About 25 years ago I worked for a few months with a team of deep
thinkers who were trying to convert Capital Leases into Operating Leases
for tax and accounting purposes. The objective was to get the most
optimal treatment; (1) tax deductible amortization of the asset and (2)
keep it off the balance sheet so as to hide the true debt level and
therefore improve balance sheet ratios. There were strict rules that
were supposed to avoid this. But is was a goldmine idea if it could be
done. This was early derivative days. Make something look different than
what it actually was. I thought it was a dumb idea, so I quit and went
to sell junk bonds at Drexel. Turns out the folks involved figured it
out and made a bundle selling it. I am still glad I was not involved.
Now, a quarter century later, the regulators are catching up to this. It is possible that changes will be made. If they do, it will have very significant implications. The Economist has an article that sums things up pretty well. Here is the link, some sections of the report:
This new rule, proposed on August 17th by the two regulators (IASB and FASB), has shocked companies everywhere.
The change will make a lot of firms look wobblier: a survey by PricewaterhouseCoopers, an accounting firm, found that it would add about 58% to the average company’s interest-bearing debt.
Many companies are close to their maximum debt limits, and the new rules could push them over the edge. Small wonder they are howling.
Other companies will see their apparent return on capital plunge. Many firms will see their debt-to-equity ratio rise and their ability to borrow fall.
You can look at each company's BS and estimate what the impact of the new rules will be. The article suggests that airlines and retailers will be hard hit. The list of companies with Operating Leases is endless. I would imagine that most of the S&P 500 will be impacted one way or the other. I did look for macro information on total outstanding operating leases and did not find a source. I think we are talking a trillion or so. Does anyone have a source for the big picture?
Watch for a big fight over this issue. Look for GE to be the biggest opponent to any changes. I think they have the most to lose in this.
It makes me laugh/cry to see that it took them 25 years to come to the conclusion that lease accounting was being abused.