Last week, the Financial Accounting Standards Board (FASB) voted in principle to put lease obligations on the balance sheet. While changes in lease accounting have been discussed since the '80s — and the present rules-making project began 10 years ago — questions linger as to how this change would affect a company’s ability to borrow money, how it would affect financial statements and whether the changes would even affect the decision to lease or purchase. Diving deeper, how would the new lease rules affect treatments of types of leases, specifically open- or closed-end?
In speaking to lessors, answers to some of these questions are fairly clear. Other answers at this point might best be categorized in the Facebook relationship status lingo — “It’s complicated.”
Let’s tackle one of the more straightforward questions first: The lessors Business Fleet spoke to agreed that the changes would have little effect on a company’s decision to lease. That decision is made based on operational ease and convenience for lessee, advantages to outsourcing ownership and administration of a business asset, a company’s ability to tap into a leasing companies’ liquidity and low cost of capital, tax benefits. “None of that is changing,” says Shlomo Crandus, chief financial officer of Wheels Inc.
“I don’t see a seismic change on how (we) go to market because I think most customers are using our services as a fleet management provider as opposed to as a pure lessor,” says Tom Coffey, vice president sales and marketing for Merchants Fleet Management.
For most midsize to large companies, these lessors say the change shouldn’t have a major effect on corporate financial statements or how taxes are reported.
But how would it affect a company’s ability to borrow? Lease obligations are already taken into account by lenders as disclosures in the footnotes of financial statements. Yet there is some disagreement on how the rules would affect covenants and their leverage ratios. Under the new rules, leases would be counted as assets and corresponding liabilities on the balance sheet, but not counted as debt.
“Our reading is that it won’t affect the covenants that are driven by debt measures or leverage because it won’t be counted there,” Crandus says.
Others have a different view, though the difference is driven in part by the type of fleet. Smaller independent and franchised car rental companies would have lease obligations disclosed in notes to financial statements if the companies are audited by an outside CPA, says Ben Rosenbloom, chief marketing officer for Marple Fleet Leasing. Most do not — so most do not notate.
“All else being equal, the leverage will increase and the ratio of net worth to assets or liabilities won’t look as good as it did before,” says Rosenbloom. “The end result will be to make it more difficult (for smaller rental companies) to meet ratio covenants in most bank loan documents.”
On the commercial fleet side, Coffey says many small and midsize companies that lease have already made changes to their lease accounting in anticipation of the rules. “A lot of companies had been already starting to show their fleet lease obligations on their balance sheets,” he says. “We’ve also seen customers go to outright capitalizing of these leases more commonly than if they treated them as pure operating expenses.”
However, the rules change will likely have an effect on the accounting of closed- and open-end leases, and this is where the Facebook term is apropos.
Under current U.S. accounting rules, most vehicle leases do not appear on the lessee’s balance sheet. Both open- and closed-end leases are written to get off-balance sheet operating lease treatment, Crandus and others note.
Under the new rules, all types of leases will go on the lessee’s balance sheet, and the amount that goes on the balance sheet will be based on the contractual term of the lease. An open-end lease containing a 12-month term that then goes month-to-month would require 12 months of payments on the balance sheet. A closed-end lease that is typically written for a contractual term of two to three years would require a larger amount on the balance sheet, assuming the fleet does not believe there is an obligation to take on any residual risk on an open-end lease, Coffey says.
But whether that will tip the scales to companies switching lease types, “It is one of many factors that the lessee evaluates and won’t make that big of an impact,” Crandus says.
Crandus and others concur that the rules will make very noticeable changes on the balance sheets of companies that have substantial equipment or real estate lease obligations, such as airlines or drugstores. “Those are the companies that the regulators and accountants are focused on,” he says.
And for those rental companies that hadn’t been footnoting leases, Rosenbloom says the potential negative effects can be mitigated or eliminated through proper planning with lessors and other financial sources.
It’s important to remember that the final rules won’t be issued until January, which could ultimately affect answers to these questions. “Exactly how those asset and liability calculations will be made and how the monthly calculations will be recorded are still very much up in the air,” says Beth Kandrysawtz, CEO of Motorlease.