In August 2010, the Financial Accounting Standards Board (FASB) released its Proposed Accounting Standards Update on Leases which, if enacted, would have essentially eliminated the concept of an operating lease and required recognition of all leases on the balance sheet. For many of our clients, this change would have impacted balance sheets, debt covenants and future real estate transactions.
Many health care providers have a significant portfolio of equipment and real estate leases, which are drafted and characterized as operating leases, so that such leases do not appear on the provider’s balance sheet, while payments are shown as expenses on the income statement. Capital leases, however, are required to appear on a provider’s balance sheet as long-term obligations.
A 2010 FASB proposal would have required many health care providers to reclassify operating leases as long-term obligations, or debt. This proposed reclassification could affect compliance with previously agreed upon financial covenants in the provider’s debt agreements, and possibly result in a default under such covenants. Further, the change in approach at the accounting level would have caused most providers to question the structure of such transactions going forward, having lost a primary benefit of entering into sale/leaseback and similar transactions.
In response to comments received, FASB and the International Accounting Standards Board (IASB) met in February 2011 and considered keeping a revised two-tier system in place for lease accounting. The two classifications under consideration are “finance leases” and “other-than-finance” leases. “Finance leases” would be treated like an installment purchase, putting both an asset and a liability on the balance sheet. “Other than finance” leases, in which the financing element is deemed not be significant, would appear on the balance sheet but flow through the income statement, like operating leases. Each Board is still in the process of establishing indicators that would be used to identify the difference between these two types of leases.
FASB and IASB, after further deliberation and discussion, intend to issue a final standard for leases later in 2011. Health care providers should consult with their legal advisors and their accountants before the effective date of the final rules in order to understand the consequences of such changes.
For More Information:
If you have any questions, feel free to contact any of the following members of Polsinelli Shughart’s health care finance team: