Shocking New Accounting Rules

The Economist magazine (website) published an article on 19 August 2010 titled "Shocking New Accounting Rules". It was further subtitled "Businesses may have to start putting leases on their balance sheets".

It was totally "sensationalism". The first paragraph said:

"WHEN you lease something—a boat, a warehouse, a machine for making ball-bearings—you agree to pay for it bit by bit over time. So it is like incurring a debt, say the International Accounting Standards Board (IASB) and America’s Financial Accounting Standards Board (FASB). Therefore, it should be on your balance-sheet. This new rule, proposed on August 17th by the two regulators, has shocked companies everywhere. It is up for public comment until December, but could be enacted as soon as June next year."

The situation mentioned in the article is for the US. In Malaysia, Financial Report Standard FRS 117 (revised) has been applicable since 2006.

The whole article is implying that the Accounting Profession is being somewhat anti-business, requiring the leases to be included in the balance sheet (thus increasing the debt position of the company).

As an accountant, though I confess not fully conversant with every detail of the FRSes, I feel upset enough by these kind of crap to make a reply.

As mentioned in that article, there had been abuses by companies in the past over the accounting for leases (operating leases vs finance leases). The International Accounting Standards Board (IASB) had issued many FRSes relating to leases (treatment and disclosure).

Simply stated, an operating lease is meant to be something, rented for use in the operation, and paid by regular rentals (daily, weekly, monthly, or yearly). A finance lease is buying an asset paid for by regular instalments (daily, weekly, monthly, or yearly). "Renting" or "buying" in the accounting sense relate to the risks and rewards associated with that asset, not just ownership.

The latest FRS just clarifies that (Para 8 of FRS 117):
"A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership."

It basically means that if you "own" the asset during the period of the lease (even if title is NOT transferred at the end of the lease), then you must treat the lease as a finance lease and include it in your balance sheet.

The clarification just removed the ambiguity in the past that allowed many companies to "reduce" their balance sheet liabilities by claiming various leases as operating leases. As this treatment is recognised as an abuse (i.e. BAD), the only companies that will be complaining are those that are BAD!