Technology is advancing rapidly, and as new machinery begins to benefit businesses it’s important to consider how upcoming lease accounting changes will influence equipment acquisition strategies, according to a recent Industrial Machinery Digest article by Toni Larson, senior vice president of industrial equipment.
In recent changes to accounting regulations, a proportion of operating leases must appear on every business balance sheet. Contrary to some initial beliefs, the final rules impose less stringency than anticipated, leaving the benefits of leasing strong. These new lease accounting rules took effect for public companies in December of 2018 and will take effect for private companies in December 2019.
First, it’s important to understand the overall impact these changes have on operating leases. Compared to the accounting treatment of a traditional loan/purchase transaction leasing is still a prudent equipment acquisition strategy, and here’s why:
- An asset value is booked equal to right-of-use (ROUs), and an offsetting liability is entered as “obligation to pay.”
- Liability is considered non-debt – therefore, it may not jeopardize debit-limit covenants.
- Compared to financing a traditional loan, there will be lower on-book balances because asset and liability records will likely be less than the cost of the asset.
While the changes presented may be confusing or overwhelming, the final guidelines are much less intimidating. To help alleviate any confusion, we’ve outlined a few frequently asked questions:
QIf leases appear on my balance sheet, won’t I violate debt limitation covenants from other loan contracts?
According to the FASB and the Uniform Commercial Code (UCC), an operating lease is not a debt – operating lease liabilities are listed under non-debt categories.
QI have a great credit rating. What happens if I capitalize operating leases on my balance sheet?
Most bank lenders and credit analysts already take footnoted operating lease obligations into account when assessing debt and liquidity ratios.
When new guidelines result in changes to accounting practices, it is important to recognize the beneficial role they play in any equipment acquisition strategy. Leasing continues to offer advantages that remain unchanged such as, alternative capital source, preservation of cash/lines of credit, 100% financing, tax advantages, flexibility, reduced obsolescence risk, and a host of other benefits.
To transition successfully into his new year of lease accounting rules, manufacturers should start by seeking counsel from both inside and outside financial professionals. These actions will allow manufacturers to acquire the equipment they need to confidently pursue their business goals.