Mandates will make hefty amounts of rent expenses disappear as corporations account for operating leases in a new way The proposed change of the decision to amend FAS 13, a 1976 rule that distinguished between capital-lease obligations, which appear on balance sheets, and operating leases, which don’t; will boost the EBITDA of companies with operating leases substantially. Companies that tend to hold large operating leases have been fearful of the impact of the rule change. Charles Mulford, an accounting professor told CFO.com “Given how EBITDA is calculated, any company with rent expense from an operation lease is going to see an increase in EBITDA.” The EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) measures a company’s ability to service debt, such an increase could provide more financial flexibility within financial covenants without a firm’s making actual improvements in its performance. The boost in EBITDA could most affect retail and technology firms because they tend to have the largest holdings of operating leases. Financial managers need to be aware this is coming and need to start working on the potential effects of this into their financial contracts that use EBITDA. Rappeport, Alan. “Lease Accounting: Falling Rents Will Boost EBITDA.” Nov. 2007: CFO Magazine ________________________________________________________ Alpha Omega’s Opinion: Treating capital leases and operating leases the same is a good idea because it elevates operating leases from the footnotes to the balance sheet where they belong. Regardless of form, leases are an interest bearing liability and a form of financing so they belong on the balance sheet. Companies often use accounting rules to get their leases off the balance sheet. This treatment enabled them to show less debt and leverage and perhaps appear stronger than they were. It may have also caused them to obtain less favorable terms than they could have gotten with a capital lease. It’s true that this change in accounting will affect EBITDA, but it’s also true that it will affect the fixed obligations that are serviced by EBITDA. In fact, a benefit from an increase in EBITDA might be more than offset by the increase in fixed obligations. Suppose a company has $5 million in EBITDA and $2 million in fixed obligations. This company has a coverage ratio of 2.5 times. If the accounting change causes EBITDA to increase to $7 million and fixed charges to increase to $4 million, its coverage ratio actually decreases to 1.75. Of course, there are many different possibilities and perspectives on EBITDA, so the impact will vary greatly. The bottom line remains the same - any analyst must understand what comprises a company’s EBITDA and understand what has changed between reporting periods.