Hidden in Plain Sight

Leasing may soon have to be justified on economic terms alone.

Moreover, he says, the tendency of companies to package multiple big-ticket items into a single lease has complicated subsequent mergers and private-equity buyouts. “If there’s $50 million of machine tools spread over five facilities and you’re buying four facilities, you may have to pay more to buy out equipment you don’t need,” he notes.

And while finance departments often drive the lease-versus-buy decision, that’s not always the case. In equipment-intensive industries, finance executives can sometimes be caught unaware of lease obligations because line managers preferred signing a lease to requesting approval for a large capital expenditure.

Charles W. Mulford, an accounting professor at the Georgia Institute of Technology, also suspects the accounting treatment may drive poor economic decisions. In theory, he says, the benefit of an operational lease is that the lessor can take advantage of economies of scale and the tax benefits of ownership, and pass some of the financial benefit along to a lessee with fewer financial resources. “That does happen,” he says. “But I suspect there are also examples where the inherent cost of funds in an operating lease is higher than a company’s actual cost of capital.” —T.R.

Bright Lines

Lease rules are easily skirted, says the SEC.

The current accounting standard for leases (FAS 13) defines a lease as a capital lease/asset sale if one of the following holds true:

(1) The lease transfers ownership to the lessee using the asset by the end of the lease term.

(2) The lease contains an option whereby the issuer can purchase the leased property at a significant discount to the expected fair value of the leased property at the end of the lease term.

(3) The term of the lease is equal to or greater than 75 percent of the estimated economic life of the leased property.

(4) The present value of the minimum lease payments to be made by the issuer is equal to or greater than 90 percent of the fair value of the leased property.

Sources: SEC, FASB

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