Lease Accounting Changes: What You Need to Know
Though the lease accounting standards are in effect for public companies, the Financial Accounting Standards Board (FASB) recently announced that the implementation for private companies, nonprofits and certain tax-exempt entities has been delayed until 12/15/2021.1
The simple truth behind the changes
The overall impact to businesses like yours might be minimal. Companies that traditionally used capital leases to finance new equipment acquisition will see little, if any, change. And, for those who used operating leases in the past, leasing can still be a prudent equipment acquisition strategy. Here’s why:
- For equipment subject to an operating lease, an asset is booked using the present value of rents and other likely payments, known as the “right-of-use” (ROU) method. An offsetting liability is entered as an “obligation to pay.”
- Because the liability is considered non-debt (classed as Other Liabilities), it may not jeopardize debt-limit covenants.
- Leasing still provides balance sheet relief. Operating leases are residual-based structures. Consequently, the asset and liability recorded will probably be less than the cost of the asset. This yields a lower on-book balance than does financing with a traditional loan or capital lease. While the actual asset book balance is dependent upon equipment leased and structure used, many companies are able to achieve book balances that are 70% to 80% of the asset value.
Leasing offers additional advantages
While the new regulations indeed incur some changes to your accounting practices (as outlined in the adjacent table), it’s important to recognize the role they play in your equipment acquisition strategy. Leasing continues to be a judicious business option and offers a host of advantages unchanged by the new accounting regulations.
Benefits of equipment leasing remain strong
Alternative capital source
- Preservation of cash and lines of credit
- Fixed rate (vs. revolver)
- 100% financing, level payments
- Financing for training and installation costs
- Skip/seasonal payments
- Lower payments resulting from tax benefits and residual investment by lessor
- Expensing of tax lease payment on income tax returns
- Trade potentially unusable depreciation benefits for lower payments
- On an after-tax cost basis, many companies now find that a tax lease is cheaper than a loan
- Leases can help companies escape or avoid a net operating loss (NOL) position
- Options to fit varying business needs at end of lease
- Simplified add-ons/easier upgrades
- Manage technology cycle/reduce obsolescence risk
- Manage asset replacement cycles
- Streamlined financing process for many transactions
- Often available at point of sale
Three steps to a proactive plan
The benefits of equipment leasing remain strong; however, businesses are still faced with the challenge of complying with accounting rules. Here are the top three actions your business can take when considering your next equipment acquisition:
- Understand the new accounting requirements in light of your historical go-to means of paying for new equipment (including residual guarantees and return fees).
- Learn how new capital and operating lease options impact your organization’s key performance metrics.
- Complete a lease vs. loan analysis and determine your lower after-tax cost of use. Try to optimize the benefits of recent changes in business tax law.
Answers to common questions
The final regulations are much less stringent than many options originally proposed. Here are a few examples of questions commonly asked by business people:
“I receive a bonus based on my company’s return on assets (ROA). Because of regulation changes, there’s a high likelihood that ROA may drop. If that’s the case, wouldn’t my company be better off acquiring equipment with a loan rather than a lease?”
Assets on an operating lease are now booked on the balance sheet, but the ROU asset is almost always less than the equipment’s purchase price. This provides lessees with at least a partial balance-sheet sheltering effect, which could be significant for high-cost assets.
“I have a great credit rating. What happens if I capitalize operating leases on my balance sheet?”
Most bank lenders and credit analysts already take footnoted operating lease obligations into account when assessing debt and liquidity ratios.
“If leases appear on my balance sheet, won’t I violate debt limitation covenants from other loan contracts?”
Not necessarily. According to the Financial Accounting Standards Board (FASB), an operating lease is not a debt. Operating lease liabilities will now be listed in a non-debt category, such as “Other Liabilities.”
Trust, expertise and reliability
To transition successfully to the new lease accounting rules, both your financial advisor and equipment provider must be well informed and experienced. Start by seeking counsel from both internal and expert sources, including your financial team and auditors. Next, confer with a trusted equipment lease professional. For dependable guidance and industry expertise on every aspect of equipment leasing, Key Equipment Finance is poised to help you meet your business goals.
Please contact us to discuss how the new lease accounting regulations will affect your business, or to address any other leasing support needs.
To learn more:
Contact your Key Equipment Finance Sales Representative