Introduction to new lease accounting rule
A new rule was passed by the Financial Accounting Standards Board, or FASB, Wednesday, November 12, when they approved a new lease accounting rule that will increase the amount of liability companies must report on their balance sheets. Those that lease equipment must now report all long-term operating leases on the balance sheet at the present value of the expected future lease payments. The approved change is scheduled to take effect for public companies in December, 2018, and private companies in December, 2019.
The goal of this new rule is to provide more accurate financial statements, while increasing transparency surrounding the accounting of a company’s leases. While companies are already required to disclose lease commitments, they currently only have to put them in the footnotes of financial statements. The new rule would require that the obligations are included in companies’ balance sheets.
This rule, which could ultimately impact the financial results of many companies around the country, begs the question: “Is leasing equipment smart for your company, or should you strictly focus on financing the purchase of new equipment?”
This paper will explore the specific changes of the new rule, while explaining the possible affects it may have on the decision making for company’s looking to obtain new equipment.
Exploring the rule change
FASB’s new rule change requires all companies to reflect their operating leases on their balance sheets at the present value of the expected future lease payments. This will significantly increase the amount of liability companies must report on their balance sheets. Even though this rule change just passed, the effort to overhaul lease-accounting rules goes back to 2005 when the Securities and Exchange Commission called on the FASB to do so. Before that, the rules had not been changed since 1976.
For large companies like CVS Health Corp. and Delta Airlines, they will now have to increase the liability they report on their balance sheets by tens of billions of dollars. CVS leases real estate for thousands of their pharmacies totaling $27.3 billion in operating-lease obligations. Their long-term debt is $11.7 billion, which means the liability reflected on their balance sheet could increase by 250 percent. Delta, which leases their aircrafts, could be forced to increase the liability on their balance sheet by almost 150 percent.1
For public companies, it is assumed that bringing leases onto their corporate balance sheets could increase the liabilities around the U.S. by $1.5 trillion, with HIS Global Insight estimating that number could be closer to $2 trillion.1
This rule does not necessarily change their creditworthiness or underlying cash flow of larger, public companies, and should not impact how investors look at their business. But for smaller, private companies, the new move could affect how investors look at their company. While the new rule is designed to help investors, lenders and other creditors more clearly see the true health of companies that owe a lot of money through off balance sheet lease commitments, it will, at a minimum, change the financial metrics, potentially create financial covenant defaults and force companies to reconsider the benefits of leasing.
“The rule change will give investors, lenders and others a more accurate picture of the financial condition of the companies to which they provide capital,” Russell Golden, FASB chairman, said.
Many regulators have often said that companies try to structure the terms of their leases to enable them to keep from officially counting many leases on their books.
The Equipment Leasing and Finance Association, or ELFA, believes this change is not that big of a story and the new guidelines should not affect how companies do business or obtain equipment. The two major changes that companies can expect are balance sheet recognition and ongoing administrative changes – both changes that should be easy to manage, according to ELFA.
ELFA goes on to note that operating leases will be capitalized, with the lessee recognizing the “value” of the asset on the balance sheet, while noting a corresponding liability for the minimum lease payments, discounted at the rate implicit in the lease. The operating lease liability will not be classified as debt, but rather it will be an “other” liability. ELFA
How this new rule will affect the economy is yet to be determined. It can be assumed that many companies will evaluate how they invest their money and obtain their equipment, but the impact of these future decisions cannot be determined this early. Many thought leaders feel this could discourage companies from leasing future equipment, instead increasing the demand to directly own through equipment finance.
About Triumph Commercial Finance
Triumph Commercial Finance offers alternative financing options that are in tune with today’s economic environment. They understand the challenges associated with acquiring equipment and machinery needed to do business while still holding onto operating capital. Their experienced team of experts knows the ins and outs of equipment finance in order to make sure all needs are met.
To learn more about the ways that Triumph Commercial Finance can help your company experience success while maintaining growth through different financing options, please visit our website.
1 Rapoport, M. (2015, November 10). Coming to a Balance Sheet Near You: $2 Trillion in Leases. Retrieved November 17, 2015, from http://www.wsj.com/articles/leases-to-put-new-weight-on-corporate-balance-sheets-1447200831