David Ramos
When I was hired at the Xerox Corporation as I started my career in sales, I learned quickly that math and understanding numbers were requirements for being successful in my new profession. In the new hire kit (that was handed to me on DAY 1 as I was on boarded) was a book titled, Selling Finance Solutions. It was required pre-reading before being sent to the famed Leesburg, VA campus (a place I attended classes so often, I felt home in their dorms and underground tunnels). Selling Finance Solutions taught the nuances of leasing and positioning our different financial vehicles for moving our solutions and where I was first introduced to the FASB 13 (Financial Accounting Standards Board statement 13).
Why do I start with this story? Because I was conducting an Account Planning Session (APS is a strategy session with sales people to coach them and help them pre-plan for targeting accounts and developing existing accounts) with a sales executive today and we were discussing a proposal he created and I asked him how he was positioning the financial component and if he understood the impact and benefit to the customer. Silence was his answer. I asked him if he understood why the customer was asking him for detailed MSRP, cash pricing/discounting figures and other financial details regarding term commitment and Fair Market Value buyout figures at the end of the term. Silence again was his answer. I asked him if he had ever heard of FASB 13 and when was the last time he picked up something besides the sports page to read…you know how this movie ends, right? I don’t have to tell you he sat there silent again, do I.
New Leasing Proposals Will Change Business
One of the hottest topics in lease accounting today is the proposed changes to the current lease accounting standards. Proposed changes to accounting rules would force all operating leases to be capitalized. If approved, this fundamental change would require companies to capitalize operating leases they traditionally keep off their balance sheets, such as those for real estate and equipment like Multi-Function Devices (MFDs). These changes to lease accounting rules will have a major impact on U.S. companies and will impact return on assets and other key financial ratios significantly. Treating lease obligations off the balance sheet helps companies, but that will likely come to an end as early as 2012.
Today, FASB 13 requires that operating leases are classified as an off-balance sheet transaction and only the current year operating lease expense is accounted for in the income statement. Corporations must also include a note in their Security and Exchange Commission 10-Q and 10-K filings detailing the anticipated rent expense for the next five years.
Operating vs. Capital Leases
An operating lease contract is similar to a rental contract: The lessee pays fees for the life of the lease and simply uses the goods (e.g., an MFD or computer system). The lessee reports these costs as operating expenses (and thus lowers taxes in this way), but takes no depreciation expense.
Capital leases are more like financed purchases, that is, under the terms of the lease, the lessee may immediately gain some of the benefits of ownership, such as charging depreciation expense (and taking tax benefits from that), and recognize the asset on the balance sheet as a capital asset.
FASB 13 Ruling on Operating vs. Capital Leases
The United States Financial Accounting Standards Board statement 13 (FASB 13) provides the definitions and criteria for deciding whether or not a lease agreement is to be considered a purchase/sale agreement (and therefore a capital lease) or a usage agreement (and therefore an operating lease). The distinction between capital and operating leases has important financial consequences: it determines who (lessor or lessee) has ownership rights and who takes depreciation for the leased goods, and who can treat lease costs as expenses, along with other factors.
Very briefly, FASB 13 states that a lease will be considered an operating lease (usage agreement) unless one or more of the following four criteria are met. If any of the following applies, the lease is then treated as a capital lease (purchase/sale agreement):
- The lease automatically transfers ownership of the property to the lessee by the end of the lease.
- The lease contains a bargain purchase option.
- The lease term equals 75 percent or more of the estimated economic life of the property.
- The present value of the minimum lease payments at the beginning of the lease term equals or exceeds 90 percent of the fair market value of the property.
Proponents for changing the FASB 13 rule argue that the current standards fail to give an accurate view of a company’s liabilities. This argument seems valid given the fact that operating leases represent the single largest source of off-balance sheet financing for most organizations. Furthermore, for many organizations, operating lease obligations represent a larger liability than all other liabilities on the balance sheet combined. For this reason, the FASB has spent decades debating the proper accounting treatment of operating leases.
Impact of FASB 13 Changes to Financial Statements
There is little doubt that the proposed FASB 13 lease accounting changes would have an enormous impact on financial statements. Simply moving operating leases onto the balance sheet would add over one trillion dollars to the balance sheet of U.S. companies. The income statement changes would have a positive effect on EBITDA due to removal of rent expense from operating expenses.
Other potential issues for companies:
- Debt ratios increasing
- Existing loan covenants
- Future borrowing capacity
- Administrative costs will increase due to:
- Requirement to calculate PV lease cost for all outstanding leases at initial transition
- Requirement to subsequently re-calculate PV lease payments and lease terms if facts change
- Financial statement audits will require more testing of lease transactions
- Companies will need to invest in new computer systems, processes and controls to monitor lease transaction
It is important to keep in mind that the proposed FASB 13 lease accounting changes do not have a direct effect on cash flow; arguably the most important indicator of financial performance. However, companies will need to invest time and money to evaluate lease structures, determine the impact to financial statements, and communicate the impact to investors and shareholders well in advance.
Although the proposed FASB 13 rule change may alter the buy versus lease decision or add a new variable to lease negotiations, accounting rules are seldom a primary driver of traditional office equipment decisions. Knowing these rules and leasing nuances though do help sales professionals demonstrate business acumen and higher understanding of the financial impact of their solutions. The proposed FASB 13 changes illustrate the fact that, more than ever, sales executives and professionals require a support system from management that provides the ability to assist companies prioritize objectives and make tactical decisions that align with their business strategies.
Equipment leasing has long been a very effective tool used by business organizations for obtaining capital and financial flexibility in the acquisition of all types of equipment used by business. The complexities of leasing are constantly changing along with the continuous development of technology and the ever-changing financial seascape. Today’s lessor needs to keep informed and be proactive in developing new marketing strategies to encompass the new standards. Although the dust has not settled on the issues at this time, the challenge to sell leasing to those lessees who currently value the benefits of off balance sheet treatment is imminent.
Focus on Developing Your Professional Skills
I have been fortunate in my sales career to have learned the value derived from sales force development. First at Xerox, who many consider pioneers in the science of selling, I learned the benefit and the impact sales training had to my productivity in the field as a sales executive. Each individual process was very detailed. They armed us with step by step instructions for every scenario…if it is a referral, do it this way, if it is a “cold call,” do it that way, etc. What I learned was that it wasn’t just the letters in the words that were important; the value was the detail of all the steps, the order, the timing and all the possible branches on the tree of possible outcomes along the way. They taught us to apply it to selling any product or service we had in our bag of tricks.
After leaving Xerox I started with IKON Office Solutions and after two years as a Regional Sales Manager I had the opportunity to work for IKON University teaching salespeople the impact of sales process on their productivity and teaching sales managers how to effectively develop, lead and execute to a plan. We became recognized by Training Magazine as having one of the Top 100 corporate training organizations in North America (#51 in 2003, # 49 in 2004). All of these skills learned in my assignments became my foundation for leading the sales force as Director of Sales in Mexico and in the North Florida Marketplace. One thing that my collective experience has taught me during my 15-year career and that is this, sales professional’s need ongoing development in order to be successful. Without it, your sales people fail or worse, you fire them, which lead to a vicious turnover cycle that negatively impacts your company and your customers. The reality is development is each individual’s responsibility, but sales leaders owe it to their sales teams to do all they can to assist in their development.
About the author: David Ramos is sales operations consultant for Strategy Development, an industry management consulting and advance sales training firm providing sales, service & MPS information, including workshops for the BTA as well as a MPS Sales eLearning program with InfoTrends. He also instructs a selling skills workshop called “Sell With Success”. You can reach him at www.strategydevelopment.com or ramos@strategydevelopment.com.
