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This article was first published in the April 2016 international edition of Accounting and Business magazine.

On 25 February, the US Financial Accounting Standards Board (FASB) issued its new lease accounting standard ASU 2016-02, Leases (Topic 842). Its equivalent across the pond, IFRS 16, released in January, supersedes the requirements in IAS 17, and while there are differences, it mirrors the new US standard.  

Both standards require a lessee to recognise assets and liabilities arising from leases on the balance sheet. According to the International Accounting Standards Board (IASB), the need for change to lease accounting responds to a lack of transparency of information about lease obligations – it cites the US Securities and Exchange Commission’s estimate of US$1.25 trillion in off-balance sheet lease obligations in 2005. The IASB notes: ‘The absence of information about leases on the balance sheet meant investors and analysts were not able to properly compare companies that borrow to buy assets with those that lease assets without making adjustments.’

According to Baruch Lev, one of the US’s most notable accounting academics and researchers, the FASB’s standards have traditionally had little impact on equity values. More specifically, ‘of the estimated 150 standards issued from FASB’s inception in 1973 through 2009, 75% had zero effect on the shares of the impacted companies. What’s more, 13% of the standards actually detracted from shareholder value and only 12% of the standards improved investors’ lot.’ 

However, in the case of leases, analysts are expecting comparative market stats to change, resulting from changes in key financial ratios derived from a lessee’s assets and liabilities. For example, a February 2012 report by the US Chamber of Commerce estimates that the IASB/FASB’s proposed standard would increase the recognised liabilities of US publicly traded companies by US$1.5 trillion, or 1.2% (US$1.1 trillion of that figure is real estate). The same study calculates that in 2011, US publicly traded companies had assets totalling US$104 trillion and liabilities totalling US$86.3 trillion. 

With the addition of the new notional liabilities and assets associated with operating leases, the authors project that reported balance sheet liabilities would grow to US$87.4 trillion and assets would increase to US$105 trillion – a 1.2% increase in total liabilities and 1% increase in total assets, respectively. They predict the fallout for US publicly traded companies will be increased borrowing costs due to risks associated with increased liabilities and decreased earnings. 

As to the impacts on preparers, according to PwC, the standard will have wide-ranging impacts for company management ‘well beyond financial reporting’, including technology and process, procurement, IT, HR, tax and treasury operations. Similarly, this ‘wholesale change’ to lease accounting, according to Deloitte, will likely result in significant implementation challenges during the transition period and beyond.    

The new US guidance will be effective for public business entities for annual periods beginning after 15 December 2018 (ie, calendar periods beginning on 1 January 2019), and interim periods therein. For all other entities, the ASU will be effective for annual periods beginning after 15 December  2019 (ie, calendar periods beginning on 1 January 2020) and interim periods thereafter. 

Ramona Dzinkowski is a Canadian economist and editor-in-chief of
the Sustainable Accounting Review