Since Halloween just ended, it’s time to put to rest the Bogeyman status of the new FASB leasing standards. Hint: this Bogeyman’s not that scary.
Trepidation might have been the word of the day when the FASB, back in 2006, at the direction of the SEC, first proposed new FASB 13 leasing guideline considerations to basically eradicate operating lease benefits. However, as we now know, after substantial influential back and forth dialogue led by many/most large cap Lessee businesses and industry associations (over a 10+ year period), a working compromise was achieved The give: improve financial reporting transparency by moving off-balance sheet operating lease reporting onto the balance sheet. The take: retain a two lease classification accounting system for both Finance (ownership model) and operating leases (non-ownership model).
Doesn’t sound like a big deal now, but without a vigilant educational campaign, and quite frankly financial/legal fight, the significant benefits of operating leases could have gone away. It took some 1,500 comment letters, significant lobbying, and utilization of many industry watchdog associations like the ELFA to spearhead efforts to educate FASB and other influential regulators on the substantial business merits of operating leases and their necessary place in the vibrant U.S. equipment finance industry. Maintaining the benefits of ownership risk reduction (residual, obsolescence, and disposal) and pricing benefits transfer will be crucial to efficiently enabling U.S. companies the capital access needed to procure strategic assets that drive individual company growth and overall U.S. GDP growth as well.
Starting in 2019, public companies will be required to bring operating leases onto the balance sheet as “non-debt” liabilities (Lessee does not own the asset – right to use),so financial transparency (debatable it wasn’t there before) will improve for investors, creditors, and analysts alike, while the business essence and benefits of operating leases remain largely intact. Comparative reporting will be retroactive three years, so there will be some accounting work to do here. That said, a little work to retain all the financial benefits listed below seems like a fair deal.
Significant operating lease benefits
- Balance sheet capital cost listed (only PV of rents) less than finance lease or cash purchase (therefore, still partially off-balance sheet)
- P&L – straight line expense of total lease payment (no front-end loaded depreciation and imputed interest costs associated with borrowing to purchase)
- Compared to borrowing to buy companies’ financial statements will report a better Return on Assets (ROA), a measure used by many equity analysts
Other leasing benefits remain
- Efficient capital raise (100% financing) no down payment, fixed rate, level pay, lower cost on balance sheet
- Low cost of capital (low payments due to tax benefits, residual and lessor capital market access) improved cash flow
- Tax benefits pricing influence (when Lessee can’t use tax benefits)
- No ownership risk (Lessee return options)
- Quick and easy approval process (much less scrutiny than loan approvals)
With respect to mid-to-large ticket asset types such as trucks, the significance of Lessor residual investments and active secondary equipment markets allow Lessees to reap meaningful benefits of lower, transparent predictable payments in addition to elimination of ownership risk. It doesn’t take a rocket scientist to figure a cost reduction basis of 35% to 40% (realistic Lessor residual investment range example), leads down several positive economic paths.
For many companies, transportation is not their core business but a means to an end; getting their product to market. That’s why, for those companies, leasing transportation assets makes sound capital preservation business sense as compared to purchasing, especially with the enormous costs to purchase and maintain today’s tech-heavy trucks. The benefits are clear for those companies that turn to leasing,
There will still be concerns regarding the new FASB guidelines, but the benefits listed above should definitely mitigate the extra time and potential expense that companies might realize. In reality, in the scheme of things, there really aren’t that many new changes. Ultimately, your focus should be on your company’s core competency and leasing will enable you to maintain that focus.
By now, most CFO’s and finance professionals alike have been exposed to enough FASB change white papers that, if shredded, could be used as mummy costumes. Hopefully, this little article properly exorcises the leasing benefits be gone ‘Bogeyman’. As a reminder, leasing benefits remain and should be a strategic finance consideration within company growth initiatives and capital asset acquisition planning.