Reforms put in motion after the financial scandals of Enron, WorldCom and others nearly a decade ago will likely soon have an effect on fleets that lease their trucks rather than buying.
Sometime between the middle and the end of 2011, the U.S. Financial Accounting Standards Board and the International Accounting Standards Board plan to issue a new accounting standard that changes how leases are reported in financial statements.
While the details have not yet been finalized, it seems pretty certain that fleets will have to start reporting operating leases as an asset on their balance sheets. Under current rules, these types of leases are totally off the balance sheet, except for footnotes, and the lease payment is simply recognized as an expense on the income statement.
The proposed changes revise current accounting treatments under existing U.S. Generally Accepted Accounting Principles and International Financial Recording Standards. These changes will not change anything on your taxes, only in your financial reporting.
Why the Change
The current lease accounting rules have been in existence since 1976, explained Brent Stevens, corporate services manager with Paclease, in a webinar last week.
"The current standard has been highly criticized ever since it was issued," he said, because it's open to interpretation, "and encourages structuring [of lease agreements] - some may say manipulation - to get the desired result."
FASB, the Financial Accounting Standards Board, which establishes the generally accepting accounting principles for the U.S., and the International Accounting Standards Board, or IASB, which does the same for about 120 other countries, announced in July 2006 they would jointly develop new lease accounting guidelines. They issued their draft proposal last August and accepted comments through mid-December. The schedule is to have final guidelines out this summer, although the exact implementation date is yet to be determined.
The reason FASB and IASB embarked on this project goes back to the Enron scandal and others like it. The Sarbanes-Oxley Act of 2002, which was the response to the major corporate and accounting scandals that included Enron, set a number of new or stricter standards for U.S. public boards, management and public accounting. The most widely known is probably the part that requires senior executives to take responsibility for financial statements. But there are also enhanced financial disclosures for off-balance-sheet transactions, among other things. And the Act requires the Securities and Exchange Commission and the Controller General to perform various studies and report to Congress. Such a report by the SEC in 2005 focused on off-balance-sheet arrangements and recommended FASB undertake a project to reconsider lease accounting standards.
Among other provisions, the draft proposal would eliminate the practice of reporting operating lease accounting off balance sheet.
"There have been a large number of comment letters received by the boards concerning the proposed rules," Stevens said. "Most have been fairly critical of some of the requirements, primarily some of the complications that may arise in complying with the proposed rules. Regardless of those letters, it's likely that leases will be reported on balance sheet. There may be some revisions to the proposal, but the bottom line is there will be on balance sheet treatment going forward."
Stevens walked webinar participants through some of those complexities that have been criticized. For instance, one highly criticized part of the proposal is how the lease term is arrived at. If there are renewal options, the lessee has to determine the most probable term, including the options.
This will likely not affect a large number of full-service truck leasing customers, as renewal options are generally not used, and when they are, it's for fairly short terms - maybe a three-year base lease with a two-year option. However, Stevens noted, "It will have a great impact on other industries, such as real estate. So those of you who lease your facilities will be subject to this portion of the rules."
More than 700 letters have been received. "Generally the letters support the goal of improved reporting; however every letter I have viewed, are generally critical of many of the provisions -- particularly the provisions that add complexity," Stevens said.
"Based on the number of comment letters that have been received, and most of them are well thought out arguments, it's my expectation that the final rules will change at least somewhat. It's not possible to determine the impact on the final rules, but I think we can expect some revisions. However, I'm confident that the operating lease treatment will be eliminated and all leases will be recorded on the balance sheet. What may change are some of the complexities in the current proposed rules."
Stevens believes that any changes won't go into effect until 2012 and more likely 2013.
Stevens said the changes will not substantially change leasing decisions and practices at fleets, being primarily limited to accounting paperwork.
Some people have expressed concern that having to report leases on the balance sheet will negatively impact their credit rating. But at least for those lenders who are familiar with the trucking industry, it's likely they already were making estimates of those liabilities based on your footnotes.
In fact, Stevens said, PriceWaterhouseCooper recently estimated, after studying how the lease reporting changes would affect 3,000 companies, that for 93 percent of those companies, they actually would report lower lease liabilities under the proposed standard than the analysts and lenders were estimating.
On the other hand, Stevens warned, the change could affect your loan covenants. "It's important to get out in front of this issue with your lenders and have a discussion up front, because you will have higher liabilities, and you may have covenants that require you to maintain minimum leverage."
Stevens also said that the changes should not change the financial lease vs. buy analysis, because that financial decision is based on after-tax cash flows.
"The tax treatment is separate from the financial reporting treatment," he said. "Another reality to keep in mind is that leases still have numerous benefits, including preservation of cash, protection from residual risk, protection from changing technology, and a predictable expense pattern."
Read more about leasing in the February issue of Heavy Duty Trucking magazine.