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In this installment of Accounting Matters, we examine potential consequences of the Financial Accounting Standards Board’s Proposed Accounting Standards Updates for Leases. In the context of a previous accounting change (FIN 48), we investigate how these changes will affect firms’ accounting choices, investment decisions, debt covenant requirements, and analysis of other key financial data. Changes in accounting standards may have significant indirect economic effect on companies as they can trigger debt covenant violations, restrict access to capital, and distort key financial information used by investors and lenders. New accounting standards may also directly affect the calculation of employee bonuses and incentives that utilize EBITDA or operating income as benchmarks. We include recommendations for managers and identify specific debt covenant components that may limit the negative consequences of the proposed change to lease accounting.
In this article, we explored the potential impact of proposed changes in accounting principles associated with leasing activity (Topic 840). This proposal would change future lease accounting, for leases with terms greater than 12 months, such that firms would be required to recognize assets and liabilities from leases in the statement of financial position. Specifically, a lessee would book a new asset representing itsrightto use the leased asset, and also a new liability forthe accompanying lease payments. We know from prior academic research that such accounting changes are not costless and the implications can be far-reaching. As wasthe case with FIN 48, at face value, the proposed accounting standard changes for leases do not appear to directly impact the economics of the company but rather alter the way these transactions are reported for financial statement purposes. However, changes in GAAP could have real economic consequences for firms using leases, as well as for their creditors. Debt covenants, management bonuses, and other contracts are often contingent on ratios or other measures calculated using financial accounting data. Changes in the standards of accounting–—such as the proposed changes for lease accounting–—may cause firms to violate debt covenants, distort employee compensation calculations, and alter other contracts.