Lease proposal could hit businesses

Source:  NZ Herald

Date: December 7, 2010

Businesses could face a big hit on their balance sheets under a proposal to include leases of buildings, cars and equipment as a liability in financial accounts, an expert warns.

The proposal is being put forward by the International Accounting Standards Board in London which sets the international financial reporting standards that New Zealand businesses now follow.

Kimberley Crook, the head of accounting advisory services for Ernst & Young in New Zealand, said the proposal could affect how businesses are valued, employee performance measures and banking covenants if it is not planned for.

The change could also produce a flow-on effect such as companies taking shorter leases on buildings or forgoing rights of renewal periods to reduce the amount they need to account for, she said.

“It’s certainly not something people should ignore.”

At the moment a lease on a building is accounted for by including the rent as an operating expense.

But under the proposed changes, if the building was leased for five years the amount to be paid over the entire time would have to be included as an asset for the use of the building and as a liability for the commitment of paying the rent over the lease period.

The liability would be high at the start of a lease period then reduce over the lease as the timeframe for the financial commitment was reduced.

“At the moment if you leased a building you wouldn’t have any kind of asset or liability on the accounts for that. As you pay rent you just view it as a cost. But under the changes it would be treated as repaying a liability.”

Crook said a company involved in a large amount of leasing could face a detrimental impact on its gearing and working capital ratios.

“For both lessees and lessors, fundamentally altering these ratios can have major consequences for banking covenants.”

The change is being proposed because there is a difference in the way finance leases – such as when something is bought on hire purchase – are treated compared with operating leases.

The difference means there is concern that some deals are being structured as operating leases to keep them off balance sheets.

Crook said Ernst & Young had called for more field testing to determine the proposal’s full impact before it was introduced.

“Given the scale of change, to do it quickly might end up with a standard people will struggle to apply.”

Submissions on the proposal close on December 15.

By Tamsyn Parker