The revelations in 2001 concerning Enron’s questionable accounting practices prompted Congress to direct the Securities and Exchange Commission (SEC) to review problematic off-balance sheet financing schemes. The SEC found that lease obligations could be kept off balance sheets causing the extent of a company’s liabilities to be understated. (Companies could opt for lease agreements instead of purchases on credit and avoid listing the recurring obligation on its books.) As a result, the Financial Accounting Standards Board (FASB), which develops standards to be used by accountants in this country, now requires payments on future lease obligations to be declared as liabilities as well.
The new rule has provoked a strong response from trade groups which claim it will cause companies to pull back some of its operations so as not to undermine its debt-to-equity ratio which garners so much attention and interest from stock analysts who play an important role in attracting –or, as the case may be, discouraging – investors from a particular company. Supporters of the proposed rule argue sophisticated analysts and investors already look beyond “the debt-to-equity ratio” and make recommendations and decisions on the basis of more variables than just this ratio. They maintain the rule will provide a more accurate picture of a company’s actual financial condition and lenders will not be taking such a high risk in providing capital to companies that show reduced liabilities due to the exclusion of lease payments on their balance sheets.
Critics go further and claim that since the rule will discourage the leasing of equipment, it will reduce annual economic growth rates by 3%, a substantial amount similar to what the financial crisis of 2008 cost the American economy. Less hyperbolic critics assert that by forcing companies to declare minor costs, such as the rental of coffee makers and copying machines, certain firms will have to employ additional accountants to do their books.
In any event, the FASB has a track record of revisiting rules by making subsequent revisions. Until then, businesses will need to include the cost of lease obligations on their balance sheets.
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