PROJECT FINANCE

orthcoming changes to FASB and IASB rules may capitalize operating leases. The change may still be two years away. But what does the prospect of this new lease accounting standard mean for lease- vs.- buy decision- making today?

   “It will make the deals stand up to economic scrutiny more so than simply accounting fiction,” says Charles Mulford, INVESCO chair and professor of accounting at the Georgia Institute of Technology, founder of the Financial Reporting and Analysis Lab and co-author of the 2005 book Creative Cash Flow Reporting: Uncovering Sustainable Financial Performance. “People ask me if I see a decline in leasing. My point is if leasing has economics to support it – if a deal is a good deal – it will still get done whether it’s on the balance sheet or not.”

   Manufacturing and technology companies are expected to see significant financial statement impact in matters relating to equipment leases as well as property. As the Lab’s recent analysis showed, in addition to some reduction in returns, the changes will do some “strange” things to financial statements, says Mulford, including boosting EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

   “Other than increased leverage, company financial statements will look better,” he says. “It will be easier to meet debt covenants, and there will be higher compensation to officers.”

   Mulford points out that virtually all leases in the corporate industrial arena are operating leases, because of their long, useful life. “That will weigh on the decision,” he says. “As financial-statement readers get more accustomed to reading leases, it will become moot. I don’t see it changing how deals are structured, except in the fact that they’re structured how they should have been structured all along.”

   According to the current FASB rule, an operating lease may stay off the balance sheet as long as the present value of payments amounts to less than 90 percent of the asset’s value, and the lease term is less than 75 percent of the asset’s expected lifespan.

   A 2005 report by the Securities and Exchange Commission estimated undiscounted liabilities for non-cancelable operating leases

at a sample of 200 large companies at $206 billion, with the extrapolated figure for all U.S. issuers approaching $1.25 trillion.

   In a survey of corporate real estate managers conducted by the Industrial Asset Management Council in fall 2004, only 37 percent of respondents reported to finance, with 17 percent reporting to corporate services, and 10 percent reporting through to a business unit. However, 14 percent of those respondents indicated that they themselves were the top managers (i.e. CFOs or similar titles).

   “The site selection is the real estate people,” says Mulford, but the financing decision will continue to be made by “someone who is responsible for financial decisions that affect the entire organization, who knows other capital expenditure requirements, beyond simply the real estate side.”

   An official change could be effected by 2010, he says. That may be an optimistic projection. Corporations may be able to use the extra time to go through their lease databases line by line and to work with their lease accounting software providers to make adjusted projections.

   Mulford says the business world is in the midst of some major changes concerning financial statement fundamentals, including liability, the definition of net worth and the gradual convergence of domestic and international accounting standards.

   “If we have this conversation in 10 years, we’ll be talking about how it’s all the same wherever you go,” he says. “Between now and then it’s going to be ugly.”