Many companies in the marine industry rely on chartering or leasing vessels to maintain some flexibility in fleet size while maximizing returns.
Over the last decade, the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have been working on a plan to overhaul lease accounting. After much debate and substantial feedback from equipment finance companies and industry groups, new lease accounting rules were approved earlier this year. The new rules will become effective starting after December 15, 2018 for public companies, and after December 15, 2019 for private companies.
Whether the lease agreement in question is with a financial institution, a competitor, or a company’s own subsidiary, the new rules will affect how workboat operators account for leased equipment. The good news is that the final guidelines are much less retributive than many options originally proposed, and that leases will still be lucrative business tools for workboat operators. Even so, businesses that lease equipment should start preparing for the transition now.
Deciphering the Changes
Although workboat operators should expect some changes to the way they account for certain types of leases, the overall impact to most businesses will be nominal. The reasons businesses in the marine industry lease equipment and the benefits they gain from doing so will remain intact under the new rules.
However, the new standard will change how leases are accounted for on corporate balance sheets. Instead of appearing as a table of future payments in the footnotes, they will appear on the balance sheet as an asset and liability, but as a non-debt liability.
The fact is, many of the lease accounting changes are relatively neutral. The new rules have no impact on the income statement, and there is a limited effect on debt covenants. The rules for classifying whether a new contract is a capital (finance) lease or an operating lease are virtually the same as before under Generally Accepted Accounting Principles (GAAP) standards.
Also, under the new rules, the capitalized asset cost with operating leases will be lower compared to a loan or cash purchase, so it is still a good option even though it is capitalized. It’s also worth noting that a workboat operator’s credit ratings should not change just because the FASB changed the rules for recording and capitalizing operating leases. Bank lenders and credit analysts already take into consideration the operating lease obligation included in a company’s footnotes. They estimate the value of the implied asset and liability created by operating leases to adjust their measures and ratios used to make credit assessments. The proposed formula to capitalize operating leases under the new rules is substantially the same as the method used by rating agencies today.
In a follow-up column next week, I’ll address some specific actions businesses can take as they decide whether or not to lease equipment, and how to implement a detailed plan before the rule changes.
The views and opinions expressed in this post are the author’s and not necessarily those of WorkBoat.