Tom Toton from Corcentric explores some of the many reasons why leasing conforms to the matching principles of accounting and business better than other asset management approaches.
There are many reasons why leasing conforms to the matching principles of accounting and business better than other asset management approaches. For one, leasing insulates the lessee from the vagaries of the used asset market, as well as the surprise expenses and pushes the valuation risk off to the lessor. It is the lessor who has the expertise and financial system that is designed to continuously mitigate such risks. And there are many other scenarios that support why leasing makes sense.
The variety of operational equipment utilization scenarios means that it is difficult to use straight-line depreciation by asset class to match the actual cost of usage and have it properly tie to revenue generation.
As we know in accounting, if you have revenue received in a given month, the expense that it took you to perform the duties associated with that revenue belong in the same financial period. Simply put, if a company is running a piece of equipment for three years and has carried revenue on that piece of equipment for the same time period, it should have an equipment expense commensurate with that revenue generation.
Things like diversity of assets by location — including type of asset, duty cycle and asset specs — are complex. Because of this complexity, it is impractical to set up a myriad of asset classes based on usage, type, location and depreciation differentials to handle it. While you might be able to set up quite a few classes of assets, it is not feasible to have a class for every asset in a fleet and its unique depreciation characteristics.
Even if basic asset classes have been set up, there is still a risk of being widely inaccurate when it comes to the market value of the equipment. Too often, as the equipment comes to the end of its useful life in a given application, the owner finds its net book value is well above the market value. What happens then is the “surprise expense” of the annual mark-to-market of asset valuation of assets nearing their end of useful operation.
When this occurs, executives complain about having catch-up expenses, which is compounded by the fact that there is no corresponding bonus or credit for underutilized assets. Unfortunately, these surprises are a common occurrence and the complaints about them are highest when the used asset market is lower.
Contract carriage and leasing companies have known this for a long time. For that reason, they directly tie monthly expenses to utilization and make predictions about end-of-term market expectations. The goal is to keep the remaining asset balance as close to market value as possible. They facilitate this via leases tied to longevity, usage and contract duration, not on the basic asset and its resulting plain depreciation. In addition, a periodic review of the assets and the secondary market allow adjustments to be made to avoid those surprise expenses.
Some lessees fear that if they enter a lease arrangement they may overpay. This can be remedied via a well-designed lease facility, individual schedules by location and/or usage with data analytics supporting the decisions based on each fleet’s specific operation. Regularly reviewing the data will surface potential problems earlier and allow for more options when dealing with imbalances. The adjustment can be as simple as keeping this asset a little longer, rather than trading that asset now.
A fleet that finds itself in the position of having to absorb too many surprise expenses may want to consider looking into sell lease-back as an option. This strategy allows a fleet to quickly get itself right-sized, as well as “right expensing.” After that, ongoing data analytics tied to a lease program end the depreciation mismatch for good.
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