LeasingNotes

Another lease tax?

Mon, 25 Jun 2007 19:34:57 -0700

What now? The latest word is that Alabama Governor Bob Riley is expected to sign a bill to raise revenue to help Baldwin County (Alabama) achieve its strategic plan, along with paying for some legislative delegation offices, and two historic sites. The largest costs in the strategic plan are related to road and bridge infrastructure. The bill allows the county commission to assess up to a 4 percent charge on the lease of "tangible" property, and up to 1.75 percent for vehicles, manufactured homes, truck trailers and tractor trailers. Fortunately for us, it does not apply to videos or boat docks. The tax, even without the videos, is expected to generate around $2 million a year.

State Representative Joe Faust sponsored the bill. I feel like I may have to pull a Biff Tannen on this guy. “Hello? Hello? Anybody home? Huh? Think, Faust. Think!” This bill has flaws at many levels. Right off the bat, it is an attack on the level playing field principle that ELFA so tirelessly promotes. Furthermore, it not only unfairly targets a specific industry (leasing!), it also has the potential to do harm to several other sectors of the local economy. For certain leasing customers, a residual-based lease payment is the only way they can afford to acquire equipment. For others, the matching of use, costs, and revenues provided by lease financing is a perfect fit with their business model. The costs of equipment acquisition just went up for these customers, but not for those who can pay cash or have larger lending facilities.]]>

The Cool Factor

Sat, 02 Jun 2007 17:49:00 -0700

Shortly after bemoaning in a recent post that I was not as young as I once was, I discovered that I wasn’t cool either (and not just in the eyes of my teenage children). Now, this probably doesn’t come as a surprise to those of you who recognize my penchant for accounting, but still, it brought me up short to find out that I work in an industry that isn’t considered cool. A double whammy and a cold one at that!

How did this startling revelation come to light? As I have said before, we need to bring in the future, future leaders to maintain the viability of the leasing industry. ELFA’s Industry Future Council and Executive Roundtable attendees also have identified this as a critical factor. One of the impediments they identified to doing so, however, is the perception of the leasing industry. Back in the day, the leasing industry had cachet. It was fast moving, developing, and a breeding ground for new products and ideas. This is no longer the case.

In addition to lacking visibility with young professionals and graduates, the leasing industry no longer has that “cool factor.” What that means, I am not exactly sure, but apparently has something to do with an inability to impress people in the bar when you tell them you work in the leasing industry. Something to do with the ‘job du jour’ mentality and leasing not being in the inner circle of hot jobs. In fairness to the comment, though, I have to say that I am getting similar feedback from younger leasing professionals as to the long-term prospects of leasing.

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Where was SOX?

Thu, 31 May 2007 17:45:15 -0700

As reported in Leasing News, Sterling Financial is struggling to survive in the aftermath of a major internal fraud committed at one of its financial services affiliates, Equipment Finance, LLC (EFI). Sterling currently expects to record a cumulative after-tax charge to its 2006 financial statements of approximately $145 million to $165 million, based upon the results of the investigation’s preliminary findings. Again, in the grand tradition of Enron, Tyco, and Worldcom, shareholders are going to take the hit. Which begs the question – “Where was SOX?”

Depending on with whom you speak, the Sarbanes-Oxley Act is either a costly, knee-jerk reaction to corporate excesses or a boon to shareholders in the form of protection from predatory executives. Although many people at the time thought that SOX, particularly Section 404, was essential to restoring confidence in the US capital markets, there have been many who subsequently have expressed reservations about its effectiveness. Even Michael Oxley, for whom SOX is named, recently stated that the act, if not wrong itself, was poorly implemented.

Irrespective of where you stand on the issue of SOX efficacy, the bottom line (how’s that for sweet accounting talk?) is that SOX was not an issue in the Sterling Financial debacle. Section 404 requires companies and their auditors to examine and report on the processes behind their financial reporting, with an emphasis on evaluating the internal controls associated with those processes.

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Future, future leaders

Fri, 18 May 2007 16:11:37 -0700

We all hear about the graying of America, with many of us actively participating in the process. It’s a fact of life that the nation, on average, is getting older. What has been apparent to some of us in the leasing industry, however, is the concomitant graying or our industry and the associated ramifications. Although these discussion have been going on for the past several years, they really hit home when industry participants pass away, or suffer from age-related problems, such as Bob Baker’s recent hospitalization.

The first thing that comes to mind is concern and sympathy for Bob and his family (our thoughts and prayers are with you). Then comes the reflection, both personal and professional, on what aging brings. When is something similar going to happen to me or one of my colleagues? Will I be ready? Are there things I should be doing to prepare for such an eventuality? How will my family and business fare? Sobering thoughts, and probably ones we don’t particularly care to dwell on, but not wanting something to happen doesn’t make it not happen.]]>

Could it be 2012?

Fri, 27 Apr 2007 06:24:26 -0700

Word coming out of the recently held IASB/FASB lease accounting working group is that things may not be as dire in the lease accounting world as was first predicted. True, the aristocrats of accounting alchemy are still determined that the risk and rewards model currently being used will be replaced, but, fortunately, the ‘right to use’ model is out in front of what is know as the ‘whole asset’ approach. Furthermore, how that ‘right to use’ may be measured is becoming clearer.

Under the whole asset approach to accounting for leases, the fair value of the asset would be capitalized in the lessee’s books, effectively eliminating any off balance sheet financing at all. The ‘right to use’ approach, however, depending on the model adopted, may still retain some off balance sheet features. Under one ‘right to use’ model, the lessee’s obligation to pay would be put on the balance sheet, along with the fair value of any purchase option, potentially putting the entire asset on the books (along with creating a derivative accounting nightmare for our industry).

Fortunately, it looks like the direction the debate is heading is to adopt what is, essentially, capital lease accounting for most leases (note the “most” comment). Under this ‘right to use’ model, the residual would still remain off the balance sheet, which, for some collateral types such as aircraft, can be significant. There also has been some discussion of exempting true usage leases, such as computers, power per seat, click contracts, etc., and, of course, the perennial favorite, small ticket leases. I can see it now – that $50 million deal you were working on? Well, it now has 5,000 schedules.

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Genie in a bottle?

Sun, 04 Mar 2007 13:21:33 -0700

Okay, I just couldn’t pass this one up. With a 412 to 0 vote, the House of Representatives passed legislation requiring the SEC, Public Accounting Oversight Board, and FASB to reduce the complexity in financial reporting. And this from the same bunch that brought us Sarbanes-Oxley! I mean, come on people – what are you thinking? (For some reason, the allegory of trying to put the genie back in the bottle comes to mind.)

The bill, entitled "Promoting Transparency in Financial Reporting Act of 2007," requires that a representative from each of the above-noted standard-setters annually appear before the Financial Services Committee and submit testimony on their efforts to reduce the complexity of financial reporting. This is to go on for the next five years, after which, I am certain, the whole problem will be solved. The bill also requires the testimony to include information pertaining to:

Reassessing complex and outdated accounting standards.
Improving the understandability, consistency, and overall usability of the existing accounting and auditing literature.
Developing principles-based accounting standards.
Encouraging the use and acceptance of interactive data.
Promoting disclosures in "plain English."

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Step-in-the-shoes regulations

Wed, 28 Feb 2007 17:16:29 -0700

That’s right – I said ‘step in the shoes’, not ‘don’t step on my blue suede shoes!’ The IRS recently issued final regulations on how to depreciate MACRS property acquired in a 1031 like-kind exchange. The final regs adopt the previously issued temporary regulations with only minor changes. So, for those of you who were concerned about entering into a full-blown LKE program based on temporary regulations, you can now breathe easy and get after it.

The final regs still maintain a step-in-the-shoes requirement for depreciating property acquired in an LKE. For those of you not familiar with this process, you have to split the depreciation on LKE replacement property into two pieces. These parts consist of (1) the remaining basis of the relinquished property that is carried over to the replacement property and (2) what is called the depreciable excess basis, which represents any additional consideration paid to acquire the replacement property. If the properties have the same recovery class and depreciation method, the remaining basis of the old property is written off over what is left of its recovery period. The depreciable excess basis is treated like separate property and is depreciated over the applicable recovery period of the asset.

As an example, assume you have forklifts with a tax basis $200,000 and three years of depreciation remaining. If you exchanged the old forklifts for new forklifts worth $500,000, you would depreciate the new forklifts in two pieces. The $200,000 piece would be depreciated using the MACRS percentages over the remaining three years, while the remaining $300,000 would be depreciated using MACRS over the next six years (assuming a 5-year class life, of course).]]>

Chinese financial leasing

Tue, 06 Feb 2007 02:50:39 -0700

China is continuing its efforts to create a viable leasing and finance industry within the country, as China's Banking Regulatory Commission (CBRC) has lifted a ban on domestic and foreign commercial banks investing in financial leasing companies. The proscription against such investment was originally put in place to keep a separation between the various types of finance companies and the products they offered.

Effective March 1, 2007, the CBRC will allow not only banks, but also leasing companies and manufacturers to hold shares in financial leasing companies. Barriers to entry, in the form of capital adequacy, also have been lowered, as the minimum registered capital of a financial leasing company is now around $13 million (an 80% reduction from the previous requirement). A minimum eight-percent capital adequacy ratio, consistent with Basel I, is still required.

These actions come on the heels of the second round of consultation on the draft Financial Leasing Law in September of last year. One aspect of this round is a law that would open the country’s aircraft leasing sector to bank capital, which now is one step closer to adoption.

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Super Bowl leasing parties

Fri, 02 Feb 2007 12:15:23 -0700

It is time, once again, for that uniquely American ritual of Super Bowl Sunday. Whether you are rooting for the Bears or Colts, looking forward to the Super Bowl commercials, or just confused at the level of hype surrounding the whole exercise, it does provide some great opportunities. Parties, parties, parties, for one thing. Not that one should need an excuse to get together with friends, but this Sunday is prime motivation to do so. The Super Bowl also provides license to consume copious amounts of food and alcohol and act foolishly. (I know these clauses are somewhere in the fine print regarding the event – I just don’t know where.)

Of course, some of us take our pleasure from the day in different ways. I for one, will, at some point during the festivities begin to wonder about the role leasing is playing in the event. For instance, how much of the equipment being used that day is leased? Even better, is there some funky thing being leased that I can add to my list of weird leases? By the way, I haven’t heard from many of you on the strangest thing that you have leased, so get on it.

Consider the broadcasting requirements of the day, alone. From where does all that equipment come? They need trucks and more trucks just to haul everyone’s stuff, and think about the electronic requirements. Flexibility and usage are the words on this day. What about generators for the venues? Platforms, telecommunications gear, cranes, forklifts, cookers, refrigerators, transportation – the list goes on and on. My guess it that even the stage that Prince sings from will be rented.

Great stuff, huh? Oh, and I heard that a game will be played, too.

Norvergence questions

Fri, 26 Jan 2007 13:59:21 -0700

While hanging out with some attorneys the other day (I know – lapse of judgment), the subject of service contracts came up, along with some enforceability issues, lessee practices, and legal foundations. Norvergence, of course, got mentioned. With that as background, I would like to pose some hypothetical questions to the lessees. The primary premise behind the questions is that, unlike the Norvergence situation, the service provider was legitimate, and the equipment was valued properly and had actual utility – basically, how business should be, and normally is, conducted. So, here we go.

Situation One – you buy equipment for $28,000 that performs an essential function and that requires some form of service (this may be fuel, electricity, or other form of service). Since the service provider is offering significant savings on the cost of the service if you pay for it up front, in a lump sum, you decide to prepay $12,000 for the services over the next four years. Unfortunately, after 18 months, the service provider goes out of business.

1. Who do you blame for this mess?

2. Do you seek legal redress and, if so, from whom?

Situation Two – same situation as One, except you buy the equipment by borrowing $28,000 from the bank, payable at $700 per month over the next 48 months. You also decide to prepay $12,000 for the services over the next four years. After 18 months, the service provider goes out of business.

1. Who do you blame for this mess?

2. Do you seek legal redress and, if so, from whom?

Do you continue to pay the bank loan on the equipment, even though it does not work without the service?]]>

The Emperor's New Clothes

Fri, 19 Jan 2007 02:10:06 -0700

Right after the ELFA annual convention last October, I had the opportunity(?) to circumnavigate the globe, which, obviously, gave me a lot of airplane time to think. As I pondered the recently attended convention, I found that, beyond the pleasure of seeing many old friends and associates, there were two key themes that I had noticed. Of the two, one was a celebration – the renaming of the ELA to the Equipment Leasing and Finance Association (ELFA), and one was a lament – the compression of margins.

Personally, I see these two themes as very connected and am surprised that no one has addressed this correlation. Is it not politically correct, does it throw water on trendy topics, or is it just uncomfortable to discuss? (I almost feel like the little boy and the Emperor’s new clothes here.) Regarding the margin compression, what does everyone expect to happen when they more actively compete in a commodity market like standard financing? Come on, this is not rocket science, folks. We all know that true leasing is more profitable and provides us with key product differentiation. Yet, we plug blithely along increasing our share of the low volume business and even celebrate the fact with a name change!

We, as an industry, our doing business in a way that offers our customer very little product differentiation and value add. Granted, competition is tight and margins are being squeezed everywhere, but each time we write a conditional sales contract, or even an EBO, we give up the ability to sell additional margin and the value that true leasing offers our customers. You would think that we would have learned by now that you can’t compete on price, which is about all you have with buck outs and loans. Where is the differentiation that defines an Outperformer?

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No delay for FIN 48

Wed, 17 Jan 2007 10:24:16 -0700

For those of you struggling with how to implement FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), in time for this year’s audit – keep struggling. Any help (or hope) that you thought might be on its way in the form of a postponement in the implementation of FIN 48 is not coming. Today, the FASB rejected any implementation delay, in spite of receiving close to 400 unsolicited letters requesting a one-year postponement in its December 15, 2006 effective date. (For those of you who don’t write to the FASB on a regular basis, for the FASB to get this many letters is absolutely astounding, solicited or not. As I think back, I don’t believe they got that many solicited responses during the original FAS 13 comment period.)

Under FIN 48, a company must determine whether it is more likely than not that any tax positions it takes will be sustained upon examination by the IRS. Once it has determined that the more likely than not standard is met, the company must measure the tax position to determine the amount of the benefit to be recognized in its financial statements using some crazy probability method (see my previous post on FIN 48 for a more painful explanation).

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Change and convergence

Wed, 13 Dec 2006 09:29:21 -0700

The hottest topic in US lease accounting these days is, of course, the changes that are expected to be made to FAS 13. I also answer a lot of questions regarding convergence with the international lease accounting standards, whether in the US or elsewhere around the world. Since I am constantly dealing with, and understand, lease accounting standards from around the world, the convergence of FAS 13 with the international standard has never really been a concern for me because I know that most standards fundamentally are the same as FAS 13. I found out that this view is a bit blind, however, in the last several weeks, culminating in the most recent ELFA Advanced Leasing Principles class I have been teaching this week.

I have come to realize that when most people ponder converging FAS 13 with the international lease accounting standard (IAS 17) they think that FAS 13 must change dramatically in order to be in sync with IAS 17. This is not the case, however, as the two standards are very much alike. Both FAS 13 and IAS 17, for instance, have classification tests regarding automatic transfer of title and bargain purchases options. Similarly, both standards have tests regarding the relationship of the lease term to economic life, and measuring the present value of the minimum lease payments. One true difference, though, is that synthetic leases are not allowed under IAS 17. Other than this, however, the two standards move pretty much in lock step.]]>

More on EBOs

Fri, 13 Oct 2006 12:40:54 -0700

One of the most common issues that I encounter in my teaching activities is the many definitions that often are used for the same word. Keeping the tax and accounting rules straight, for instance, is always confusing. This phenomenon is not limited to the regulatory arena, however. We in the leasing industry always are using similar terms to describe different products, etc. This is what has occurred in a recent post I made on Early Buyouts (EBOs). Luckily, my friend, Rick Remiker, the Managing Director of Merrill Lynch Capital – EF, has stepped in to help clarify EBO terminology by sharing his experience with us.

The context for Rick’s comments was my description of two types of EBOs. One of them was used to create off balance sheet leases, and the other form was used to meet potential flexibility issues of the lessee. Based on his experience, Rick believes that most industry participants would characterize an EBO as strictly an early buyout option without the ability to return the equipment at the EBO point. (As you may recall, the question that originated this discussion was “How does an EBO help with the FAS13 tests?”).

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Principles or pain?

Wed, 04 Oct 2006 13:09:42 -0700

Although not exactly sure as to what they will be, we all know that changes to lease accounting are coming. To emphasize this point, the FASB and IASB are talking tough regarding sticking to the proposed 2009 timetable. There even appears to be support for changes growing among senior finance executives, according to a national survey conducted by Grant Thornton LLP. In this survey, 63% of the executives responded “Yes” when asked, "Should lease accounting rules be revised to give investors more transparency?". This percentage was in line with the response to the question of, "Do we need greater transparency in financial reporting?", which was 65% in the affirmative.

The question I have is “How are these changes going to fit into the concept of principles-based accounting?” (Principles-based accounting suggests that the accounting for a transaction should be based on a broad conceptual framework, rather than bright-line tests.) I have no problem with this approach in theory, but the accounting regulators, while espousing the notion in words, have done exactly the opposite. Just look at the number of EITF topics and FASB staff positions that are issued each year. Rather than letting auditors apply the principles, they continue to drill down into the accounting application with even more specificity and rules. Where are the principles if we need to have specific guidance such that the regulators create a rule for every accounting nuance that arises?

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