06 November 2012

IASB/Hoogervorst: Leasing standard essential for uncovering hidden leverage

Hans Hoogervorst, Chairman of the IASB, called on securities regulators and national accounting standard-setters to support the IASB's joint efforts with the FASB to "bring much-needed transparency" to lease accounting.

Speaking at the London School of Economics and Political Science, Mr Hoogervorst highlighted the extent to which lease arrangements have become one of the greatest sources of off balance sheet financing for many companies.

The vast majority of lease contracts are not recorded on the balance sheet, even though they usually contain a heavy element of financing. For many companies, such as airlines and railway companies, the off-balance sheet financing numbers can be quite substantial.

What’s more, the companies providing the financing are more often than not banks or subsidiaries of banks. If this financing were in the form of a loan to purchase an asset, then it would be recorded. Call it a lease and miraculously it does not show up in the books. In Mr Hoogervorst´s book is written, if it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck. So is the case with debt – leasing or otherwise.

Right now, most analysts take an educated guess on what the real but hidden leverage of leasing is by using the basic information that is disclosed and by applying a rule-of-thumb multiple. It seems odd to expect an analyst to guess the liabilities associated with leases when management already has this information at its fingertips. That is why it is urgent the IASB creates a new standard on leasing and that is exactly what the IASB is doing, in close cooperation with the FASB.

Companies tend to love off-balance sheet financing, as it masks the true extent of their leverage and many of those that make extensive use of leasing for this purpose are not happy. Furthermore, the leasing industry itself is fighting its own battle. Members of the US congress, heavily lobbied by the industry, are writing letters to our colleagues at the FASB.

A recent report in the United States claimed that our joint efforts with the FASB to record leases on balance sheet will lead to 190,000 jobs being lost in the US alone. The SEC predicted it would happen. In June 2005, the SEC submitted a report to Congress regarding the use of off-balance sheet arrangements. Arguing for a change in lease accounting, the report said, and Mr Hoogervorst quoted: “The fact that lease structuring based on the accounting guidance has become so prevalent will likely mean that there will be strong resistance to significant changes to the leasing guidance, both from preparers who have become accustomed to designing leases that achieve various reporting goals, and from other parties that assist those preparers.”

These words turned out to be quite prophetic. As the financial crisis was caused by excessive leverage, efforts to shed light on hidden leverage should be warmly welcomed around the world.

Mr Hoogervorst explained how efforts to bring greater transparency in financial reporting often met strong resistance and lobbying from vested interests, but that in the fullness of time, those enhancements became accepted as normal business practice.

Press release

Full speech

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