As we move into 2019, U.S. businesses will have to plan for changes to lease accounting rules, which take effect for public companies this month and for private companies in December 2019.
The new lease accounting regulations require that a portion of operating leases appear on every business balance sheet. While this only means minor changes to most businesses, it’s important for manufacturers to understand the changes and make a plan for complying with them.
Understanding the Overall Impact
It is important to understand that the changes in operating leases will impact businesses minimally. Compared to the accounting treatment of traditional loans/purchase transactions, leasing will still be a prudent strategy. Here are a few reasons why:
- Because liability is considered as non-debt, it may not jeopardize debt-limit covenants.
- Due to the residual nature of operating leases, the asset and liability recorded may be less than the cost of the asset. This yields a lower on-book balance than a traditional loan would.
The Good News
One of the most common questions regarding the new rules is what will happen to a company’s credit rating if it capitalizes operating leases on the balance sheet. The good news is, the overall impact will be nominal. Most bank lenders and credit analysists already take footnoted operating lease obligations into account when assessing debt and liquidity ratios. According to FASB and UCC, an operating lease is not a debt – this helps to alleviate concerns about violating debt limitation covenants and other loan contracts if leases appear on the balance sheet.
Another positive under the new guidelines is that assets on an operating lease will be booked on the balance sheet resulting in a straight-line P&L expense. Therefore, a lease, compared to a loan, yields better earning benefits.
A Breakdown of the Benefits
While the new guidelines incur some changes, it’s important to understand that leasing continues to be a judicious business decision. Here are a few examples of benefits:
- Alternative capital source - allows for preservation of cash and lines of credit. Also, fixed rate vs. revolver.
- Cash flow savings - 100% financing, financing for training and installation costs.
- Tax advantages - expensing of full payment on income tax returns.
Make a Plan
While the impact of the lease accounting changes is minimal, it is still important for businesses to comply with the new rules. Manufacturers can stay ahead of the curve by evaluating their current lease obligations, understanding the requirements of the reported obligation, and completing a lease vs. loan analysis to verify which provides a lower after-tax cost of use. With dependable guidance, manufacturers can easily comply with all changes and be positioned for success for years to come.
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