If you're accounting for future lease obligations as debt, then I think you somehow have to account for future exclusive use of the thing you are leasing as an asset.
It's easy to value the future lease obligation -- monthly payment * remaining term. But without a way to value the corresponding leasehold this change seems like it just distorts financials in a way that makes the data less useful.
"Under IFRS 16, a lessee is required to recognize an asset for the right to use the leased item and a liability for the present value of its future lease payments." https://en.m.wikipedia.org/wiki/IFRS_16
Remember that leases aren’t just leases for real estate. Many companies operationize most or all capital costs. Companies dump all sorts of crap into them.
When I used to sell stuff in college, my fortune 50 customers dumped all sorts of stuff into leases like office supplies, etc. My account had me running around buying thousands of pens from stores around us to for one Fortune 50 customer to roll into a lease for a bunch of servers.
I would like to caveat by explanation by saying I am admittedly less versed in IFRS than US GAAP, so there may be some technical differences between the two, but the spirit should be the same - there is actually corresponding gross up of your assets, equal to the net present value of your minimum lease payments, when you put the lease obligation on your balance sheet.
So at the the time you sign a new lease, you will put an asset and liability of equivalent value on the books. Assuming the useful life of the asset extends past the lease term, general expectation is that the asset value would be amortized over the term of the lease, and at the same time, interest expense will be recorded on the lease obligation. Ultimately the same amount of expense will be recorded (equal to the minimum lease payments), but the timing of the expense is different as it front loads the expense (because of the interest accretion). So you have that and the balance sheet gross up that will be different. The change, in theory, provides greater transparency related to what can be a significant obligation for a company.
Unfortunately many leased items are rarely able to produce an income or realise a "sale price" if the original purpose is gone.
Thus more often than not, its asset value is almost impossible to reliably be assertained by the business let alone by an external party.
For example if all these aeroplanes i have have an income producing capability of producing n $millions but my business can't use them at a profit because of competition, how are the aeroplanes "asset" value ever going to be realised? they are effectively worthless.
So the balance sheet should show them at a high figure when business is good, and when business goes down the toilet they should be written off as they can't even be sold.
There is such a thing as a "capital lease", or at least there used to be. Capital leases work in this way--both asset and liability are recorded. It's only fair that the new rules for operating leases works this way too.
David Stockton's been pounding this for a long time, he pointed out that Toys R'Us was the first canary to fall. His point is, cheap credit has allowed many unhealthy businesses to keep sputtering along for a long time without making changes.
Granted, Stockton is kind of a gold bug, and former Reagan budget director trickle down fan, but he's reformed on the debt issue and taxes now, and has been basically predicting an apocalypse once central banks start cleaning up their balance sheets and tightening interest rates.
> he pointed out that Toys R'Us was the first canary to fall. His point is, cheap credit has allowed many unhealthy businesses to keep sputtering along for a long time without making changes
That's an odd point to support with Toys R Us? From what I read, a third party borrowed money to buy the (profitable) Toys R Us. The new, indebted, Toys R Us is still profitable except for the cost of servicing the debt that, notably, it didn't choose to take on. Therefore it's going bankrupt and the buyers are getting wiped out, but the store will be fine because its business is perfectly healthy - revenues exceed cost of operation.
This promises to be a nightmare for small business. By way of a few examples, a company will need to evaluate whether its right to use tangible personal property is actually its own property subject to personal property tax, sales tax and use tax. Generation transfer and businesses sale valuations will be impacted on a perishable lease "asset" values. There will be disputes about the differences between Fair Market Value and GAAP value. Even colocation, SAAS and software leases with terms greater than one year may be impacted by this rule.
How much will this shift the Capex verse Opex dynamic which typically is perceived to be one of the many motivating factors towards cloud computing adoption?
The cost to own and manage is still greater, but it for terms longer than one year it will likely raise costs to lessees, and will certainly impact their balance sheets.
This will make debt more attractive for companies that produce something. At the moment the fact that leases are not visible drives productive companies to rent equipment instead of renting money. The big beneficiary were GE Capital and the like that in turn rented the money often at a discount. Leasing companies will continue to enjoy some economies of scale but have lost a strategic advantage. Any effect this rule change will have on companies will show up magnified in the leasing companies.
As an example of how accounting rules can affect investor perception:
When Apple started selling the iPhone, they recognized the revenue for each phone over 2 years. They thought they had to do that in order to provide free software updates.
Within a couple years the accounting rule changed and Apple could report full revenue from an iPhone sale upfront. Suddenly their GAAP earnings jumped, which led to a stock jump too.
> “The Company plans to adopt the new revenue standards in its first quarter of 2019 utilizing the full retrospective adoption method,”
It won't have much of an impact as the deferred revenue is accounted for and is not the full price of the phone, but the value of future software updates ($25):
> For all periods presented, the Company’s estimated selling price for the software upgrade right included with each iPhone and Apple TV sold is $25 and $10, respectively.
In layman’s terms, does this mean that some company a) borrowing money for 10 years to buy machinery, and b) leasing that machinery for the next 10 years, will be reported equally on its balance sheet?
More or less. Big difference is that 10 years leasing would still be less debt/asset than owning (cars being a prime exampel with leasing usually being for 3 years at a time, obviously a smaller asset/debt than buying the same car).
If you are opening an airline, you need to buy aircraft (amongst many other things). (Commercial) aircraft are extremely expensive but generate generate value long after they are acquired. It is a lot cheaper to incur devt by leasing those planes than it is to buy them outright.
Personal debt is different, in most cases, and is a lot closer to the reality of your statement. I’m spending about $11,000 for our wedding, all inclusive. I paid for that with a credit card. I can’t make revenue off of that wedding outright (though I guess it can become an asset if an epic YouTube video comes out of it and becomes a viral sensation that survives the test of time), so that debt isn’t useful. But I made a risk calculation that me paying for everything upfront and paying for it later is more important than waiting the n years it would take to save for that wedding and pay everything in cash. That decision _could_ bite me in the ass in a few years when IT is 100% automated by ML/AI putting the cloud into the blockchain, but I made that decision assuming that that wouldn’t happen. :-)
[+] [-] zaroth|8 years ago|reply
It's easy to value the future lease obligation -- monthly payment * remaining term. But without a way to value the corresponding leasehold this change seems like it just distorts financials in a way that makes the data less useful.
[+] [-] sologoub|8 years ago|reply
"Under IFRS 16, a lessee is required to recognize an asset for the right to use the leased item and a liability for the present value of its future lease payments." https://en.m.wikipedia.org/wiki/IFRS_16
[+] [-] Spooky23|8 years ago|reply
When I used to sell stuff in college, my fortune 50 customers dumped all sorts of stuff into leases like office supplies, etc. My account had me running around buying thousands of pens from stores around us to for one Fortune 50 customer to roll into a lease for a bunch of servers.
[+] [-] teekert|8 years ago|reply
[+] [-] fitchjo|8 years ago|reply
So at the the time you sign a new lease, you will put an asset and liability of equivalent value on the books. Assuming the useful life of the asset extends past the lease term, general expectation is that the asset value would be amortized over the term of the lease, and at the same time, interest expense will be recorded on the lease obligation. Ultimately the same amount of expense will be recorded (equal to the minimum lease payments), but the timing of the expense is different as it front loads the expense (because of the interest accretion). So you have that and the balance sheet gross up that will be different. The change, in theory, provides greater transparency related to what can be a significant obligation for a company.
[+] [-] binarymax|8 years ago|reply
[+] [-] basicplus2|8 years ago|reply
Thus more often than not, its asset value is almost impossible to reliably be assertained by the business let alone by an external party.
For example if all these aeroplanes i have have an income producing capability of producing n $millions but my business can't use them at a profit because of competition, how are the aeroplanes "asset" value ever going to be realised? they are effectively worthless.
So the balance sheet should show them at a high figure when business is good, and when business goes down the toilet they should be written off as they can't even be sold.
[+] [-] kpwagner|8 years ago|reply
[+] [-] unknown|8 years ago|reply
[deleted]
[+] [-] georgecarlin|8 years ago|reply
[+] [-] cromwellian|8 years ago|reply
Granted, Stockton is kind of a gold bug, and former Reagan budget director trickle down fan, but he's reformed on the debt issue and taxes now, and has been basically predicting an apocalypse once central banks start cleaning up their balance sheets and tightening interest rates.
[+] [-] thaumasiotes|8 years ago|reply
That's an odd point to support with Toys R Us? From what I read, a third party borrowed money to buy the (profitable) Toys R Us. The new, indebted, Toys R Us is still profitable except for the cost of servicing the debt that, notably, it didn't choose to take on. Therefore it's going bankrupt and the buyers are getting wiped out, but the store will be fine because its business is perfectly healthy - revenues exceed cost of operation.
[+] [-] rrggrr|8 years ago|reply
[+] [-] quuquuquu|8 years ago|reply
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[+] [-] redwood|8 years ago|reply
[+] [-] rrggrr|8 years ago|reply
[+] [-] heisenbit|8 years ago|reply
[+] [-] known|8 years ago|reply
[+] [-] snowwrestler|8 years ago|reply
When Apple started selling the iPhone, they recognized the revenue for each phone over 2 years. They thought they had to do that in order to provide free software updates.
Within a couple years the accounting rule changed and Apple could report full revenue from an iPhone sale upfront. Suddenly their GAAP earnings jumped, which led to a stock jump too.
[+] [-] jonknee|8 years ago|reply
https://www.marketwatch.com/story/apple-changes-tune-on-new-...
> “The Company plans to adopt the new revenue standards in its first quarter of 2019 utilizing the full retrospective adoption method,”
It won't have much of an impact as the deferred revenue is accounted for and is not the full price of the phone, but the value of future software updates ($25):
https://www.sec.gov/Archives/edgar/data/320193/0001193125100...
> For all periods presented, the Company’s estimated selling price for the software upgrade right included with each iPhone and Apple TV sold is $25 and $10, respectively.
[+] [-] runeks|8 years ago|reply
[+] [-] heos|8 years ago|reply
[+] [-] aisofteng|8 years ago|reply
[+] [-] kgwgk|8 years ago|reply
[+] [-] Torai|8 years ago|reply
[+] [-] nunez|8 years ago|reply
If you are opening an airline, you need to buy aircraft (amongst many other things). (Commercial) aircraft are extremely expensive but generate generate value long after they are acquired. It is a lot cheaper to incur devt by leasing those planes than it is to buy them outright.
Personal debt is different, in most cases, and is a lot closer to the reality of your statement. I’m spending about $11,000 for our wedding, all inclusive. I paid for that with a credit card. I can’t make revenue off of that wedding outright (though I guess it can become an asset if an epic YouTube video comes out of it and becomes a viral sensation that survives the test of time), so that debt isn’t useful. But I made a risk calculation that me paying for everything upfront and paying for it later is more important than waiting the n years it would take to save for that wedding and pay everything in cash. That decision _could_ bite me in the ass in a few years when IT is 100% automated by ML/AI putting the cloud into the blockchain, but I made that decision assuming that that wouldn’t happen. :-)