Leasing practices are changing. Although these changes will not be fully effective until December 15th, 2018 for public entities and December 15th, 2019 for all others, it is best to know what the changes will be and how you can prepare.
Currently, office equipment leasing transactions are usually implemented as one of two options: Operating leases (most commonly referred to as Fair Market Value or FMV) and Capital leases (referred to as Dollar Buyout leases).
Types of Leases
Operating, or FMV, leases are treated like a rental; your lease payments are an expense and the asset stays off your balance sheet. At the end of the lease, there is usually a purchase option to exercise the “Fair Market Value” determined by the leasing company at the end of the lease, not the beginning. This treatment allows your copier company to come back to you at the end of the lease and say, “It’s time to refresh all of your copiers,” as they control the assets and can determine their disposition, including the purchase price should you decide you want to keep them and just continue maintenance.
Capital, or Dollar Buyout, leases are structured more like a loan; the asset is treated as owned by the lessee so it must appear on your balance sheet. This type of lease is really an extended purchase option, since you are paying off the asset during the life of the lease agreement.
Most organizations in the past have opted for an Operating/FMV lease to avoid having to recognize the liability on their balance sheet. I’ve heard this over and over from our clients as we write lease agreements, “No matter what, the lease needs to be an operational expense.” We know this requirement is being driven by finance to drive better balance sheet metrics, even though this type of lease gives more control to the lessor.
There is usually very little difference in the monthly payment between these two options.
Now steps in the IRS with new rules…. Topic 842.
New Practices with Leases
The new practices will change the name of Capital lease to Finance lease, with both Operating and Capital (Finance) leases being shown on your balance sheet for any terms greater than one year.
Let me repeat that…. Both types of leases will ultimately end up on your balance sheet as a liability.
This begs the question, “ Why wouldn’t you pay a few dollars more per month and make all leases a Finance lease since it has to be on your balance sheet anyway? Then you have the option to not replace your copier at the end of the lease, and simply run it a few more years without a lease payment?” Your copier vendor most likely does not offer this option as it hurts their refresh sales opportunity.
At Lasers Resource, we take a different approach. We don’t push clients into a one-sided lease agreement. We openly and transparently explain the difference and will advise the proper approach. For instance, we see many non-profits with an Operating / FMV lease because they shopped the “lowest bid” monthly payment. The non-profit ends up paying more in property taxes (even though they’re tax exempt) due to the Capital lease structure.
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Additionally, there will be no more bundling of services. Topic 842 requires that all leased and non-leased components to be separated. This means that you will no longer be able to roll your lease payments and maintenance agreement payments into one charge. If you have this type of “bundled agreement”, you will need to contact your provider to separate these amounts by the deadline.
For more information on this topic, a prominent local CPA firm, Hungerford Nichols, recently published an “Obituary for the Operating Lease”. You can read more on this topic and how these changes will impact your company here.