Leasing equipment has long been a standard practice for businesses and can be an attractive option for several reasons. Because there is a minimal capital outlay, leasing allows businesses to utilize its cash or debt to meet other needs that they are facing. Additionally, businesses in industries that are regularly innovating do not want to be saddled with old equipment and want the payment flexibility that leasing provides over ownership. To show one of the biggest benefits of leasing, it’s important to understand the two primary types leases. A capital lease is a debt-to-own asset where at the end of payments, the asset is owned outright. An operating lease is far different, where the lessee makes payments for the ability to use the asset, but will not gain equity.
In the past, many companies were attracted to leasing because under the old rules, GAAP allowed business to keep their operating leases off-balance-sheet. Now, under the new leasing standard, ASU 2016-02, companies are required to recognize all leased assets and liabilities on their balance sheets in an effort to increase balance sheet transparency since lease payments are contractual obligations of the company.
This standard is not being implemented overnight for private companies. The new standard of operating lease reporting will be effective for the fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early application is permitted.
With the advantage of keeping assets off the balance sheet going away, companies should re-evaluate their lease vs. buy decisions. The decision should be made based on what is more economically beneficial to the company. Building leases will likely remain more attractive to retail companies. Additionally, for rapidly depreciating equipment, leasing will is expected to remain more attractive than owning. Companies should weigh the costs and benefits when making lease vs. buy decisions, considering that shorter term leases may have more exposure to risks such as price increases.
Here are five steps to take to consider the impact the new lease transparency standards will have on your business:
Identify all lease agreements held by the company.
Evaluate each lease to determine the applicable accounting model to apply (capital or operating).
· If a lease is one year or less and does not include an option to purchase the underlying asset, it is considered a short-term lease and monthly payments are expensed on the Income Statement. There is no requirement to record the asset and related future payment obligation on the Balance Sheet.
Consider whether you need to renegotiate leases.
Make sure your team understands how leases should be presented in your company’s financial statements. Gather the required information on existing leases and capture data on new leases to decrease the chances of disruption or noncompliance later.
While some companies believe this is simply a rearrangement to fulfill new compliance regulations, it also presents an opportunity to revisit sections of your business that be on autopilot. Do you actually need the things that have been regularly leased? Should you reevaluate the life cycle of equipment in your business? Could you be getting a better deal by purchasing the equipment? Winston Churchill once famously said, “Never let a good crisis go to waste.” For more information about the new FASB lease guidance, please contact Brittany Carman at 423-486-9300.