Leasing Rule Changes Will Impact On Balance Sheets

Media Release

20 August 2010

Leasing Rule Changes Will Have Big Impact On Balance Sheets

New Zealand’s top 20 companies, along with the Government, will need to book an extra $10.7 billion on their balance sheets if rules on the way operating leases are recorded as a liability are adopted.

An Exposure Draft (ED), that has just been released for comment by the International Accounting Standards Board (IASB), wants all lease arrangements to be reflected in balance sheets. At present, an operating lease, which is any lease arrangement that is not a finance lease, does not have to be recorded in the balance sheet.

Mark Hucklesby, National Technical Director for accounting firm Grant Thornton, said that the changes will increase debt levels, putting some companies in breach of debt covenants and making it harder for businesses trying to secure finance.

“It will put an extra $5 billion on the Government’s debt books, and it will put a total of $5.7 billion on the books of New Zealand’s top 20 companies (excluding Foodstuffs where figures were not available). If the charges are adopted Woolworths NZ Group would need to increase its liabilities by $878 million, Air New Zealand by $751 million and National Australia Bank Group by $724 million.

“Of the $5 billion that the Government has in operating leases, approximately half are related to non cancellable accommodation leases.

“Many companies are fearful that the change will force their balance sheets to balloon overnight and change all sorts of leverage and debt ratios, forcing them to renegotiate covenants with their lenders.

“It doesn’t really change net worth, but it will change return on asset formulae, return on equity formulae and debt servicing,” he said.

The primary justification behind this move is a wish by standard setters to generate accounting results that are more useful for decision makers. To add weight to the significance of this change the US Financial Accounting Standards Board has joined forces with the IASB on this topic.

“Given New Zealand’s decision to adopt International Financial Reporting Standards (IFRS), an ED mirroring what has just been released by the IASB will soon be issued for comment by the New Zealand Institute of Chartered Accountants’ Financial Reporting Standards Board.

“Basically, a leasing arrangement is all about providing a source of finance to acquire assets which in turn helps the company generate income. If adopted, the changes are likely to have a negative impact on the asset and performance ratios of many organisations,” he said.

The proposed changes will get rid of the anomaly where two similar lease arrangements (one classified as a finance lease and the other as an operating lease) can be accounted for quite differently.

“At present, if one has a finance lease, the right to use the leased asset and the financial obligations associated with its use both appear on the balance sheet while an operating lease only requires payments to be noted on an income statement.

“These proposed changes are far-reaching and will affect many organisations. Business owners would be well advised to acquaint themselves with the contents of the ED, and if they disagree with what is being proposed, now would be a good time to come forward,” he said.

A summary of the main proposals of the ED are as follows:

Eliminating the requirement to classify a lease contract as an operating or finance lease.

A single accounting model would instead apply for all leases, with a lessee recognising a ‘right to use asset’ representing its obligation to pay lease rentals.

The individual components of a lease contract (such as options to renew, purchase options, contingent rental arrangements or residual value guarantees) would not be recognised separately. Instead entities would recognise a single right-of-use asset and single obligation to pay that reflects expected outcomes.

A new hybrid accounting model for lessors, under which leases that expose the lessor to significant risks and benefits associated with the underlying asset will be accounted for using a performance obligation approach; while a derecogntion approach will be used for all other leases.

For full details of the IASB announcement see: http://www.ifrs.org/News/Press+Releases/leases+exposure+draft+August+2010.htm

ENDS

© Scoop Media