No discussion of leases would be complete without touching on the fluid lease accounting standards implementation. Over the past decade the Financial Accounting Standards Board (“FASB”) has been working with industry players to establish a new standard for lease accounting with its chief goal to provide clarity on lease obligations within corporation’s financial statements. The example that most people relate to the most is the Enron scandal. The Enron implosion is an MBA student’s typical year 2 case study whereby they have to read through the history of the company’s wrong doings and read through their SEC reporting footnotes like a fiction novel.
Real estate leases under 15 years of length are classified as operating leases as opposed to other longer financial obligations that would be considered capital leases. The differences between the two have to do with how they are reported on the company’s financial statements. The problem that FASB is looking to solve is that operating leases currently do not have to be disclosed on a company’s financial statements. You might not feel like that is a big deal for smaller privately held companies. However, for any company that is public or that relies on external capital sources, it is imperative to understand all of a company’s financial obligations to be able to assess risk and to be able to analyze comparable investments.
Let’s say you are simply looking to invest your retirement funds between two companies, and you find that the both are equally attractive. They may have similarly attractive management teams, future prospects of success within their industry and adequate capital. What if you found out that one of the companies has been signing long term leases, at above market rates, with all of their landlords in order to have their landlords build out overly fancy spaces. Would that have an impact on your value judgement and comparisons of companies?
I don’t pretend to be an FASB guidelines expert, but I know who the FASB experts are to call when clients have issues.
What I have found is that the relationship of quantity of locations and lease management go hand and hand and that the implementation of lease accounting, administration and management software are often times tools to turn an opaque and tangential financial statement reference into data that is extracted, standardized and available to investors.