Changes loom menacingly in the land of lease accounting. Be afraid… or not.
Many fiercely oppose pending changes to lease accounting, changes that would make leases look more like purchases on financial statements. While it may cause temporary turbulence with bank covenants and the like, I see a silver lining: because these changes make leases look less attractive on financial statements, I predict that many companies will make better decisions on their equipment and IT investments.
Why? Because many bad projects, projects with negative value if purchased, magically appear profitable if leased. “Appear” is the operative word because the profit is likely an illusion.
The two biggest warning flags are:
The best practice for avoiding errors is to base project approvals on purchase scenarios. Only after clearing that hurdle should we consider whether leasing is the preferred financing arrangement. However, if projects had a low or negative values if purchased but were approved based on a leasing scenario, it’s a good bet that those projects were mistakes.
It’s Never Over
The new accounting rules may temporarily curtail leasing, inadvertently reducing the number of bad projects that sneak through approval. However, leasing is an industry known for its creativity in ‘financial engineering.’ We will likely see new structures evolve that artfully dodge the new rules and the threat of errors return.
In any event, decision-makers need to keep up their guard when asked to approve projects employing leasing or any other fancy financing maneuvers. In every case ask the question, “What is the project value if we purchase the equipment outright?” If the project is a loser as a straight purchase, it is almost guaranteed that the fancy financing is simply concealing a bad project. If you would like to explore this further, drop me a line.
©Verax Point Consulting, LLC