Tuesday, November 18, 2014

Misinformed congressmen in WSJ

In the Nov. 10, 2014, issue of the Wall Street Journal, congressmen Brad Sherman and Peter King attacked the planned new lease accounting standard, claiming that it will "fabricate trillions in new debt" and thereby crush the economy. They reference a study that foresees a loss of at least 190,000 U.S. jobs, and $27.5 billion in economic activity (up to a worst-case scenario of 3.3 million lost jobs and $400 billion in lost GDP!). All for an accounting change?

There are several problems with this attack. The most significant is that the study forecasts the effect of a standard that is no longer being proposed. The study was written in early 2012, when the proposal was to treat all leases as capital, including all optional renewal periods deemed "more likely than not" to be exercised. This proposal was eventually recognized as onerous by the boards, and substantially scaled back. While the IASB has retained the plan to treat all leases as capital with a one-size-fits-all calculation process, it eliminated including options unless exercise is "reasonably certain." The FASB has made the same adjustment to options, has chosen to keep a separate accounting model for operating leases, and is now saying that the liability to be shown on the balance sheet should be considered a "non-debt liability," meaning it will not affect debt covenants in loans, bonds, and the like.

The op-ed contains other inaccuracies. It suggests that under the new proposal, businesses would be burdened 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." This is ridiculous, and was never part of any proposal coming from the boards. A fundamental concept of lease accounting is that fair value is not remeasured during the life of the lease, except by algorithm; the fair value is assumed to be the amortized net asset value, unless a material impairment needs to be recognized. This is true under FAS 13, and has not changed in the slightest as part of the new proposals. The op-ed also talks about accelerating expense recognition; that will happen to companies covered by international IFRS rules, but not under the current FASB proposal.

The op-ed notes that Congressman Sherman is an accountant. But obviously he doesn't have enough time to keep up on what's really happening in accounting. He should be embarrassed to have put his name on a column that misstates accounting principles and proposals so badly. (So should Rep. King, though he doesn't claim an accountant's credentials.) They darkly warn that Congress will have to act to rein in the FASB if the SEC doesn't. One hopes that they'll learn the actual facts before they try to politicize accounting standards.

The Nov. 17 issue of the Journal includes several letters to the editor, most of which point out the value of capitalizing lease obligations, and noting that banks often require doing this pro forma already. The new proposal, they argue, will simply reflect economic reality. I'm surprised that none of them note that Sherman and King are attacking a straw man.