Top Concerns About the New Lease Accounting Rules – Responses Included
CIT Group, in collaboration with CFO Research, had a survey, reported in CFO magazine, based on 158 responses from finance executives at US companies with between $25 million and $1 billion in revenue. Two-thirds of responses came from employees at companies with annual revenues of $25 million to $249 million. The topic was the new lease accounting rules. The participants surveyed had some concerns/questions about the new lease rules. Here are my responses to their questions:
Concern: The new accounting standard risked removing the rationale for leasing. “We employ leasing now due to the ability to carry less debt on our balance sheet, so as to free up financing for other capital improvements,” reported the head of finance for a financial services firm.
Response: For US companies, the new lease accounting rules will NOT increase debt on the balance sheet. This is a common misconception about the new rules. The new liabilities to be recorded on the balance sheet under the new lease accounting rules will not be deemed debt.
Concern: “My company prefers to lease long-term assets and have the flexibility to upgrade when technological upgrades warrant it.”
Response: Nothing about the new lease accounting rules precludes companies from upgrading to new assets if they choose. If these long term assets are currently recorded as capital leases, there will be very little difference between current accounting and the new lease rules. If the leases are currently recorded as operating leases, sure, the accounting becomes slightly more complex, but the “financial effect” on the income statement, EBITDA and Debt remains exactly the same. Companies will still have the flexibility to upgrade to new assets.
Concern: How the final form of the proposal will alter such key financial measures as return on assets, debt to equity, and cash flow.
Response: The new lease accounting rules will have NO EFFECT on Debt to Equity or Cash flow. It will, however, have a detrimental effect on return on assets, because under the new lease accounting rules an asset (called a right of use or ROU asset) is recorded on the balance sheet, without a corresponding increase in income.
Concern: Questions about the new rule’s impact on on a company’s ability to meet the terms of its existing bank covenants.
Response: This one is tricky. If your covenants are based primarily on “Debt” ratios, then your covenants will not be affected by the new lease rules. If, however, your covenants are based on return on assets, or total liabilities, the new rules could be detrimental to your financials. To avoid potential complications, some companies are specifying in their covenants that the ratios are based on GAAP as it exists as of a specific time. Please consult with your attorneys to determine if this course of action will work for you. In addition, please realize that this will be a high tide that affects all boats, but as my friend Sal Inserra (Atlanta Office Managing Partner at Crowe Horwath) once remarked, “Banks are smart and will not lose good clients simply based on an accounting change.”
Concern: The CIT-sponsored survey found 43% of respondents maintained either that they are not very well informed or that they feel that it is too early to tell what the impacts of the new accounting standard will be. This finding comes despite the fact that the survey also shows that two-thirds (65%) of respondents rank leasing as either critical to or an important part of their company’s growth over the next two years.
Response: If at this point you have not started evaluating the effect of the new lease accounting rules on your operations, frankly speaking, you are already behind.
Click here to read the full article by Pat Sweet from Asset Finance International.
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