Get Ready for Changes in Lease Reporting

Wednesday, December 08, 2010

By Richard Paine, Sr., from the December 2010 edition of MarineNews

Since the middle of 2006, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have been working towards changing how companies report their lease transactions on their balance sheets. Those companies (including publicly traded entities) whose reporting complies with Generally Accepted Accounting Principals (GAAP) must observe the reporting regulations as set down by FASB. The most recent FASB statement regarding lease accounting was made in 1976 and is known as FAS 13.

FAS 13 as we know it is undergoing major change. Consult your accountant to determine the scope of the change and how it will affect your business. As with anything else financial, the new rules will be both complex and arcane. Briefly:

Currently, there are two categories of leases. Operating leases (or in our business, bareboat charters) are financial instruments wherein the lessor/shipowner retains ownership of the asset, can claim and depreciate the asset over its economic life and reports rent from the lessee/charterer as income. For the lessee, operating leases are generally “off-balance sheet” and are currently required to be disclosed only as footnotes on the lessee’s balance sheet. As the lease is not reported as a liability, it tends to skew the overall financial picture of the lessee, especially long term liabilities. The lessee can deduct the lease rental payment as an operating expense.

Capital leases are in effect finance contracts, are treated as liabilities and appear as such on the lessee’s balance sheet. The lessee depreciates the asset, pays “rent” to the lessor consisting of interest and principal, amortizing the lease amount over a given period of time. As the lessor does not claim depreciation in a capital lease, the lessee’s rent payment is usually somewhat higher than in an operating lease. The ownership of the asset is effectively in the hands of the lessee as are the financial benefits and penalties.

To qualify a lease as a capital lease, any one of four tests must be met:
(1)    The lessee owns the asset at the end of the lease term.
(2)    There is a bargain purchase price option at the end of the lease term.
(3)    The term of the lease is 75% or more of the economic life of the asset.
(4)    The present value of the rents, using the lessee’s incremental borrowing rate, is 90% or more of the fair market value of the asset.

FASB and IASB want to treat all leases as capital leases and are formulating new rules for compliance to their proposed new reporting standards. While not yet in force, FASB issued an “Exposure Draft” On August 17, 2010 for comment by December 15, 2010. It is expected to issue a new “Exposure Draft” of the proposed regulation by early 2011 with implementation in late 2011 effective in 2012 or 2013.

Currently reporting under FAS 13 is a complex issue. The Boards are seeking to simplify financial reporting by re-categorizing all operating leases as capital leases. The rules for reporting will affect both lessor and lessee. Their goal is to create a more realistic picture of the financial condition of a company by providing a more accurate assessment of a company’s assets and liabilities.

Credit quality, timing of expenses, changes to EBITDA and continued compliance with existing covenants will be affected. Higher debt-to-equity ratios and lower interest coverage ratios will force credit ratings down a notch or two and will roil the credit waters for the foreseeable future. Not good, especially in the turbulent wake of the most recent credit and banking industry tsunamis. Lessors and lenders may find it very difficult to underwrite and approve transactions to the same client as their credit, after these accounting changes take effect, may decline significantly.

It is important to note that current operating leases will not be grandfathered into the new reporting scheme. Your operating leases will become capital leases virtually overnight and the previously unreported long term debt they reflect will land on your balance sheet just as quickly. The new rules will, when implemented, immediately impact all FASB/GAAP reporting companies with leases on or off their books.

Expect fewer leases with shorter lease terms, more uncertain valuation of assets, weakened balance sheet strength, and overall a more difficult credit environment. Although the changes may result in simpler and more accurate reporting they will create financial turmoil. On the upside, however, real financial transparency should enable investors to match revenue and expenses including all future commitments and enable them to make better investment decisions. Ultimately, it may be worth some of the pain. We’ll see.

Richard J. Paine, Sr. is the President of Marine-Finance.Com, a maritime consulting firm specializing in the financing and leasing of commercial marine vessels and other equipment. He can be reached at rpaine@marine-finance.com or 516-431-9285.

Maritime Reporter September 2014 Digital Edition
FREE Maritime Reporter Subscription
Latest Maritime News    rss feeds

Legal

ITIC Measures against Ebola

The International Transport Intermediaries Club (ITIC) has issued the following general advice related to the outbreak of Ebola. Vessels that have recently

ClassNK's Guidelines for Exhaust Gas Cleaning Systems

Leading classification society ClassNK announced that it has released Guidelines for Exhaust Gas Cleaning Systems. These guidelines cover class safety requirements

China, Vietnam Pledge Maritime Cooperation

China and Vietnam have agreed to "address and control" maritime disputes, state media said on Friday, as differences over the potentially energy-rich South China

Finance

Nordic American Offshore Declares Dividend

Nordic American Offshore Ltd. today announced that its board of directors has declared a dividend of $0.45 per common share for the third quarter 2014. This is the same as for the second quarter 2014.

Bollore Africa Logistics Sees Profit Plunge in H1

First half 2014 profit at shipping company Bollore Africa Logistics plunged to 5.89 billion CFA francs ($11.48 million) from 9.45 billion CFA francs in the same period last year,

Maduro Says Venezuela's 2015 Budget to Put Oil at $60

Venezuela's 2015 budget will be based on a target oil price of $60 dollars per barrel, President Nicolas Maduro said on Friday night, but he repeated expectations that prices will recover.

 
 
Maritime Careers / Shipboard Positions Maritime Contracts Maritime Security Maritime Standards Naval Architecture Pipelines Pod Propulsion Port Authority Ship Electronics Ship Repair
rss | archive | history | articles | privacy | terms and conditions | contributors | top maritime news | about us | copyright | maritime magazines
maritime security news | shipbuilding news | maritime industry | shipping news | maritime reporting | workboats news | ship design | maritime business

Time taken: 0.1899 sec (5 req/sec)