In the intricate financial landscape navigated by Chief Financial Officers (CFOs), every decision has a ripple effect on a company’s bottom line. One of the pivotal areas under the spotlight, especially with the advent of the ASC 842 lease accounting standard, is the structuring of lease terms. Let’s dive deeper into the strategic significance of re-evaluating lease terms and its potential to reduce tax liabilities.
Longer Lease Terms and Increased Liabilities:
With the implementation of ASC 842, most leases, including previously off-balance-sheet operating leases, now need to be recorded on the balance sheet as liabilities. The value of this liability is primarily determined by the present value of future lease payments. Therefore, the longer the lease term, the higher the total future payments, leading to a larger lease liability on the balance sheet.
Consequences of a higher lease liability include:
- Impact on Financial Ratios: Elevated lease liabilities can distort key financial ratios like debt-to-equity, which investors, lenders, and other stakeholders closely monitor.
- Loan Covenants: A surge in liabilities may breach loan covenants that have restrictions based on a company’s total liabilities or specific financial metrics.
- Tax Implications: Depending on jurisdiction and specific tax laws, increased liabilities might have cascading effects on tax calculations and payments.
Strategic Re-evaluation of Lease Agreements:
A proactive CFO can leverage the following strategies to optimize lease agreements:
- Shorter Lease Terms: Opting for shorter lease durations can decrease the total future lease payments, thereby reducing the present value of the liability. This approach offers greater flexibility to adapt to changing business needs and market conditions.
- Early Termination Options: Incorporating options to terminate leases early can provide an escape hatch if circumstances change. While there might be penalties or costs associated with early termination, they might be outweighed by the benefits of reduced liabilities and increased flexibility.
- Renegotiation with Lessors: Engaging in dialogue with lessors to modify existing lease terms or structure new agreements more favorably can lead to mutually beneficial outcomes. This can include seeking better rates, shorter terms, or more favorable termination clauses.
- Periodic Review: Rather than a one-off exercise, CFOs should institutionalize the practice of periodically reviewing lease agreements. This ongoing oversight ensures that the company’s leasing strategy aligns with its evolving financial and operational goals.
- Collaboration with Legal and Tax Teams: Collaborating closely with internal legal and tax teams during the re-evaluation process ensures that all changes are compliant and optimized for tax benefits.
In conclusion, in the era of ASC 842, the re-evaluation of lease terms isn’t just a tactical move but a strategic imperative. By meticulously analyzing and adjusting lease agreements, CFOs can significantly influence their company’s financial health, tax exposure, and operational flexibility.
You can take a video tour of iLeasePro or schedule some time on our online demo calendar to see how iLeasePro can help you and your firm with the overall lease management of your lease portfolio. For more information on increasing productivity and efficiency of your lease portfolio, check out our blog and our extensive lease accounting and lease management knowledge base.
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