A Sure-Fire Way to Harm The Economy
By BRAD SHERMAN And PETER KING
Nov. 9, 2014
Just as it seems the U.S. economy might be turning a corner, a little-known and seemingly benign change in accounting rules could cost millions of jobs and billions in lost economic growth. Most business owners and their employees have no idea what may be coming.
The agencies that establish accounting standards in the U.S., Europe and Asia have a proposal, now gaining momentum, to change how companies present leased property and equipment on their financial statements. If it is implemented, the effect would be dramatic.
For hundreds of years companies have treated most lease payments as operating expenses, like rent, and not put them on their balance sheets. Under new accounting standards they would report the leases they hold on their balance sheets as liabilities—equal to the net present value of all future lease payments, which in some cases run for 20 or 30 years.
IHS Global Insight has estimated that the new rule would add $2 trillion to the liabilities on companies’ balance sheets, while also adding $2 trillion in “assets” (the right to use the property or equipment). The U.S. Financial Accounting Standards Board (FASB) says this will “provide users of financial statements with a complete and understandable picture of an entity’s leasing activities.” That’s the supposed benefit. But the costs are extraordinary.
An economic analysis by Chang and Adams Consulting for several leading nonprofit and commercial organizations found that the changes—first proposed in 2010 by the FASB and the London-based International Accounting Standards Board (IASB)—would raise the cost of capital for lessees, in the process destroying 190,000 U.S. jobs and shrinking the economy by $27.5 billion annually. And that was the best-case scenario. At worst, the cost would be 3.3 million lost jobs and an economic hit of over $400 billion a year, indefinitely.
Businesses of all sizes have long-term loans from banks and other financial institutions. Those loans typically contain covenants allowing the bank to demand immediate repayment when liabilities grow unusually quickly, upsetting, for instance, the ratio of the company’s debt-to-equity agreed upon at the time of the loan. Because the new accounting rules would fabricate trillions in new debt, they would trigger widespread violations of these covenants. Banks could then pull the loan, demand higher interest, or require new collateral and guarantees.
Some have proposed a five-year transition to the new rules. But this won’t solve the problem, because many business loans are for much longer terms. Pushing the effective date of the rules into the future merely delays the impact.
The additional burdens associated with constantly tracking and remeasuring the “fair value” of leases of every kind, from a business’s office space to the photocopier down the hall, will hit businesses, and their employees and consumers, directly in the pocketbook. According to some critics, the accounting-rule change would distort the financial condition of businesses by accelerating expenses over a short timeline rather than reflect expenses over the life of a lease.
Many private parties have sent public comment letters to the FASB urging it and the IASB to conduct field tests to see how much it would really cost lessees and tenants to do all the work the new leasing rules would require. Congress has asked the FASB for a rigorous cost-benefit analysis and field testing to objectively assess the risks of the accounting changes. Neither has been undertaken. Yet all indications are that the U.S. and international accounting-standards boards are going ahead with only minor revisions to their proposal, which may be finalized next year.
In 1973 the Securities and Exchange Commission formally outsourced the job of writing accounting rules to the FASB. While the SEC is authorized to seek help from private standard-setting bodies on this issue, the Sarbanes-Oxley Act of 2002 explicitly reminded the SEC that these quasi-government agencies can only “assist the Commission” in fulfilling the SEC’s own responsibility to establish accounting standards for publicly held companies.
If the SEC insists on relying so heavily on the FASB, then the FASB must adhere to the same requirements of transparency, public input, and cost-benefit analysis the SEC is required to meet. By law the SEC must analyze whether proposed rules will enhance efficiency, competition and capital formation, or whether the costs outweigh the benefits. The lease accounting proposal needs this analysis, but thus far the FASB and SEC have not even begun it. The SEC must increase its oversight of the FASB on this vital matter—or Congress will.
Mr. Sherman, an accountant, is a Democratic congressman from California. Mr. King is a Republican congressman from New York. Both are senior members of the House Financial Services Committee.
For more information read Congressman Brad Sherman's letter to the Financial Accounting Standards Board HERE