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Using Analytics to Reduce the Specter of Capitalizing All Operating Leases [Infographic]

By Josh Leonard

Josh Leonard
Partner, Real
Estate Consulting,
Deloitte Financial
Advisory Services LLP


Use any metaphor that comes to mind: going down the rabbit hole, stepping into the looking glass, landing in an alternate universe—whatever your preference, the depiction is apt. When Financial Accounting Standards No.13 (FAS 13) goes away and new operating lease accounting rules takes effect, there will be disconcerting, monumental change in many companies’ balance sheets, and it is not likely to be a pretty one.

As things stand now, companies can account for operating leases off balance sheet. Not so when the new changes come into play. At a stroke of FASB’s pen, approximately 1.5 trillion dollars’ worth of operating lease expenses will be need to be capitalized (which had previously been shown only as a footnote to the financial statements) which will add some really ugly numbers to the balance sheet for companies whose portfolios contain big chunks of real estate and leased equipment.

Scary as it sounds, though, the rule change is not the bogeyman here. Almost everyone will have to comply; the playing field will be level. That would be good if companies knew what the playing field looked like. Most do not. In fact, according to a February 2011 survey by Deloitte, 93% of companies are not prepared to comply with the new standards. A little more than 66% have not even analyzed the possible effects the change will have on their business.1

It does not really need to be said that these numbers are frightening, does it? Many companies in the survey did not have a good handle on what they should do to deal with the changes. Abandoning leasing toward acquisition was the choice of 25% of respondents. Some 40% said they would look at shorter term leases that would have a lesser effect on the balance sheet. Another 44% said they would try to alter lease terms. It is going to be a real upheaval.

What to do? Crystal balls would be good. Maybe one of those 1970s' magic eight balls would do. Do not have one? No problem; they do not work anyway. What does work is a commitment by companies to face the problem and use the data at their disposal to look at the numbers and try to understand how the changes wrought by the significant changes to FAS 13 will affect the bottom line.

Absent black magic and outdated toys, there is an option that companies can use to help them understand how the changes will affect their business. Analytics is that option. Analytics techniques such as scenario analysis and predictive modeling can provide companies with the ability to look at the future, play around with it, and try to build best-case scenarios to deal with the massive changes FAS 13 will bring.

As an example, let us look at what will happen to the balance sheet and the profit and loss when the new rule takes effect. You can take all of your operating lease information, run scenario modeling on it, and look at it over multiple time horizons—say one year, three years, or five years. You can see how capitalizing these operating leases will hit the books in the short term and the long term. You can answer questions, such as “How is this going to look on my balance sheet over time?” and “How is this going to impact the bottom line?” You can also figure out the implication of lease versus buy over time.

That is only one example of the power of analytics. Companies can also use analytics to model tax changes, buy-versus-lease options, lease-term options—the list is almost endless. The point is that using analytics can help companies get out of that woeful group of the 93% of companies who are not prepared to deal with the significant changes in FAS 13 and move into the group that is prepared. The new lease accounting is coming, no doubt. Which group do you belong to?

[1] A Deloitte survey on the FASB's proposed changes to lease accounting standards, 2011

A Response from an Industry Leader

Subodh Naik
ERS Director,
Deloitte LLP

Using analytics to reduce the specter of capitalizing all operating leases

Much has changed since our original research findings, which were published last year. There has been extensive ongoing debate about the finer accounting aspects of the standard—and a final standard will most likely be issued in 2013. Still, many companies are only beginning to realize the sheer magnitude of the efforts involved in inventorying their total population of leases and collecting necessary operational and financial data to support the requirements of the standard.

In my opinion, the industry should take a dual approach. First, industry leaders should voice their points of view to the FASB to refine the exposure draft where there is a compelling argument to be made. Simultaneously, they should also commence efforts to gather lease data in a systematic and organized manner so that they will not get caught flatfooted when the standard is issued. Finally, because of the significance of the issue, the sooner companies begin this effort, the better off they will be when it comes time to implement!

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This publication contains general information only and Deloitte Financial Advisory Services LLP ("Deloitte FAS") is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser.

Deloitte FAS shall not be responsible for any loss sustained by any person who relies on this publication.

As used in this document, “Deloitte” means Deloitte Financial Advisory Services LLP, a subsidiary of Deloitte LLP. Please see about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting.

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