When Leases Become Liabilities

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Changes to accounting standards may prevent hospitals from doing off-balance-sheet financing.

New accounting rules for equipment leases may soon change, forcing hospitals and other organizations to recognize their leases as assets rather than expenses. The new rule will add more cost and complexity to equipment leasing, say industry experts.

Since 1976, lease accounting rules have allowed all industries to account for equipment leases as either a capital lease or an operating lease. Many hospitals use the latter because it allows them to account for an equipment lease as a monthly expense rather than as an asset that goes on the balance sheet. "At the end of the term, the responsibility of the lessee is extinguished, they give the asset back to the owner of the equipment, and everyone goes on their merry way," says Ralph Petta, vice president for research and industry services at the Equipment Leasing and Finance Association in Washington, DC. "In this way, the lessee is able to shift the burden of ownership to another party," he adds.

The Financial Accounting Standards Board in the United States and the International Accounting Standards Board, however, have put together a project designed to change the rules by eliminating operating, or off-balance-sheet, leases and forcing lessees to use the capital lease accounting technique. The final rule will be issued in 2011, says Petta.

The upshot is lessees will have to recognize the asset and the accompanying liability as an asset without the distinction between ownership and use, says Petta. "It will make it more difficult for a lot of lessees and companies who only wish to use equipment and expense their equipment on their monthly financial statement."

It also creates a big hassle for hospitals that own land, but not the medical office buildings they lease on their property. Stella Visaggio, CPA, chief financial officer at Hackettstown (NJ) Regional Medical Center, says an unintended consequence of the new rule is that buildings residing on land that hospitals own may have to be accounted for as both an asset and a liability. Hackettstown Regional Medical Center, she says, leases about 35% of a 40,000-square-foot medical office building on land the hospital owns. A third party owns the building and leases out the rest of the space to physicians. The space the hospital leases is accounted for as an operating lease expense.

If the new accounting standard passes, Visaggio asks, "Will we have to account for that building as an asset when we really don't lease or own the entire building?" Visaggio is also concerned that under the new rule she will have to depreciate an asset that really isn't an asset. "Why would I want to depreciate something that we don't lease [in entirety] or own," says Visaggio.

She says it is common for hospitals to own the land but not the buildings. "Many hospitals don't want to give up the land, because it helps them control who is in the building." Hospitals also typically choose not to own medical buildings so they can free up their debt capacity to make other purchases or do renovations, says Visaggio.

Currently, the project, which could become rule, poses more questions than answers for hospitals. Ultimately, says Visaggio, hospitals? core business is not leasing or owning medical office buildings; the new rule will impact organizations at different levels.

Michelle Ponte

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