Even as credit becomes more readily available, whether to buy or lease equipment is a question facing many DCs.
While there is no correct answer that fits every situation or every practice, leasing is far more complicated and may be getting more complex, compared to the simplicity of buying.
Due to negotiations between the International Accounting Standards Board (IASB) that sets rules for many countries around the globe, and the
U.S. Financial Accounting Standards Board (FASB) that writes the rules in the U.S., the lease accounting rules are changing. The new rules will soon require many practices and businesses to add all but the shortest leases to their balance sheets as liabilities (much like debt), therefore affecting the way potential lenders, investors, and suppliers view the practice.
Currently, few leases get recorded because the guidelines allow lease contracts to be structured to appear as simple rentals. If an obligation is not recorded on a balance sheet, it makes a practice appear less leveraged than it really is.
The existing guidance under the Generally Accepted Accounting Principles (GAAP) says chiropractors are only required to record lease obligations on their balance sheets when the arrangements are comparable to financing transactions, such as rent-to- own contracts for buildings or vehicles.
According to the Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), practices that lease assets will now be required to recognize assets and liabilities on their balance sheets when the lease term is longer than 12 months.
Previously, the recognition, measurement, and presentation of expenses and cash flows arising from a lease for lessees primarily depended on its classification as a finance (capital) lease or operating lease.
But unlike current GAAP in the U.S., which requires only capital leases to be recognized on the balance sheet, the new standard requires practices and businesses to include both types of leases on their books.
Obviously, this is a huge change from the current practice of requiring lessees to only record a large asset and a large liability on their balance sheet. Practices and businesses will no longer be able to structure lease agreements to achieve off-balance-sheet reporting and will, in many cases, have to monitor the effect of this change on their debt-to-capital ratio and related debt covenants.
However, the new guidance is not expected to prevent any chiropractor from acquiring the equipment and assets necessary to grow his or her practice. In fact, there are many reasons to lease equipment, and the primary factors will remain intact under the new rules such as maintaining cash flow, preserving capital, obtaining flexible financial solutions, and avoiding obsolescence.
On the other end of the leasing transaction, lessor accounting will remain largely unchanged. The vast majority of operating leases should, for example, remain classified as operating leases, and lessors should continue to recognize lease income for those leases on a generally straight-line basis over the lease term, according to the FASB.
Equipment leasing is similar to a loan, in which the lender buys and owns equipment and then rents it to a chiropractic practice at a flat monthly rate for a specified number of months.
Although lease financing is generally more expensive than bank financing, it often is more easily obtained.
Among the reasons given by chiropractic professionals for leasing are the ability to have the latest equipment, consistent expenses for budgeting purposes, help in managing practice growth, and no down payments.
Leasing offers real advantages, including reduced cash outflows and greater control, but that’s not all. Here are some additional advantages to leasing:
- Conventional bank loans usually require more money up front than leasing.
- Leasing generally requires only one or two payments up front instead of the substantial down payments often required when purchasing.
- Leasing offers 100-percent financing, meaning a practice can acquire essential equipment and begin using it immediately to generate revenues with no money down.
- The full amount of the equipment, as well as service or maintenance, can be included in the lease, which spreads the cost over the term of the lease and frees up cash flow for the practice.
- Leasing provides a hedge against technology obsolescence by allowing a practice to upgrade its equipment at the end of the leasing term.
- Operating lease payments are generally treated as fully deductible business expenses. A tax professional should be consulted to determine what percentage of leases can be deducted under the new guidelines and the advice of an accountant for help phasing in the new leasing guidelines may also prove valuable.
The nuts and bolts
In addition to making balance sheets larger, the new guidelines will change income statements for many practices. Currently, a practice that leases equipment for $1,000 a year for five years would show a $1,000 expense each year.
Under the new guidelines, that practice would show a larger expense in early years and a smaller one in later years. This is because the accounting would be similar to when a practice has borrowed money to purchase the asset, paying off the loan in equal payments over five years. The interest expense will be higher earlier.
Another significant change will mean that most real estate leases will be accounted for differently. While they too would go on the lessee’s balance sheet, the value would be based on the expected lease payments over the life of the lease. The lessee would not have to exercise renewal options, unless those options were so favorable as to clearly give a financial incentive to renew.
In cases where the lease payment is based on something that will vary (such as a retail store lease where the lessee pays a fixed rate plus a percentage of income), the value would not have to reflect the expected additional payments. This would keep the asset value—and the related debt—lower than it might otherwise be.
If, however, the rent would vary based on an index, such as the Consumer Price Index, the initial value would be based on the current level of the index. The values of the asset and liability would be updated every year as the index changes.
Examining the benefits
The new lease accounting guidelines, like the FASB’S slightly older set of rules on recognizing income, also offers a treat for many small practices, albeit a somewhat hidden one. The new leasing guidelines will, admittedly, require a detailed collecting and recording of existing leases held by a practice. Fortunately, such accounting will allow a serious study of how well all of those leases fit into the practice’s business model.
Should the practice continue on its past course with automatic, “as-is” lease renewals? After all, while much focus is on the cost of compliance, there are also ways to identify cost savings by examining the leasing activities of the chiropractic practice. Another consideration is whether the existing contracts with patients that generate revenue are still the right type for the practice now that new guidelines exist?
Consider implementing now
Publicly traded companies will be required to adopt the new standard for fiscal years after Dec. 15, 2018. For calendar-year-end public companies, this means an adoption date of Jan. 1, 2019, and retroactive application to previously issued annual and interim financial statements for 2017 and 2018.
Nonpublic companies, including privately owned businesses and professional practices, will be required to apply the new leasing standard for fiscal years after Dec.15, 2019. Thus, for most chiropractic practices, this means an adoption date of Jan.1, 2020, and retroactive application to previously issued annual financial statements for 2018 and 2019. But no one will object if a practice jumps the gun in applying the new guidelines.
Although these effective dates might seem like they are quite far away, every chiropractor should begin preparing for the new lease accounting requirements now. With many chiropractic practices involved with a number of leases and lessors, the long adoption period can mean fewer surprises with existing leases.
The bottom line
Should your chiropractic practice lease or buy equipment? Leasing equipment and other business property can be a good option for a practice with limited capital or in need of equipment that must be upgraded every few years.
Purchasing equipment can be a better option for established practices and businesses or for equipment with a long usable life.
Although taxes play a role in whether to lease or to purchase, they should not be the deciding factor. But take account of the new accounting guidelines and the accompanying impact on your practice’s financial status, so they don’t come as a surprise.
Mark E. Battersby is a tax and financial adviser, freelance writer, lecturer, and author located in Philadelphia. He can be reached at 610-789-2480.
Disclaimer: The author is not engaged in rendering tax, legal, or accounting advice. Please consult your professional adviser about issues related to your practice.