Mission Matters Insights
Accounting for Leases Follow-upAugust 19, 2013
Exploring cash payment options vs. leasing equipment.
As I mentioned in my blog from September 28, 2012, the FASB and IASB are moving toward a new standard of accounting for leases. This post will bring you briefly up to date on that project and then discuss what I think is a more important topic related to the question of leasing.
In May 2013, the FASB and IASB jointly issued a proposal to increase transparency and comparability by recognizing the assets and liabilities that arise from lease transactions on the lessee’s balance sheet. The public comment period for those wishing to comment on this proposal ends on September 13, 2013. Subsequent to the comment period, the Boards plan to consider all feedback and begin re-deliberations of all significant issues during the fourth quarter of 2013. Nothing more is promised other than that.
The question of accounting for leases goes back over 40 years when the FASB first indicated that when a lease conveys all or most of the rights and risks of ownership to the lessee, the lease should be accounted for as a purchase. This means that the asset acquired and the related liability to pay for it should be placed on the balance sheet of the lessee. Sounds simple, doesn’t it? The fact that we are still talking about how to account for leases 40 years later is a testament to the creativity of the leasing companies as they write contracts conveying the right to use equipment to the lessee.
I would like to take a step back for a minute and forget about how to account for a lease and focus on how to best acquire machinery and equipment. It is obvious that once the FASB and IASB conclude their work, almost all leases will appear on the lessee’s financial statements as assets and related liabilities. The calculations of the amounts to record may be complex and convoluted, but an asset and liability will soon be on the balance sheet.
This is probably a good thing. I say this because companies may finally focus on the fact that they are acquiring an asset for a long term and agreeing to pay for that asset over time which, therefore, includes a cost for the time value of money – in other words, interest expense. Unfortunately, over the years we have seen companies enter into leases and pay exorbitantly high interest rates compared to what they could have paid had they purchased the asset and financed it through conventional financing options.
In some cases, management did not realize that they were in fact acquiring an asset that was “sold” to them as a lease. They failed to take the time to analyze and discover that they were in fact assuming all of the rights and risks of ownership together with a non-cancellable liability. Assets, which if purchased would have required board approval, were leased without invoking this control procedure. They also probably did not research alternative financing options which in many cases may have been substantially less costly than the interest rate implicit in the lease terms.
So the next time you are in need of a new or replacement piece of equipment and the manufacturer or dealer offers you the opportunity to lease it, be sure to ask about the price to pay cash for it. Then explore your financing options for obtaining that cash. Only then will you be able to make the best decision for your company.
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