By Mark Boada, Senior Editor
New rules for how publicly traded companies account for fleet vehicle operating leases start to take effect this year, but it appears that other than complying with the paperwork requirements, the general consensus among both fleet leasing companies and accounting firms is that they won’t change the way core fleet decisions are made.
The real aim of the new rule isn’t to change the way fleets do business, but to provide full disclosure to investors about how much money fleet operators owe by putting both sides of the lease on a company’s balance sheet. To clarify, I offer this little bit of review.
First of all, what’s a balance sheet? It’s a document that shows on one side the dollar value of all of a company’s assets, like raw materials, real estate, equipment, accounts receivable, bank accounts, petty cash, and investments. On the other side, it shows a company’s liabilities — mainly its short- and long-term debt and accounts payable – plus stockholder equity. The accounting requirement is that the sum total of the firm’s liabilities plus stockholder equity equals the total of the company’s assets. In other words, that they “balance” each other to the penny.
Until the new accounting rules, operating leases weren’t required to be listed on the balance sheet. Instead, they were treated like a rental arrangement and accounted for in a company’s income statement, where the payments were treated as an expense. This had the effect of reducing the company’s profit and, therefore, its income tax liability.
Instead, the new rule requires fleet vehicle operating leases to be treated like capital leases and be accounted for on the balance sheet. The value of the vehicles (technically speaking, the net present value of the fleet’s “right of use” of the vehicles) has to be listed as an asset, while the sum total of future lease payments has to be shown on the list of the firm’s liabilities. Essentially, these two should cancel out, and the only additional cost of the new regulation is setting up the accounting procedures to comply with the requirements.
Now, that might sound innocuous, but there was a potential problem here: if the future lease payments were considered debt, it would change the firm’s debt-to-equity ratio by making it look like all of sudden the company had taken a ton of new loans. If that were true, it could violate a number of loan agreements and could force credit bureaus that rate the company’s bonds to lower its credit rating. That, in turn, could force the company to pay higher interest rates on its debt, squeeze profits, reduce its expenses and lower its stock price.
But FASB solved this problem by declaring that future lease payments are NOT to be considered debt. And so with a wave of its magic wand, all of these potentially negative consequences were swept away.
This being the case, fleet leasing companies have been advising their clients that leasing still retains all of its advantages over purchasing their vehicles. Operating leases will still free up a company’s capital, and lease payments can still be taken as an expense that produces tax benefits. Similarly, the benefits of capital leases – which already are accounted for on balance sheets – remain unaffected: companies can continue to claim vehicle depreciation on their tax returns.
To be precise, operating leases don’t have to be shown on a publicly traded company’s balance sheet until 2018, but to make that happen the procedures to comply need to be put in place this year. (Privately owned companies have until 2019 to make the change.)
Fleet managers should expect to be called upon, if they haven’t already, by their organization’s finance and accounting departments to provide full information about their vehicles and lease contracts in order for them to make the calculations needed to comply with the new rule. Other than that, it seems at this time that fleets can just continue doing what they do best in the same ways they’ve been doing it.