Urge to converge upends lease accounting and reporting

Valuation experts will never look at income statements and balance sheets the same again under proposed changes designed to unite lease accounting around the world.

Almost all companies will be affected by the changes introduced by the agreement between the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) to create a new, converged approach to lease accounting that would eradicate the old distinction between operating and capital leases.

Exposure draft: The new Proposed Accounting Standards Update—Leases (Topic 842): a revision of the 2010 proposed FASB Accounting Standards Update, Leases (Topic 840) says that all assets and liabilities arising from leases must be recognized on the balance sheet. Critics of the current rules say they allow too many leased assets to be invisible, which means the books don't accurately reflect a company’s true financial picture. We agree.

Valuation experts need to understand the implications of the rule changes now because it is likely that existing leases will not be grandfathered. The changes will affect virtually all firms because leasing assets is so common. Of course, companies that lease assets to others will especially be affected.

Here are the main implications on company financials from the proposed changes:

• Balance sheets will grow, and companies will appear to be more leveraged;

• Lease expense will fluctuate because the lease will be amortized using the effective interest method, so the expense will be higher in the early years and lower in the later years (under operating leases, lease expense stayed constant); and

• Certain financial ratios could be affected because EBITDA would change, as lease expense would be replaced with interest and depreciation expense.

The IASB and FASB have been working together since 2002 to achieve convergence of IFRS and U.S. GAAP. The new converged standard for leases is part of this effort and is designed to significantly increase global comparability, which it will do because of the number of organizations that use leases.

The new exposure draft can be found on the websites of IASB and FASB.

Valuation professionals know the challenge that businesses that combine real estate and operations pose. But there is another angle to consider. A recent New York Times article notes a small number of corporations have made an “aggressive move” to convert standard companies to real estate investment trusts (REITs) to avoid federal taxes.

Value increase: This strategy also appears to have a positive effect on value. A recent research report found that seven out of eight companies that became REITs in the bull market since March 2009 rose more after their conversions than another industry gauge, the MSCI U.S. REIT Index. The report goes on to say that “we see potential for a number of new REIT sectors in the future, including energy infrastructure (midstream pipelines, solar and wind farms, etc.), railroads, public infrastructure (private highways, bridges, ports, etc.), farmland, cemeteries and others.”

The IRS has become more liberal in its interpretation of “real property,” thus paving the way for more conversions. In a recent private letter ruling, the IRS allowed a data center and document storage company to convert to a REIT. Find an extended discussion of the recent IRS Private Letter Ruling 201314002, 2012 PLR LEXIS 1751 (April 5, 2013) in the June Business Valuation Update; the ruling is posted at BVLaw.

Watch out: The trouble is, this strategy could be seen as a loophole that needs to be closed. According to a report in the Wall Street Journal, Congress is scrutinizing the REIT exemption, which could bite the dust if the conversions push the envelope too much.

Valuation professionals will find loads of useful information in the June issue of BVU. Here’s a sampling:

• Key BV Topics From Latest APB Public Meeting. BVU speaks with Jay E. Fishman (Financial Research Associates), chair of the Appraisal Practices Board (APB), about the main takeaways from the recent APB public meeting in Austin, Texas.
  
  
• Valuing Shareholder Loans in Divorce: Sorting Out the Problem. Not intuitively obvious, the question of shareholder loans in the context of a valuation for divorce purposes is examined here, the first of a three-part series by Christine Baker (Meyers, Harrison & Pia LLC).
  
  
• Social Media: Unicorn or Horse for BV Professionals? Proven ways valuation experts build their practices by posting, blogging, and tweeting. Written by Rod Burkert (Burkert Valuation Advisors LLC) and Barbara Walters Price (Mercer Capital).
  
  
• Lost Business or Lost Profits? Key Considerations for Economic Damages Cases. These cases have important distinctions, and each implies its own analysis and calculations. It’s all explained by Neil Beaton (Alvarez and Marsal) and Tyler Farmer (Calfo Harrigan Leyh & Eakes).
  
  
• What to Consider When Carving Out the Value of a Firm’s Website. Stuart Weiss talks with Mike Pellegrino (Pellegrino & Associates LLC) about the intrinsic value of a firm’s website—separate and apart from the business itself.

To read these articles—plus a digest of the latest court cases—see the June issue of BVU.

CPE events ripped from the headlines

Last week’s BVWire discussed a recent bombshell court case where a jury found a hospital guilty of violating illegal kickback laws. The financial penalties could be so severe that the hospital may go bankrupt. The hospital tripped up on “commercial reasonableness,” which can be an elusive concept. That’s why you need to attend Commercial Reasonableness and FMV in Healthcare Valuation on May 29, featuring Mark Dietrich and James Pinna (Hunton & Williams), who will give you a better understanding of this slippery concept.

The May issue of BVU includes a case digest of a manufacturer of women's handbags suing over trademark infringement (Brighton Collectibles, Inc. v. RK Texas Leather Mfg.). There has been a rise in the volume of these types of cases. In Lost Profits in Trademark and Copyright Cases, expert John Pilkinton (Lone Peak Valuation Group) and attorney Jed Hansen (Thorpe North and Western) examine the processes of defining, analyzing, and measuring claims for damages on protected ideas, terms, or phrases. Part 4 of BVR’s 2013 Online Symposium on Economic Damages, this June 11 webinar will address emerging trends in the fields of trademark and copyright damages.

To ensure this email is delivered to your inbox, please add editor@bvwire.com to your e-mail address book. We respect your online time and privacy and pledge not to abuse this medium. To unsubscribe to BVWire™ reply to this e-mail with 'REMOVE BVWire' in the subject line or use the link below. This email was sent to %%emailaddress%%

Copyright © 2013 by Business Valuation Resources, LLC
BVWire™ (ISSN 1933-9364) is published weekly by
Business Valuation Resources, LLC

BVResources

BVMarketData

BVLibrary

BV Publications

BVR Education & CPE