In the first edition of CFO Chats, a new column from Bill Bosco of Leasing 101, Bosco outlines how a synthetic or operating lease can be more advantageous for a lessee than a “dollar out” lease.
Bill Bosco, President, Leasing 101
This is a new column for the Monitor and a new approach to Monitor articles. The premise is to present a slice in the life of a leasing sales person, so this column will feature common (yet fictional) conversations between a leasing sales person and their customer, the CFO of a company. These conversations could be formal sales calls or quick phone conversations to see how the customer is
doing, if the CFO is facing and new problems or if there are any new projects that may lead to new business for the lessor.
Since they may only face large financing decisions a few times a year, CFOs don’t usually know the array of leasing products available to them, so sales people need to know how to probe, solve problems and offer the structure that best serves the customer’s needs. So here we go with our first CFO Chat.
LEASING SALES PERSON: Hello. What’s new?
CFO: My tax manager says we were so profitable last year that we used up our net operating loss (NOL) and we will pay federal income taxes this year. We need to add $20 million in IT equipment and I was thinking of drawing on my bank lines to buy the assets since we have room in our line of credit. We should take advantage of bonus MACRS (bonus depreciation), as we can use the tax benefits of ownership of depreciable assets.
LEASING SALES PERSON: Have you considered leasing the IT equipment?
CFO: The IT vendor’s leasing guy is offering a “dollar out” lease where we will basically own the assets once we make all the lease payments. We’ll get the tax benefits of MACRS depreciation, as the “dollar out” lease is a finance lease for tax purposes. In other words, the IRS considers a “dollar out” lease the same as a financed purchase of the assets. It is an alternative that I am considering.
LEASING SALES PERSON: It’s true that the “dollar out” lease will give you tax ownership and 100% financing, but under the Topic 842 lease accounting rules, that structure (a finance lease) will be capitalized on your balance sheet as an asset and debt liability at 100% of the cost of the assets. Also, do you realize that drawing under your bank lines will also result in added debt at 100% of the cost of the asset and that the line of credit is debt and a floating rate loan?
Many feel the Federal Reserve will raise rates again this year. I think you should consider saving room in the line of credit for short-term needs. The added debt will also impact your debt ratios and may impact your debt limit covenants. The added assets will negatively impact measures like return on assets (ROA), return on equity (ROE) and return on invested capital (ROIC).
There are other lease options that will allow you to be the tax owner and should be more attractive from a financial presentation perspective than a borrowing or finance lease and they should not cost you anymore. I do have to ask one other question: Are you measured by EBITDA?
CFO: No, we are focused on ROE and earnings per share.
LEASING SALES PERSON: In that case, I think you should do a synthetic lease, as it is a financing for tax purposes (you will get
all the tax benefits) yet it is treated as an operating lease for accounting purposes. If properly structured, it will capitalize the lease at significantly less than the asset cost (there will be less of a negative impact to ROA, ROE, ROIC and debt ratios and limits). The expense pattern of an operating lease is a straight line rent expense that you report in your financial statements (the average rent for the lease term). That is a positive impact to EPS. Borrowing to buy or the “dollar out” lease will result in front loaded P&L cost equal to the sum of straight-line depreciation plus interest expense that will be high in the beginning of the loan and decline over its life as the loan or finance lease balance amortizes.
If you continue to always lease leasable assets using operating lease structures (synthetic or not) the benefits of lower reported assets and P&L cost will be permanent. I have the analysis to prove it. In other words, your key financial measures will be permanently better than if you buy all your leasable assets.
Additionally, and very importantly, the lease liability of an operating lease is not classified as debt. Instead, it is classified as an operating lease liability, meaning it is an operating liability and not debt as the obligation disappears in bankruptcy, so the liability does not impact debt limits in covenants.
CFO: How do I know what lease product it the right one for my company and how to I get the right product?
LEASING SALES PERSON: I don’t expect you to be an expert in lease products. I do think you should call me when you have new asset acquisition in mind. Use me as your advisor, as my company, ABC Leasing, is relationship-minded and we have a broad lease product offering. We want to be your lessor of choice. •
ABOUT THE AUTHOR: Bill Bosco is the president of Leasing 101, a lease consulting company. Bosco has more than 45 years of experience in the leasing industry. His areas of expertise are accounting, tax, financial analysis, structuring, pricing and training. He was on the Equipment Leasing and Finance Association’s accounting committee from 1988 to 2017 and was chairman for 10 years. He is a frequent author and speaker on leasing topics. He was selected to the FASB/IASB Lease Project working group. He can be reached at firstname.lastname@example.org.
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