Article about leasing MHE in spite of the new accounting rules
1. Article aboutleasingMHEin spite of the new accountingrules
Leaseswill nowbe accountedforundernew rules. Thisrule change will affectequipmentfinancing
decisions. Iamwritingthisarticle toexplainwhythe thinkingaboutwhethertopurchase or lease lift
trucks shouldnotchange at all.
What is behindthe changes in accounting?
Despite the protectionistandnationalisticimpulsesthat are growingin most countries these days,
capital doestendto move freelythroughoutmuchof the globe. For investorstobe able to make
appropriate investmentdecisions,whethertheyare buyingstocksorbondsor simplydecidingwhether
to hire a foreignenterprise toworkon a majorproject,decisionmakers have tobe able toreadthe
financialsof acompany in anycountry andcompare themto anyothercompanyin anothercountry.
In orderto achieve whatisknownasconvergence of accountingstandards,the IFRS(International
Financial ReportingStandards)usedinEurope andGAAP (GenerallyAcceptedAccountingPrinciples)
usedinthe UnitedStates have to be consistentwithone another. Aftermanyyearsof analysisand
consideration,IFRSandFASB(FederalAccountingStandardsBoard) have reachedasclose aspossible to
convergence regardingaccountingforleases. The authoritieswereconcernedabouthiddendebt inthe
formof lease obligations,andbecause of the assumptionthatnoanalystiscapable of turningpagesto
the notessectionof financials(where lease obligationsare alwayslisted), boththe IASBandFASBhave
beenworkingonmakingnewrulesforthe accountingtreatmentof leases.
The decisionshave beenmade andthe newsisnot ideal forlessors. There wasone areaof
disagreementthatcouldnotbe resolved,whichis whetheroperatingleasesstillhave aplace in
accounting. In the end,there wasa decisionthatthe US will still have twotypesof leases,one of which
will be writtenoff inastraightline muchas it istoday. For the restof the world underIFRSstandards,
the assetswill be accountedforina complex manner: the lessee mustnow treatanephemeral asset
knownas a “right-to-use”whichistransferredfromthe lessortothe lessee. I’mstill tryingtogetmy
mindaroundthe conceptthat somethingthatI ownas a lessoris now generatinganassetthat someone
else alsoowns. Thissoundsa bitlike spookyentanglementinQuantumphysics,but the decision has
beenmade sothere isnot much pointinfurtherargument.
How does thisimpact the leasing/purchasingdecision?
Clientswillnow face increased reportingburdensinordertolease equipment,includingarestatement
of pastleasesgoingbackthree years. Thiswill cause some users tochoose notto lease at all if the
hassle factormakesleasing difficultforoverburdenedaccountingstaffs.
In the case of MHE that wouldbe lettingthe cartdrive the horse. There are still greatreasonsto lease
the right kindof equipment. While leasingforsimple “balance sheetengineering”may longerbe a
smart thingto do, some assets simply should notbe owned. The righttype of equipmentcanbe
2. managedmore cost effectively if the equipmentisleased andnotowned bythe user. Material Handling
Equipmentfitsintothiscategoryveryneatly.
Material HandlingEquipmentis anassetthatis depletedwithuse. Anythingthatwearsoutandhas to
be replacedona more or lessregularschedule isacandidate fora lease. A lease enablesthe userto
make a decisionatthe endof the term to keepequipmentfora specificandcustomizedterm, orto
replace the equipment. Mycompany,PacificRimCapital,specializesinthisarena, andconstructs many
differenttype of leasesandrenewsthemforwhatevertermisperfectforourclient’ssituation.
Whena user decidestopurchase equipmentlike MHEit almostalwaysdefaultstokeepingitlongerthan
it should. Thisisbecause areplacementdecision isoften drivenbythe bookvalue of the asset. Witha
lease,if anassetiswearingout and becomingexpensive tomaintain afterthree yearsof heavyusage,
the usersimplyordersanotherone. Incontrast, owned equipmentwillhave tobe sold (whichrequires
expertise) andif ithasnot beendepreciatedoverthatshort36 monthterm, the ownermay take a book
value hit,which isa reductiontoprofit.
Leasingenables alesseetoconstructa contract that matchesits exactusage. For example,we often
write three yearleasesonbatteriesandfive yearleasesonthe lifttrucks. This,asany readerof thisblog
will know,allowsthe managertoreplace the batteriesastheygetusedupand still keepthe trucks.
Finally,itisimportanttonote that anyassetthat is ownedhasto be disposedof. A lessorof MHE will
have a great deal of expertise andexperienceremarketinganddisposingof forkliftsandrelated
equipment. PRC,havingleasedliterallybillionsof dollarsof MHE,has a significantnumberof people
and resourcespointedatthisproblem. A userwhois burdenedwiththe managementof hiswarehouse,
factoryor distributioncenter,hasalotmore on hisor herplate thanjust gettingthe maximumamount
of moneyoutof usedup equipment. Thisoftenresultsinthe userkeepingthe equipmenttoolongor
justsellingthe equipmenttoocheaply. Again,thiscan cause a hitto the bottomline.
In summary,there are manyreasonsto lease assetsthatbecome “depleted”overtime. Itmayno
longermake sense tolease somethingjusttogetoperatinglease treatmentand“keepitoff the balance
sheet”butit still issmartto lease the a rightkindof productionasset. MHE isone such asset.