Monitor - November/December 2011

SPECIAL SERIES: LEASE ACCOUNTING

• • Synthetic leases may become a more popular product for lessees that can use the tax benefits as the capitalized amount will be low compared to the equipment cost.

FIGURE 1: Examples of Probable Impact By Product

LEASE•TYPE• TERMS•

FMV “true” leases — Cost = $1,000,000

“rated” credits Term = 60 months
Rent = $14,332 in advance
Residual assumed = 20%
Pre-tax implicit rate = 2.0%

FMV “true” leases —
“lesser” credits
Cost = $1,000,000
Term = 36 months
Rent = $15,349in advance
Residual assumed = 20%
Pre-tax implicit rate = 4.0%

Dollar out Synthetic leases Dollar out to a state municipal-owned hospital (under §103)

Muni financing to a
not-for-profit 501c3
hospital with $1
purchase option
Cost = $100,000
Term = 60 months
Rent = $1,879 in advance
Purchase Option = $1
Implicit rate = 5%

Cost = $100,000
Term = 60 months
Rent = $1,440 in advance
Month 60 PO/RVG = 30%
Implicit rate = 5%

Cost = $100,000
Term = 60 months
Rent = $1,749 in advance
Purchase Option = $1
Implicit rate = 2.0%

Cost = $100,000
Term = 60 months
Rent = $1,749 in advance
Month 60 PO/RVG = 30%
Implicit rate = 2.0%

LESSEE•CAPITALIZED•AMOUNT•

$809,220 (81% of equipment cost)
assuming a lessee incremental
borrowing rate of 2.5%

$826,383 (81% of equipment cost)
assuming a lessee incremental
borrowing rate of 2.5%

$100,000 = cost of equipment

$76,624 (77% of cost)

$0

$100,000

• • The municipal tax exempt lease product where the lessee is a municipal hospital will remain popular (as it will be unchanged) as the Government Accounting Standards Board (GASB) has not taken up a lease accounting change project as of this writing.

COMMENTARY

• Pricing assumes 100% bonus

• MACRS

• Low PV/amount capitalized makes the product attractive

• Same result as current capital lease accounting

• Purchase option and residual guarantee ignored except to the extent that the residual is “in the money”

• Low PV/amount capitalized makes the product attractive

• Municipalities use government accounting (GASB), which still recognizes operating lease treatment for dollar out leases with non-appropriation clauses

• Same result as current capital lease accounting

• To achieve some accounting benefit, the transaction may be structured as a synthetic lease

• • The impact of front ending of lessee P&L lease costs will not be too severe given that lease terms are not long in this industry segment. Typical lease terms range from five to seven years.

The P&L cost pattern will be front ended and will not be called rent expense. Rent expense will be replaced by straight-line amortization of the ROU asset and imputed interest on the lease obligation. The front-ended pattern will cause lessees to book deferred tax assets as book expenses reported will exceed the tax deductions for rent in the early years of the lease. The front-ended pattern is a timing difference that will turn around in the second half of the lease term. The front ending effect will be lower the shorter the lease term as illustrated in Figure 2.

• • Lessees that receive operating lease cost reimbursement
from Medicare/Medicaid will still only get cost reimbursement
for rent paid when the new rules take effect. With the front
ending of lease costs as proposed, it will mean that reported
lease costs in the early years of the lease term will be
more than costs reimbursed, although this is a temporary
difference as the costs reimbursed in the last half of the lease
will be higher than reported lease costs. Cost reimbursement
rules do not allow for reimbursement of the ROU asset
amortization and the imputed interest on the lease obligation.