The ongoing consultation process around the proposed accountancy changes to formulate a common standard for all leased assets including company cars has put forward the proposal that all leases, whether they are finance or operating leases, should be on the company’s balance sheet. As a result, companies would be required to highlight how much their future liabilities are to their lease provider for these leased assets. The exception to this is short-term leases of less than 12 months, which will be exempt from the restriction.
Currently, if businesses are leasing vehicles on an operating lease they benefit by the liability not being shown on the balance sheet. In the future, the liability and assets must be transparent to lenders, demonstrating the total financial commitments of the organisation.
This new approach is referred to as the “right of use” approach and will mean the company (the lessee) would need to present the right to use the leased item and its corresponding liability (how much they owe the leasing company for leasing the vehicle) in their accounts. This could lead to a change in a company’s policy when it comes to leasing items of property, machinery, vehicles, etc.
For companies with a strong balance sheet the proposed changes should not have a significant impact. However, for organisations with a high level of indebtedness and gearing it may affect their ability to obtain credit with asset funders, banks and other lenders.
It certainly makes logical sense for the financiers and accountancy profession to adopt a consistent approach on how assets (owned or not) are represented on companies’ accounts. Without this approach, working out what the true level of liabilities and indebtedness of a business is will remain a challenge and therefore many organisations within the corporate sector could potentially be refused funding at a time when the sector is showing some initial signs of re-investing.
If companies are concerned about their gearing with lenders some may choose to rent or lease from suppliers for less than 12 months, relieving them of their obligation to show the assets on the balance sheet. If so, we’re likely to see the introduction of product innovations from the contract hire or flexi-rent sectors designed to attract this type of business. These might be in the form of more short-term leases (12 months or less) with no renewal option so that they retain the existing benefits of operating leases and qualify for off-balance sheet accounting under the proposed new standards.
With the consultation process still not exhausted – it is expected to be completed by the end of the summer 2014 – the timelines will be crystallised and the process will become clearer. The new standards are then likely to be adopted by 2017 with full progressive change achieved by 2018.
In the meantime, companies are advised to consult with their accountant and leasing or fleet management provider to check all the facts and figures and choose the appropriate course of action so they can ensure they are ready when the new standards come into force.