The FASB (Financial Accounting Standards Board) and the IASB (International Accounting Standards Board) are recommending that the use of operating leases be scrapped and that all leases be treated as capital leases. For over 40 years FAS 13 has been the standard. This step will change all that.
Under the proposed rules operating leases will be capitalized with both an asset and a liability account. Rent expense would go away and depreciation and interest expense would take it’s place.
Why is this important to a CFO? It’s the financial ratios! EBITDA no longer becomes useful in valuing a company. Your debt to equity ratio becomes inflated and the debt service coverage ratio becomes compressed. All you bank covenants will have to be modified to reflect the new presentation.
The question is: does this increased complexity add value to the process of evaluating the financial performance of a company? We will have to wait and see. Until July 2010 the accounting regulators are soliciting comments to their proposed changes. Implementation would not begin until 2011.