From CNBC:
- A big change in lease accounting rules effective Jan. 1 requires companies to record operating leases on their balance sheets.
- Operating leases include everything a company rents to run its business, from office space, equipment, factories to planes and cars.
- The accounting change will result in an increase in company leverage, a key measure when evaluating a company’s risk.
A new corporate accounting rule is about to pull an estimated $3 trillion out of the shadows.
Starting this year, companies are required to record the cost of renting assets used in their operations, such as office space, equipment, planes and cars, on their balance sheets rather than bury that expense in the footnotes of their financial statements, thanks to a new accounting standard now in effect.
The result will be trillions of dollars added to liabilities on their books. Until now, only leases that led to the purchase of the asset were accounted for in this manner. The change, by the Financial Accounting Standards Board, is supposed to make it easier for investors to evaluate a company’s financial obligations.
Sheri Wyatt, a partner at accounting firm PricewaterhouseCoopers, said “It’s going to affect all companies’ leverage. They will have more liabilities on their books than they had previously.”
Morgan Stanley expects the consumer discretionary sector to experience the largest increase in debt because of this change, and it estimates the leverage ratio for the retail sector to grow to 3.4 times from 1.2 times.
U.S. public companies are committed to a total of $3 trillion in operating leases, according to International Accounting Standards Board. Companies with large amounts of operating leases include retailers and restaurants that lease properties and airlines and shipping companies that lease airplanes, cars and ships.
It may force investors, including quantitative funds, to change the way they measure certain financial criteria they use in making their investment decisions. Leverage — measured in the ratios of debt to earnings or debt to equity — is a fundamental number used when evaluating a company’s risk....MUCH MORE
