately from other financial statements. The key, according to the standard setters, is more disclosure. When the standard does come through, balance sheets will be more transparent. It could, however, create a number of issues for companies. One is working out how much of the lease the company actually controls given that these instruments have been set up at arm's length. A change in accounting rules could also increase amount of liabilities on a company's balance sheet. This might force some entities to renegotiate debt covenants.

As Tammy Whitehouse writes in Compliance Week, the new rules will cause all sorts of headaches for companies. Whichever way you look at it, companies will be screaming. But for investors at least, there will be more transparency

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