Dispute Erupts Over Alleged Impact of New Lease Rules

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By Steve Burkholder

Aug. 25 — A behind-the-scenes debate on the allegedly damaging economic consequences of upcoming changes to lease accounting rules burst into the open at the Financial Accounting Standards Board.

The dispute is marked by bluntly-worded exchanges amid mostly diplomatic language.

A member of the U.S. House of Representatives weighed in with a critical letter to the board. The FASB chairman wrote back Aug. 5.

FASB Parent Responds to Criticisms

The debate is revealed in an April report, funded by FASB's parent, the Financial Accounting Foundation, that counters a 2012 study financed by the Chamber of Commerce and real estate trade groups. The 2012 Chamber study forecast, controversially, substantial national job loss and big corporate debt would be caused by the new leasing standards.

The FAF is the oversight body of FASB and the Governmental Accounting Standards Board.

FASB hopes to issue its lease accounting rules by Dec. 31. They aren't expected to become effective for a few to several years—not earlier than 2017 and perhaps not before 2019.

The most marked change to long-standing U.S. accounting principles presented by the forthcoming standards is that lease-related liabilities and assets will be on company balance sheets for the first time.

Otherwise, FASB—unlike the International Accounting Standards Board, with its own version of new rules—would largely leave in place current lease-related recipes for income statements.

Congressman Writes to FASB

U.S. Rep. Brad Sherman (D-Calif.) wrote a letter dated July 15 to the FASB chairman to complain that he hasn't received “any assurances” that empirical studies on the potential costs of the lease accounting standards have been carried out.

Sherman, a member of the House Financial Services Committee, cited concerns that he and “over 60 other members of Congress” have regarding implementation and compliance costs of the planned leases rules. He suggested the changes “will have negative impacts not only at the entity level, but cumulatively for our economy.”

Sherman wrote positively of the 2012 Chamber of Commerce-funded study by Chang & Adams Consulting, now Andrew Chang & Co LLC. In the study, Chang & Adams asserts that the proposed lease accounting rules—which have been revised since 2012—would increase the liabilities of U.S. public companies by $1.5 trillion and “destroy” between 190,000 and 3.3 million jobs.

Legislator Slams FAF-Funded Study

The California Democrat strongly criticized the FAF counter study.

That study, conducted by Robert Lipe, a professor of accounting at the University of South Carolina, concluded in part that the predicted effects on jobs and U.S. gross domestic product were “significantly overstated.”

Sherman noted that the Lipe study, which was completed in April, hadn't been posted at FASB's website or otherwise published. The lawmaker in turn cited the July 1 letter to FASB and IASB from Andrew Chang, in which he pointed out shortcomings he contends are in the Lipe study. To that letter, Chang appended a copy of the Lipe study.

Sherman wrote that Chang's July 1 letter, which critiques the Lipe report, “clearly demonstrates that the FASB cannot rely on Professor Lipe's speculation and surmises.” The legislator argued that the academic's study deserved “wide-spread excoriation.”

Sherman called on FASB to meet with Chang soon. The board has invited the California consultant to meet with it, FASB officials have said. A time and place for a possible presentation is being worked out, Chang and a board spokeswoman told Bloomberg BNA, Aug. 21 and Aug. 18.

In his four-page letter to FASB and IASB, Chang defended his research in the face of shortcomings that Lipe, a University of South Carolina professor, sees in the study by the corporate groups' consultant.

Chang, in turn, pointed out what he sees as errant inferences, “unfounded assumption,” and “fallacious logic” in Lipe's analysis.

For his part, Lipe told Bloomberg BNA Aug. 21: “Nothing in the response by Andrew Chang causes me to change my conclusion regarding the analysis in the Chang & Adams study.”

He said that he was asked by FASB to take a careful look at the quantitative analysis in the Chang & Adams study. He concluded that “the quantitative assessment” in the 2012 study “was unlikely to accurately predict the effects of the FASB's proposal to capitalize all long-term leases,” he said in the interview.

Lipe said he based that on several items of evidence. Those included existing peer-reviewed academic literature, practices of credit rating agencies, his knowledge of lease accounting and “historical experience with past mandated accounting changes where constituents predicted extremely adverse consequences,” he told Bloomberg BNA.

FASB's Golden Responds to Sherman

In an Aug. 5 letter to Sherman, FASB Chairman Russell Golden said that the board has invited Chang to discuss his concerns.

The proposed leases standard “has been given lengthy and thorough consideration,” including extensive outreach and study of some 1,740 comment letters, Golden wrote.

The FASB chairman also pointed out that the analysis Chang & Adams carried out focused on a proposal that FASB is no longer pursuing.

The FASB chairman also pointed out that the analysis Chang & Adams carried out focused on a proposal that FASB is no longer pursuing.

“With regard to the potential economic impact and behavioral effects, the proposed leasing standard, like all accounting standards, is intended to reflect—not to drive—economic activity and behavior and to promote reporting that neutrally reflects in the financial statements a company's activities,” Golden wrote.

Golden on Lipe's Task for FASB

In his letter to Sherman, the FASB chairman described the board's commitment to carry out “a robust assessment of costs and benefits associated with the proposed leasing standard.” As part of that, FASB retained, via FAF, Lipe, whom the board chief described as “a respected academic and accounting expert to analyze the Chang study.

“Dr. Lipe was particularly well-positioned to conduct this analysis,” Golden wrote. An earlier paper by Lipe was among works cited by the Securities and Exchange Commission in the agency's wide-ranging study of off-balance-sheet accounting for certain contractual obligations, including those stemming from leases, and whether such obligations should be recorded on the balance sheet, according to the FASB chairman.

Referring to Lipe's analysis of the 2012 lease accounting study by Chang & Adams, Golden wrote to Sherman: “As you know, Dr. Lipe concluded that the negative financial impacts of the leases proposal projected by the Chang study were significantly overstated.”

FASB Chief: Board Weighs All Conflicting Views

On the weighing of costs and benefits, Golden told Sherman that “the financial accounting standard-setting process sometimes results in controversial proposaIs.

“That is why the FASB believes,” he continued, “it is imperative that our process take into consideration the often conflicting views of all affected stakeholders as we seek to achieve the right balance” of improving standards and fostering financial reporting that provides transparent, useful information to investors and other users of financial statements.

For decades, accounting rulemakers, regulators, investors and academics have pointed to the off-balance-sheet treatment of leases. They criticized that treatment as a product of form-over-substance accounting that doesn't reflect the economics of transactions.

“For the leases standard, the FASB will assess the cost of implementing changes against the benefits of making enhanced information available to financial statements users,” Golden wrote to Rep. Sherman.

The FASB chairman outlined a multi-faceted gauging of costs and benefits. That includes a weighing of the relevance, significance and accuracy of the information to financial statement users; effects on comparability of reported information, in the U.S. and internationally; and “the effort and cost involved in implementing the change,” Golden wrote.

Lipe's Key Findings

Lipe outlined several factors in the Chang & Adams study that, when viewed in combination, he concluded, point to substantial overstatement of the job loss and GDP reduction said to stem from the use of FASB's leasing proposal.

“Overall,” Lipe wrote of the report by Chang & Adams Consulting, his analysis “casts serious doubt as to the validity of the predictions made by the CA study.”

The factors, as laid out by Lipe the executive summary of his paper, include:

• an “unrealistic assumption” that credit analysts and banks ignore the liabilities and assets in off-balance-sheet leases “but then fully incorporate those” items in their analysis once FASB's proposed lease accounting proposal is adopted as generally accepted accounting principles;

• a misspecification of the liability recognition model in the Chang study, resulting in a prediction of “extreme economic effects” in a way that overstates the effects of required accounting changes;

• a failure to use discounted cash flows that stem from future lease payments, causing an overstatement of the predicted economic effects; and

• when the above factors—“the unrealistic assumptions, the specification problem, and the failure to discount”—are viewed in combination, the distinct effects of each factor “likely causes additional overstatement beyond the effects of the other two factors.”


On the last, viewed-in-combination factor, Lipe argued that “the only possible conclusion is that the CA study substantially overstates the loss of jobs and GDP reduction associated with the FASB's proposed lease accounting.”

Chang Rebuttal to Lipe 

In his July 1 letter to FASB and IASB, Chang asserted that Lipe's paper contains “speculations” and “several material errors.” It reflects an offering of opinions “without resort to empirical data,” he stated.

Chang also states that FASB's earlier draft standard on leases—amended since 2012—“still retains the most troubling provisions from an economic impact standpoint.”

The planned leases standard, in its current form, “will have negative consequences on an indeterminate number of U.S. companies, leading to an erosion of jobs and output throughout the U.S. economy,” Chang argues.

He cited several publications showing, he concluded, that “industry is becoming more vocal about the negative impact” that accounting practice changes portended by expected from the proposed standard will have on business operations.

The publications include a 2014 Wall Street Journal report on a Grant Thornton International survey of corporate executives and directors. The survey, according to Chang's summary, resulted in 75 percent of the executives polled reporting that “their loans could be recalled if covenant violations are triggered by the standard”— an eventuality that is subject to debate.

Chang also outlined reporting in a February 2014 article in CFO.com on the leases standards' potential impact on banks, including predictions of higher capital requirements. He wrote that Lipe doesn't address those publications.

Chang also faulted, among other things, Lipe's “unconventional,” “to say the least,” study of a kind of parallel application by two companies—AT&T and Chrysler in the early 1990s—of the Chang & Adams study's model to the accrual of liabilities by use of an earlier FASB standard on accounting for post-retirement health care and other benefits—the former FAS 106.

The predicted serious economic effects of that standard on post-employment benefits, or “OPEBs,” didn't materialize for AT&T and Chrysler in terms of increased costs of borrowing or higher liability-to-asset ratios, Lipe found. Dire economic effects from the advent of the new rules on OPEBs didn't occur generally across the economy.

However, Chang asserted, Lipe's method in applying the 2012 CA study's model to the application of the old FAS 106 by AT&T and Chrysler amounts to evidence of the scholar's “fallacious logic” and “overreach” that produced “a flawed generalization.“

For his part, in a Bloomberg BNA interview Lipe defended as appropriate the use of the AT&T and Chrysler parallel study of the application of the Chang research model to the accounting of post-employment benefits.

Discord on Debt Covenants

A key fulcrum in the newest debate between Lipe and Chang is the latter's emphasis on the possibility that the lease accounting standard would put at risk companies' debt covenants. Larger amounts of lease-related liabilities would trigger violations of debt covenants and adverse decisions from banks, according to the warnings.

To counter Lipe's views on the topic—a discounting of the alleged threat— Chang employs quotations from participants in the accounting and banking marketplace that point to the possibility of negative impact on debt covenants, or at least the need for companies to talk to their bankers before the planned lease accounting standards go into effect.

Longer Phase-In for Rule Advocated

In his letter to the FASB chairman, Rep. Sherman also focuses in part on the debt covenants issue. The lawmaker wrote that Golden “personally agreed with me that the debt covenant issue is substantial.” The FASB chief signaled, according to Sherman, that the issue warranted “a five-year phase-in.”

Sherman wrote that he favors a 10-year phase-in of the new lease accounting rules.

Golden told Sherman in his Aug. 5 letter that the board has heard similar concerns from other people about what the legislator wrote on newly recorded lease-related liabilities having a possible impact on debt covenants “and on accounting judgments.”

Lenders Signal No Bad Repercussions

Golden cited research by FASB's staff, including a review of academic studies, suggesting that “covenant violations caused by mandated accounting changes are not typical in practice.”

In addition, the FASB chairman said that the board's staff held discussions with lenders on the lease accounting changes and potential effects on loan covenants. Those talks “have shown that recording lease assets and liabilities in the financial statements will not significantly impact a company's borrowing,” Golden wrote to Rep. Sherman.

For his part, Lipe wrote on the debt covenants issue that evidence he reviewed in his work for the FAF “suggests that the majority of lessees are unlikely to face significant negative consequences due to debt covenant violations.”

“Research shows few companies reports of covenants due to mandatory changes in accounting methods,” Lipe continued. In part that is because “many debt covenants exclude the effects of mandatory accounting changes.” That is due—again, in part— because “covenants within loans made to companies with significant operating leases are written in ways that are not sensitive to whether the lease assets and liabilities are capitalized or not,” he wrote.

At a New York University roundtable on lease accounting in March, Martin Fridson, chief investment officer at Lehmann Livian Fridson Advisors LLP, discounted the likelihood of the leases accounting rules triggering widespread debt covenant violations.

“These outcomes will be rare, if they occur at all,” Fridson said March 2 at the Stern School of Business forum.

Longer Phase-In for Private Companies?

FASB officials suggest that the timing of the effective date of the forthcoming standards on leases might mitigate the debt covenant issue, especially as it may affect private companies.

The board “understands that the longer timeframe between issuance and implementation of the final standard, the greater the likelihood that debt covenants will roll over, mature or be updated through the natural origination process,” FASB’s Golden wrote in his letter to Sherman.

In a future public meeting the board will consider setting an extended effective date for the leases standard for private companies, “for those debt covenants that could possibly be affected,” the board chairman wrote.

Improved Accounting, ‘Better Economic Decisions?'

In his April 2015 report, Lipe wrote of a post-implementation gauging of the costs and benefits of the standard on retiree health care and other post-retirement benefits. The context was his study of the application of the Chang study's model to accounting for other postemployment benefits by AT&T and Chrysler in the early 1990s.

Lipe said he talked with top corporate accounting officers at conferences before and after the advent of FAS 106, now Accounting Standards Codification 715. The same people who were “harshly critical” of the standard earlier later stated that FAS 106 “helped them to see the real costs of the promises they had been making, which helped managers make better decisions.”

“Experiences such as these lead me to conclude that changing a mandated accounting standard cannot devastate an economy or an industry, nor can it save an industry that is in decline,” Lipe wrote. “Financial statement users do not respond to mandated accounting changes as if the changes reflect shifts in the fundamental economics of the reporting entity.”

On the other hand, he continued, improving accounting standards “can lead to better economic decisions, and those improved decisions usually help the economy, although quantifying this effect is incredibly difficult.”

To contact the reporter on this story: Steve Burkholder in Norwalk, Conn., at sburkholder@bna.com

To contact the editor responsible for this story: Laura Tieger Salisbury at lsalisbury@bna.com

The July letters to FASB from Rep. Brad Sherman and Andrew Chang, with the latter's appendix containing the April 2015 report by Robert Lipe, are available at http://www.fasb.org/jsp/FASB/CommentLetter_C/CommentLetterPage&cid=1218220137090&project_id=LEASES-14.

For a discussion on lease accounting, see 5114-2nd, Accounting for Leases: Fundamental Principles, at 5114.

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