As promised on my previous article, this article will be on the definition of the word, “Lease”. As it turns out, just like so many other buzz words in our society, certain words have legal definitions that do not coincide with Webster’s definitions. Go figure.
The IRS and the accounting people have a different definition for the word, “Lease” than the rest of society. Merriam-Webster Dictionary defines the word, “Lease”, as a contract by which one conveys real estate, equipment, or facilities for a specified term and for a specified rent. Note, on a lease, the title does not convey. Ownership of the said property is retained by the original party. The lease party only has use of the property.
FASB’s (Financial Accounting Standards Board) definition of a Lease is defined as “A contract that conveys the right to use an asset (the underlying asset) for a period of time.”
When an asset is purchased, the company own the asset and the cost is capitalized over the life of the asset. When an asset is leased, the company does not own the asset and the cost should be expensed over the term of the lease. That is not the case anymore.
Accountants manipulate balance sheets through the use of lease agreements. Large companies lease, not because they can’t afford to buy. Leasing allows for leverage of available resources. By keeping assets off of balance sheets, company’s financial ratios are more appealing to banks. To help curb this misuse, In lieu of Capital & Operating leases we now have “Right-of-use assets”.
The accountant folks have put a new definition on the word, “Lease”. According to the new FASB accounting standards, a leased asset is now considered an on the books asset because of the right to use that asset. The book value of that leased asset is the present value of the lease obligation. Consequently, if the asset goes on the books, so does the corresponding liability. Balance sheets must show this incurred liability. Does not matter that you do not own the leased property.
Because of this new lease definition by FASB, there are two owners of asset. The entity that leased out the asset (lessor) and the entity that leased the asset (lessee). Rest assured that standards are in place to insure capitalization of those assets is only allowed once. Do you see how muddy this could get?
Under the old lease requirements, lease assets and liabilities where not on the company’s balance sheet. The lease payments were expensed on the company’s income statement. Bankers and investors had no knowledge of the company’s long term lease obligations.
It would simplify accounting so much if companies would purchase assets outright. Lease liabilities are just as real as purchase liabilities. Just as Congress makes laws, Congress tweaks those same laws over and over. Every new layer adds to the complexity. Common sense and curbing cost are of no concern.
The Republicans blame the Democrats for companies outsourcing jobs. Now companies are leaving the US. Complex laws, codes, and regulations are hard to enforce and costly to implement. Laws and rules based on principles might be the answer.
Note, GAAP (Generally Accepted Accounting Principles) are based on principles. Lawyers take principles and convert those principles into volumes and volumes of extremely specific and complex codes. Then other lawyers change the wording or definition, after a judge sets a new precedent, to alter the outcome. That is ridiculous.
Brett Bickham
Clifton, TX