The FASB has recently decided to rethink it’s original plans for implementation of new standards for lease accounting. Make no mistake, it’s coming, but it’s just being deferred a little longer. They are planning on issuing a new exposure draft in the first quarter of 2012.

The main reason for the delay in issuance of a standard has been the push back that the FASB received on the initial exposure draft. The outcry from people on both philosophical and practical grounds was immense. While many, including us, intellectually accept the notion of capitalizing leases used for financing purposes the regime being proposed by the FASB was so far reaching that it just didn’t make sense in many cases. Some of the pushback was also directed at the some of the unintended consequences of moving itemsfrom the footnotes to balance sheet.

One of those effects is the math associated with some financial ratios. If obligations that were previously disclosed in the footnotes are suddenly moved to the balance sheet, firms will appear more levered which is to say that leverage ratios would increase. In reality, underwriters, analysts etc…already include off-balance sheet financing arrangements when looking at a company’s debt load however generally loan documents define debt to equity and leverage ratiosas on-balance sheet math exercises only. For example, a requirement to maintain a leverage ratio of X% would not include in its calculation any operating lease obligations disclosed in the footnotes under the current regime.

The most obvious consequence of shifting leverage ratios could be a non-monetary default. While it’s extremely unlikely that a lender or other obligor would try to enforce the consequences of such a default and at the extreme it’s unlikely that a judge would approve a foreclosure or force a bankruptcy based on one, it does potentially give the lender or obligor another bite at the apple in cases where the relationship is already strained. In theory, it could also have an effect on other things like ability to obtain surety bonds, or conduct other transactions where an affirmation of not being in any default is required. It could also, in theory, have a cascading effect on cross-collateralized obligations whereby a default (non-monetary or otherwise) on one causes the others to go as well.

The reality is this; the magnitude of these changes is going to be very small. Simply put,basic economics trumps everything else. The fact that a borrower is or isn’t paying is a lot more persuasive that any foot fault. Also, on a go forward basis underwriting standards won’t need any significant adjustment because they capture these so called off-balance sheet arrangements anyway.

Bottom-line, no technical accounting changes that enhance the transparency of something that’s already therewill have any real impact of the basic economics of business as we know it.

Instant Insights /

Non-Monetary Defaults and Lease Accounting

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