Leasing standard: unwanted Christmas present?

As the year draws to an end, so the long awaited new lease accounting standards come closer to being released, but almost half of finance professionals are unaware of the significant changes to the company balance sheet which will follow, and 78% have yet to evaluate the impact of the new approach on their financial statements, according to new research from CIT Group, in collaboration with CFO Research.

Under the proposed standard, companies will have to record all leases longer than 12 months in term on the balance sheet, as nondebt liabilities. Currently, companies can simply expense operating leases for equipment and other assets. Whether negotiating new leases or renegotiating existing ones, finance executives need to prepare for the potential impact of the new requirement.

Too early to tell

But 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.

The survey results, reported in CFO magazine, were 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.

In individual responses, some indicated that 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.

Another response highlighted the fact that leasing gives companies operating flexibility and some protection against technological obsolescence. “Large capital equipment incorporates the latest technologies and these improve our operating efficiencies,” said the head of a company in the natural resources/mining sector, “so we want to be using the latest equipment.”

According to the head of finance for a company in the wholesale/retail sector: “My company prefers to lease long-term assets and have the flexibility to upgrade when technological upgrades warrant it.”

“Business as usual”

Current expectations are that the Financial Accounting Standards Board (FASB) will finalize its leasing proposal in early 2016, with an effective date of 2019.

However, nearly eight out of 10 respondents (78%) report that they have yet to evaluate the potential impact of the proposed changes on the financial statements. While 41% indicate plans to do so “at the appropriate time,” 37% say they have no plans to evaluate the new standard’s impact at all.

Most (73%) of respondents say their companies will “continue with business as usual”, although 45% say they either do not think that their companies are well prepared to adapt to the proposed change (34%) or simply don’t know if their companies are prepared (11%).

There’s concern about how lease accounting changes will affect their reporting of liabilities, and whether the final form of the proposal will alter such key financial measures as return on assets, debt to equity, and cash flow. Others have questions about the new rule’s impact on operating decisions and on a company’s ability to meet the terms of its existing bank covenants.

Cost and disruption

Despite the fact that very few respondents (6%) believe that the new standard will make leasing a more attractive financing option, a majority (65%) say they are unlikely to change their leasing portfolios solely as a consequence of the accounting change.

But many respondents say they have concerns about the cost and/or disruption involved in changing their companies’ financial statements, which has the effect of making leasing less attractive due to the complexity and work required by the new standard.

“The cost, both monetarily as well as structurally, of renegotiating our banking covenants to accommodate this standard will likely be significant enough to slow our forward momentum,” predicts the head of finance for a midsize private company in the retail/wholesale sector.