Thrown off balance?

True, moving these off-balance sheet liabilities on to the balance sheet is in substance a cosmetic exercise. The newly created on-balance sheet liability will be matched by a newly created asset relating to the leases. Also, there will be no change to the total cost associated with leases in the profit and loss account, although, the cost will be split up into a separate depreciation charge and interest charge to mimic the accounting treatment used for company-owned assets. What's more, companies do disclose the value of their operating leases already in the notes to their accounts. So in an ideal world, investors would be taking full account of these lease commitments, which in many regards are akin to debt, when assessing a company's finances.

However, for anyone that struggles to be convinced by “efficient market hypothesis”, it would not be altogether surprising if the market has not been paying full attention to these off-balance sheet liabilities – out of sight and out of mind, and all that. In which case, as the new regime comes into force, investors may well sit up and pay more attention to the financial risks associated with lease commitments. After all, why would the International Accounting Standards Board (ISAB) feel the need to push through the new rules if everything was totally hunky dory as it is.

For some companies that have asset-centric business models and lease most of the assets they use (this is often a very sensible model for a company to employ), the change in the numbers on the balance sheet will be huge. Take, for example, flexible office space provider Regus (RGU). It has achieved excellent growth assisted by a model of leasing properties which it then refurbishes and relets. There can be little argument this is a business financing a significant proportion of its growth by making commitments to make future rental payments. Therefore, any analysis of what would otherwise seem a modest £191m net debt position needs to be seen in the context of the £3.7bn of off-balance sheet lease obligations disclosed in the notes of its last accounts. From 2019, these lease commitments will have to be reflected on the balance sheet making them easier to build into an assessment of the company's financial position and far harder for the market to ignore.

Iconic Information, the company behind the ShareScope and SharePad investment tools, provides users with key data on both a lease-adjusted and unadjusted basis. The total value attributed to a company's leases is based on an estimate made from its reported operating lease expenses. The table below shows both lease-adjusted and unadjusted enterprise values (EV) for FTSE 350 companies based on Iconic's calculations. EV tries to provide a fuller view of the value of a company by not only looking at the price being put on its shares (the market cap) but also factoring in net debt. Given lease commitments are very similar to debt, these can be factored in to the calculation to give a lease-adjusted EV:

While the table below does not provide an exact replica of lease-adjusted EVs were the accounting changes already in force, it gives a good indication of the companies whose balance sheets are likely to look most different (more leveraged) following the change. The table is ordered from highest to lowest percentage change in EV caused by the lease adjustment.

Source: Iconic Information/Sharepad