Lease accounting: are current rules as bad as some say?

• Author: Fleming, Michael
• Position: FinancialREPORTING

Since 1995, calls to revise lease accounting standards have come from a number of regulatory and standards-setting bodies, including the Financial Accounting Standards Board (FASB). Articles portraying leasing rules as inadequate continue to appear in the financial press. But, criticism of the lease accounting standard, FAS 13, is plagued with myths. FAS 13 is a rules-based system that some want to replace with a standard that is principles-based. The following attempts to dispel some myths:

* Myth: Leases are engineered to avoid capitalization. The reality is "structured" operating leases, also know as synthetic leases, represented only 1 percent of leasing business in 2004. Most operating leases occur naturally as a result of tax rules requiring lessors to take residual risk, and competition is pushing assumed residuals increasingly higher.

* Myth: Current lease accounting rules do not recognize material assets and liabilities arising from operating leases. Over 70 percent of the dollar volume of operating leases is real estate-related. However, a look at equipment operating lease statistics only shows that the vast majority of the transaction volume is comprised of small and mid-sized transactions of less than $250,000, with average lease terms of less than four years, whose capitalized value would be less than 0.4 percent of assets and 1.2 percent of debt.

* Myth: The operating lease vs. capital lease distinction is based on bright-line tests that are arbitrary. The truth is that bright-line tests serve the important purpose of ensuring consistency of reported results among the thousands of public companies who use large, medium and small accounting firms to certify their financial statements. FAS 13's 10 percent guide delineating where risk is substantial was not selected at random and without reason in 1976 when the standard was adopted; rather, it was founded in the logic that retaining risk in amounts equal or greater than 10 percent represents substantial risk.

* Myth: Lease accounting rules are overly complex. Indeed, lease transactions often are multi-faceted. But, the view that capitalizing all leases is the simple fix that will result in consistency is flawed as well. Such a change will be at the expense of usefulness, understandability and meaningfulness of the financial reports and create a costly compliance burden. Capitalizing all leases would only simplify the process of classifying a lease. It would add complexity...