Signs seem to be pointing to the operating lease going the way of the dodo bird, or my favorite dinosaur, the Dimetrodon. Extinct may not be the right term, but much like today’s chickens may be living relatives of the dinosaurs of old, the capital lease may soon be the only living relative of the operating lease.
Let’s start with the basics: For years an operating lease has been defined as a lease under which the lessor owned the equipment installed on the lessee’s property for a defined period of time, without any transfer of ownership rights. At the end of the operating lease term, the asset being leased could be removed and returned to the lessor, purchased at its fair market value, or re-leased at terms to be negotiated. Terms for an operating lease are always shorter than the useful life of the equipment begin financed.
The key element of an operating lease and the reason for it’s downfall (much like the dodo’s inability to fly), is the argument that an operating lease is considered “off balance sheet”, or in other words, the lease is treated just like a rental expense and does not add to the debt load of the borrower. In our world of clean energy finance- this had the wonderful result of providing financing options to entities that would otherwise not be able to add debt to their balance sheets.
The Financial Accounting Standards Board (FASB), in a statement released at the end of 2015 made it quite clear that it would be changing the rules to require balance sheet disclosure of operating leases.
In many ways, at least in our niche world of efficiency equipment leasing, this means that operating leases are basically deader than a Dimetrodon. Their main benefit, which was off-balance sheet treatment, is gone, and they now belong in a museum of financing and accounting (a most exciting place!).
So Let’s Recap:
- The operating lease was unique because the payment was treated as an operating expense, and did not add to the debt load on the balance sheet of the borrower.
- Dimetrodons are cool, but dead.
- Thus even though operating leases, like Dimetrodons (and not so much the clunky Dodo), were cool, they are also about to become extinct.
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