Leased equipment might include office equipment (furniture, photocopiers), industrial equipment (forklifts, machinery), transportation equipment (trucks, planes), and IT equipment (laptops, servers). The average Fortune 500 company leases between 1000 and 10,000 pieces of equipment representing between $100M and $1B of leasing obligations. Despite the relatively large size and dollar value of these equipment leasing portfolios, most companies have relatively few processes and controls to support their leasing program. No one organization clearly owns leasing within the company, and no one software application stores all of the leasing data. As a result, most CFOs don’t know what equipment they are leasing, where it is located, and when the leases expire.
Read more about Equipment Lease Management and the challenges it solves.
“Split-Stream Renewals” is one of the more complicated equipment leasing scenarios we have faced. Suppose you are a chemicals company that has leased 30 servers for your data center. At the end of the lease term, the IT department decides that it wants to keep 10 of the servers to support a critical production application for another 12 months. What about the other 20 servers? IT plans to send them back at some point in the near future.
Therefore, the Procurement department negotiates a 12-month renewal for the 10 servers on a quarterly payment schedule. The other 20 servers go into month-to-month evergreen payments. A few weeks later IT decides that it needs to keep the 20 servers for at least six months while the workloads are transitioned to newer boxes. Rather than continue the evergreen payments, Procurement decides to negotiate a six-month renewal for the 20 servers.
Here is where it gets tricky. The renewals for the 10 servers and the 20 servers both have quarterly payments. But the payment cycles are different. The 10 server payments are due January, April, July and October. The 20 server payments are due in March and June.
Can your ERP application handle the accounting and lease management for split-stream renewal scenario? We didn’t think so.
We have lots of interesting examples, but two that stand out are:
Corporate Jets – We hosted a competitive bid for two Gulfstream G650s. Multiple leasing companies bid on the lease terms which saved our customer $4.4 Million. That’s big money!
Here is a picture of the Gulfstream.
Mining Equipment – We financed a deal in Zambia. It was for $550,000 of mining equipment. How cool is that?
Here is a map of Africa with Zambia highlighted in case you are wondering where it is.
We helped one customer bid out a lease for forklifts and golf carts. What do forklifts and golf carts have to do with one another? This company operates a number of very large distribution centers. In those warehouses they use the forklifts to move materials and pallets around and they use golf carts to move the people around.
Although this makes perfect sense to warehouse managers, we found that it was confusing to leasing companies. We couldn’t find a single leasing company who would finance the leases for both forklifts and golf carts on the same schedule, so we had to do a split-award to different leasing companies.
FAQs – The New Lease Accounting Rules
The new lease accounting standards were under development for a period of 10 years. A joint project between FASB and IASB, multiple exposure drafts were issued with extensive public comments. Before FASB’s ASU 2016-02 and IFRS 16, lease accounting rules had not been updated in 40 years. The original rationale behind the standards were to protect everyday investors from potentially misleading financial statements.
With these new assets and liabilities, financial metrics, such as return on assets, EBITDA, interest coverage, and operating leverage, could change significantly for some companies. How will shareholders, bondholders, lenders, and credit rating agencies respond to these changes? Will these new liabilities on the balance sheet impact corporations’ ability to borrow money? What about their existing debt covenants? Will these accounting changes impact market capitalization or stock price?
With the introduction of the new lease accounting standards, several trillion dollars worth of assets and liabilities will transfer onto corporate balance sheets over the coming years. How will those new assets and liabilities impact the financial metrics that institutional and retail investors use to evaluate the financial performance of publicly traded companies? How will these new accounting rules impact asset turnover, return on assets and quick ratio?
According to the International Accounting Standards Board (IASB), listed companies are estimated to have around $3.3 trillion of leasing commitments, over 85 percent of which are off-balance sheet. Leasing obligations for a specific company can range from a few million dollars (on the low end) to tens of billions of dollars (on the high end). For example, Walgreens and AT&T each have over $30 billion in operating leasing obligations, while Hershey and Harley Davidson each have only a little more than $50 million in operating leases.
The deadline for applying the new standards is the end of 2019. However, actual deadlines will vary depending upon your fiscal year. For companies whose fiscal years end on December 31 the deadline will be in 2019. For companies whose fiscal years end March 30, June 30, or September 30, the deadline will be the respective dates in 2020.
A wealth of excellent documentation has been produced on the technical accounting aspects of the new lease accounting standards. The boards (FASB and IASB) have each published impact analysis studies and detailed accounting examples in addition to the actual standards documentation itself. Each of the Big Four (PWC, EY, Deloitte, and KPMG) have also published excellent perspectives, discussions, and guides to interpret the standards.
See a list of the Top 10 List of Resources and Guides on the New Lease Accounting Standards.
FAQs – How to Implement the New Lease Accounting Rules
Early on in the project you will need to identify who should be on your lease accounting project team. You will also need to decide who should lead the project and who should be the executive sponsor. At most large organizations, real estate is managed by a centralized group at headquarters along with office managers at various facilities. Equipment leases are trickier as these assets are owned by many different stakeholders across the business.
How long will it take to comply with the new accounting standards? Estimates vary from 6-12 months to 12-24 months. The real answer is that you won’t know until you get started and get knee-deep into the analysis. In our experience, the project implementation time frame will be influenced by the current state of your lease accounting, the complexity of your equipment leasing program, and the availability of key stakeholders to participate in the project.