The shifting leasing landscape
Significant accounting changes are looming that could affect companies that lease anything from offices, warehouses and machinery to motor vehicles, trucks and photocopiers.
The changes were first flagged in a discussion paper, Leases: preliminary views, released by the International Accounting Standards Board (IASB) and US Financial Accounting Standards Board in March last year.
Anna Crawford, accounting technical partner at Deloitte Touche Tohmatsu, says the proposals could lead to fundamental changes in the accounting for operating leases.
“Currently, operating leases are off balance sheet. Under these proposals, they will come on to the balance sheet and could affect covenants, gearing and performance ratios.
“They will affect the balance sheet, income statement and the earnings before interest, tax and amortisation (EBITA) numbers... but will not change the cash flows of the underlying leases.
“The proposals may also impose an administration burden on companies who may have to keep some kind of leasing register going forward.”
KPMG audit partner Kris Peach, elaborates: “All leases, whether currently classified as operating or financing, will be recognised on balance sheet. However, some transactions currently regarded as leases will be treated as ‘purchases’, with an associated financial liability. The greatest effect will be on those leases currently classified as operating leases, which will now recognise a lease asset and lease liability.
“This will also affect the Profit and Loss (P&L) statement as there will be finance expense recognised, rather than rental expense for leases currently classified as operating, and there will be a greater upfront impact on the P&L in the early years. Even leases currently classified as finance will find the amounts recognised will change.”
Crawford notes that the discussion paper will be followed by an exposure draft. It is expected out in the first half this year and is likely to provide more details about the changes. “Until the final standard is released, things are not cast in stone, but there is a very high degree of probability that these proposals will go through,” she says. “These proposals will probably not become effective until 2013, so companies will have two to three years to get used to them.”
So what should directors be doing in the meanwhile?
According to Crawford, the first step is to start understanding their organisations’ exposure to leases. “How many leases do they actually have? In the past, particularly when operating leases were off balance sheet, it is possible that not all leases were being captured.”
Peach adds: “Directors should ask management for an assessment of the effect on the balance sheet, P&L and debt covenants as a result of the changes. Directors and management will need to be ready to explain the impact to analysts and other users when it becomes effective. Generally, most finance lenders would be assessing existing leases in a similar way to the IASB proposals, but it would be wise to closely consider existing debt arrangements.
“If the company is currently renegotiating debt arrangements, directors should consider whether flexibility can be built into the arrangements when determining appropriate debt covenants to minimise the impact of the new standard when it’s effective. If part of the attraction of using operating leasing was to keep such finance off balance sheet, directors may wish to redo the comparison of the cost of the leasing finance against other forms of finance.”
Other changes
FleetPartners’ director of sales and marketing Adam Trevaskus believes future tax reforms will also have a large effect on fleet leasing, as the regime is aligned to the Federal Government’s environmental agenda.
“These tax reforms will result in a fundamental change to fleet leasing as it has done in the rest of the world,” he says. “In Australia, it is still the case that ‘the more you drive, the less you pay’, which is not sustainable. Any proposed increase in statutory tax brackets is simply ‘playing around the edges’ to satisfy the political agenda as opposed to the environmental one. However, in due course, this will have to change and with it so will the fleet policies of many organisations.”
He adds: “In advance of the tax reforms, we are already seeing changes as a result of foreign tax regimes because of the ‘long reach’ of global companies imposing their greener vehicle policies that are aligned to their own domestic tax laws.
“Prior to employee attitudes changing in Australia, companies are using this to recruit from competitors who have taken steps to remove large vehicles from their fleet policies. Therefore, the emphasis must be on making sure employees are engaged early on when formulating new fleet policies.”
The global financial crisis has also brought other changes to the leasing market. According to Trevaskus, companies are now more risk adverse, which means that more stakeholders are being brought into the decision-making process. More information is being requested and there is great discussion about the rationale, which has led to longer time scales and ironically, indecision.
In addition, he says companies are trying to address the challenge of balancing cost, choice and responsibility. This is as a result of occupational health and safety issues, company environmental charters and providing value (for staff retention purposes) to employees. “This value proposition is even more important due to restrictions companies currently have on increasing of salaries. Therefore, they are looking for ways to enhance employee packages by facilitating various vehicle-related benefits. Organisations are beginning to appreciate that you can increase choice without increasing cost.”
Common mistakes
What are the common mistakes made by companies who sign up for fleet operating leases?
“I’m always surprised by how little analysis businesses conduct on the ‘lease versus purchase’ decision. They need to look at both the financial impact as well as the ramifications of the potential loss of flexibility,” says Nigel Malcolm, founder and managing director of Fleetcare.
Malcolm adds that companies often fail to understand the true cost of leasing. “Many companies only think short-term – that is, about the perceived accounting convenience of leasing. The reality is that an off balance sheet leased fleet will cost more to operate. Vehicle maintenance will cost more than ‘a pay as you go’ scenario; finance will cost more and end of term costs will be high,” he says.
In addition, he says: “Companies actually think they can control their lease costs! They enter into complex pooling/profit share arrangements that take internal resources to manage and rarely break even.
He says companies often lock in with one leasing supplier for a number of years and fail to “shop” quotes to ensure competitiveness, which is good for the leasing company.
“Companies also fail to understand that they don’t get the best deal by going to tender and selecting the lowest quote at that time and then expecting that same performance from their supplier for the term of the contract. There are too many variables that they cannot control.”
FleetPartners’ director of sales and marketing Adam Trevaskus adds that mistakes occur when fleet operators focus too much on the fees and margins required at the expense of seeing the value of leasing and the true costs.
“These components only make up around five per cent of the total operating cost of the fleet. Therefore, the focus should really be on which fleet management organisation (FMO) can provide real value on the other 95 per cent. Choosing a partner on the basis of a $5 or $10 per month difference will not save money in the long-term.
“If you get the right value equation in your fleet, this can translate into more dollars. Companies need to select a FMO not on the basis of ‘selling a quote’, rather ask themselves this question: Will the FMO continuously challenge our business to strive for continuous improvement in the strategic value of the fleet?”