More on the fallout from the Enron scandal: changes in accounting practices and what it means to companies. From Bloomberg:
02/27 12:42
FASB Change May Add $100 Billion Debt to Books (Update2)
By Rob Urban
Norwalk, Connecticut, Feb. 27 (Bloomberg) -- U.S. companies may have to add more than $100 billion in debts to their books after accounting rule makers pass new regulations on the use of so- called synthetic leases used to hide real estate loans.
The Financial Accounting Standards Board members today agreed on most new rules for the type of financing vehicles that contributed to Enron Corp.'s collapse. Those rules will force ``the large majority of all synthetic lease'' arrangements to be reflected on corporate balance sheets, said FASB Chairman Edmund Jenkins.
Investors say the leases, which provide the tax benefits of real estate ownership while keeping the debt off the company's books, obscure the extent of a company's liabilities, and expose it to interest-rate risks. They're used by more than 2,000 companies in the U.S., including AOL Time Warner Inc., Microsoft Corp., Cisco Systems Inc. and Symantec Corp. to finance everything from headquarters buildings to retail stores.
``If the company could eventually be on the hook, then the liability should be fully disclosed on the balance sheet,'' said Victor Cunningham, director of research for the $1 billion Olstein Financial Alert Fund. ``Synthetic leases are short-term agreements and if we learn anything from Enron, it should be that this is not the kind of surprise that investors should have.''
AOL
In a synthetic lease arrangement, a financial institution sets up a special-purpose entity that borrows money to finance a new construction or to purchase an existing building for a company. AOL, for example, plans to finance construction of its new Manhattan headquarters through a synthetic lease arrangement set up by Bank of America Corp.
The entity holds the title and leases it to the company for the term of the lease, typically three to seven years, with the possibility for renewal. The leases also can be used for equipment purchases. During the lease's term, the company is allowed to deduct interest payments and depreciation of the property's value on its taxes. For accounting purposes, however, it treats the arrangement as a standard operating lease and keeps the property and the debt off its balance sheet.
The use of synthetic leases to finance real estate and equipment purchases has exploded over the past five years or so, said Richard Ader, chairman of U.S. Realty Advisors, a New York company that arranges traditional real estate leases.
Special-purpose entities, the off-balance sheet entities used in synthetic lease arrangements, hold more than $100 billion in corporate debt, Ader estimated.
`Just a Footnote'
``The banks structured these transactions and they used to run around with the accountants selling them,'' Ader said. ``You had the benefits of the tax deductions and yet for reporting purposes you treat it as a lease so the rent is just a footnote.''
Adding billions of dollars in debts to corporate America's books shouldn't adversely affect the companies' ability to borrow, said John Malysa, a senior director at Fitch Inc. That's because credit rating companies like Fitch, Standard & Poor's Corp. and Moody's Investors Service already take the leases into account in assessing a company's creditworthiness.
Most companies also describe the arrangements, in varying amounts of detail, in footnotes to their financial statements.
The effect of the proposed change will depend on the value of the real estate involved. If it's lost value since it was purchased, the company would have to book the property at its current market value, while its liability would include the entire remaining debt.
FASB, a private group that sets the ``generally accepted accounting principles'' used by U.S. corporations, plans to propose new guidelines on special-purpose entities, the off- balance-sheet vehicles used in synthetic lease arrangements, by next month. After a public comment period, new rules could be in place by June.
Who's In Control
The focus of the accounting standards board's effort will be to determine who controls the entity and who gets the benefit from it. The board's effort accelerated after the collapse of Enron, which used more than 3,000 off-balance sheet partnerships to hide billions of dollars in debt and inflate earnings.
``There's a sense of urgency now,'' said Ray Simpson, FASB's project manager for rule changes on consolidation.
If a sponsoring company controls the entity, and has the benefit of using the property, then it must be included in the company's consolidated financial statements, said Simpson.
``The lessee receives the primary benefits and by virtue of guarantees has the risks as well, so it would have to be consolidated on the balance sheet'' under proposed rule changes, said Simpson.
By April
The board expects to finish new rules, termed an interpretation of existing guidelines by the end of April. After a public comment period, they should be implemented by August said Jenkins. They'll apply immediately to new special purpose entities. Existing entities will have to meet the new rules by the beginning of a company's next fiscal year after Dec. 15.
Already, many companies are shying away from synthetic leases, said Thomas Elmer, a principal in Deloitte & Touche's real estate consulting business.
``We have had clients that were considering synthetics and decided on a different route; we've had other clients who have them and are now talking about unwinding them,'' said Elmer.
Krispy Kreme Doughnuts Inc. this month said it would eschew a planned $35 million synthetic lease for a new factory and put the financing cost on its books. A subsidiary of Wachovia Bank agreed to acquire the property and lease it to Krispy Kreme.
New Headquarters
AOL Time Warner plans to use a synthetic lease for a planned complex that will house its new headquarters, as well as a hotel, condominiums, a theater and retail space, said spokeswoman Tricia Primrose. If the rules are changed, AOL will use another financing method, she said.
Symantec, which makes computer-security products including Norton antivirus software, will continue using synthetic leases, Chief Executive John Thompson said. Symantec has $116.2 million in debt related to synthetic leases that doesn't appear on its balance sheet, according to a regulatory filing.
``I am not going to run away from a legal and useful financial instrument because of Enronitis,'' Thompson said.
AI
