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Economic Uncertainty Drives Changes to Leasing of Long-Lived Assets

May 04, 2020, 07:00 AM

Recent events affecting the global financial health of businesses have forced CFOs and treasurers to conserve and preserve cash. Leasing, a long-favored technique of treasurers worldwide, will proliferate in this new environment.

How to Preserve Cash and Enhance Free Cash Flow

Increasing free cash flow through leasing, which is critical during challenging economic environments, enables both large and small businesses to obtain long-lived assets while maintaining the best and most flush cash position to further fuel their cash preservation efforts. Businesses can increase their free cash flow meaningfully if strategic lease initiatives are undertaken.

With cash management taking hold as a new daily activity, businesses are exploring any and all additional efforts needed to keep daily operations open and enhance liquidity. A key tactic many in this environment are deploying is a transparent action plan with lessors that focuses on renegotiating the terms of existing leases to include:

Seek Out Abatements: The ability to defer rent or lease payments for a period of time, also referred to as “Rent Holidays.” Abatements are generally accounted for as modifications requiring remeasurement of the lease liability and ROU asset using the most recent and appropriate Incremental Borrowing Rate (IBR).

Request Payment Forgiveness: Through negotiation with the lessor, the ability to have certain payments forgiven thus increasing cash flow. Payment forgiveness is generally accounted for as a deal modification requiring remeasurement of the lease liability and ROU asset using the most recent and appropriate Incremental Borrowing Rate (IBR).

Ask for Interest Rate Reductions on Leases: By reducing the interest rate built into a lease, payments will go down and cash flow will be enhanced. Payment reductions are generally accounted for as a deal modification requiring remeasurement of the lease liability and ROU asset using the most recent and appropriate Incremental Borrowing Rate (IBR).

Change the Length of the Term on Leases: By reducing the term of a lease, payments will go down and cash flow will be enhanced. Changes in the length of a lease are generally accounted for as a deal modification requiring remeasurement of the lease liability and ROU asset using the most recent and appropriate Incremental Borrowing Rate (IBR).

Full and Partial Lease Restructuring: By reducing the term of a lease and reducing payment amounts, or deferring payments and extending the lease term, payments in the short-term will go down and cash flow will be enhanced. Full lease restructurings are generally accounted for as a deal modification requiring remeasurement of the lease liability and ROU asset using the most recent and appropriate Incremental Borrowing Rate (IBR).

Obtain Current & Future Lease Incentives: By obtaining current and future lease incentives from the lessor, outflows directed to say leasehold improvements will now be covered by the lessor resulting in lower payments in the short-term and cash flow will be enhanced. Obtaining lease incentives are generally accounted for as a deal modification requiring remeasurement of the lease liability and ROU asset using the most recent and appropriate Incremental Borrowing Rate (IBR). Multiple incentives or future dated incentives must be discounted appropriately.

Change Fixed Payments to Variable Payments: By changing fixed payments to variable payments, such as based on asset utilization or a percentage of revenues, outflows will be better matched to cash inflows resulting in enhanced cash flows. Changes to payment structures are generally accounted for as a deal modification requiring remeasurement of the lease liability and ROU asset using the most recent and appropriate Incremental Borrowing Rate (IBR). Variable payments are generally accounted for as period costs.

Seek Loyalty Payments: By obtaining a loyalty payment for the lessor, cash inflows are enhanced. Obtaining loyalty payments are generally accounted for as a deal modification requiring remeasurement of the lease liability and ROU asset using the most recent and appropriate Incremental Borrowing Rate (IBR). Multiple loyalty payments or future dated loyalty payments must be discounted appropriately.

Partial Lease Terminations: The early return of a portion of a leased asset, say a floor in a building or certain vehicles in a fleet lease. By reducing the assets in a lease, cash flows are reduced and cash is enhanced. Partial lease terminations are generally accounted for as a deal modification requiring remeasurement of the remaining lease liability and ROU asset using the most recent and appropriate Incremental Borrowing Rate (IBR). A gain or loss may be generated due to the early termination of a portion of the lease

Full Lease Terminations: The early return of an entire leased asset. By terminating the lease, cash flows are reduced and cash is enhanced. Full lease terminations are generally accounted for as early terminations of the lease.

Long-lived assets to be held and used by an entity are to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We are seeing many companies partially or fully impair leased and other assets. As the economic picture comes more into focus over time, we will see potential revisions to initial impairment estimates. Leased assets for the first time, will be reviewed and tested for impairment, resulting in partial and full impairments in calendar first quarter and second quarter of 2020.
 
Navigating Uncertainty

The voluminous lease changes and revisions to estimates present a significant challenge to lease accountants, corporate controllers, treasurers, CFOs and their financial reporting teams. If robust functionality in lease accounting and lease lifecycle management systems and related controls does not currently exist, these changes will significantly burden all companies reporting under U.S. GAAP and/or IFRS with lease accounting compliance issues and deficiencies.
 
Deals are changing rapidly, estimates are being revised, renegotiations are ongoing, and consolidations and retrenchments are happening. Businesses tackling the added complexity and velocity of changes to lease portfolios and revised estimates, including impairments, will ultimately require robust lease accounting and lease lifecycle management for compliance with accounting standards and management information.

Robust Lease Automation Drives Success

Lease accounting will continue to become more complicated and transaction heavy, due to changes driven by the world economy. To find success moving forward, financial teams must seek systems that automate both lease accounting processes and controls, taking away a great portion of human intervention and allowing for corporate policies and information to be automated. Ultimately, these robust systems will save human capital and create a repeatable result for each new lease or lease modification, ensuring that policies are consistently applied to all leases and comply with existing corporate policy.

Len Neuhaus, CPA
Vice President, Lease Accounting | LeaseAccelerator
Len Neuhaus is the Vice President of Lease Accounting for LeaseAccelerator. He works closely with large public and middle-market private companies to help them successfully transition to and maintain compliance with the ASC 842 and IFRS 16 standards. With over 30 years’ experience as a CPA, Chief Financial Officer and Chief Operating Officer, Neuhaus brings a practical, real-world perspective to overcoming implementation challenges with accounting change projects.

Prior to joining LeaseAccelerator in 2019, he most recently led the Project Management Office for the implementation of ASC 842, Leases, and ASC 606, Revenue from Contracts with Customers, at International Flavors & Fragrances Inc. – a global Fortune 500 entity listed on the NYSE. Before IFF, Neuhaus served in various C-level roles and board of director positions at companies such as Hain Celestial Group, Hauppauge Digital, AECOS, Talon Air, United Benefits and Pension Services, SFG Financial, and First Asset Management.
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