As we’ve noted in previous blogs, off-balance sheet financing is a perfectly acceptable and ethical accounting practice that may be able to help your business limit its on-sheet debt and honor previously-existing loan covenants. Common off-balance sheet financing techniques include take-or-pay and/or through-put contracts, redeemable preferred shares, and account receivables financing.
However, in 2016, rules surrounding one of the most commonly utilized methods of off-balance sheet financing, operational leases, changed dramatically.
If you’ve used this type of financing in the past, or were planning to use it in 2017, keep reading. We’ll explore the changes together as well as their impact on your financing choices.
Rules Governing Off-Balance Sheet Financing
Before we delve into the changes made regarding leases and off-balance sheet financing, we think it’s important to point out that this accounting practice does indeed have rules governing its use. It’s highly likely that you’ve heard about Enron and the bankruptcy scandal which revealed unscrupulous off-balance sheet techniques utilized by its financial leadership during that time. Because of this and other scandals, off-balance sheet financing is often regarded with a skeptical eye by many small business owners. However, we must clarify that while the individuals involved with Enron most certainly utilized this financing practice in the wrong way, it’s possible to use it in a completely ethical “right” way.
The rules about how off-balance sheet financing can and cannot be used legally are set forth by the Generally Accepted Accounting Principles (GAAP), first utilized in 1936 by the American Institute Of Accountants. In case you’ve never heard of these regulations before, you should know that “
How Leases Were Previously Treated Under Off-Balance Sheet Financing Rules
Under the previously accepted accounting rules, businesses were required to classify leases as either finance or operating leases. If classified as a finance lease, lessees were required to recognized the obligation on their balance sheet. If classified as an operating lease, lessees were not required to recognized the financial obligation on their balance sheet, an opportunity that many businesses were eager to capitalize on so as to reduce their overt debt.
What Has Changed
The International Accounting Standards Board (IASB) recently concluded a decade-long study into off-balance sheet financing and leases, and recently altered their recommendation regarding this practice. According to the IASB, off-balance sheet treatment of operating leases by lessees has come to an end. In most cases the accounting for lessors is unchanged, however. More notable changes for lessees include:
- New definition of a “lease”
- Leasing and non-leasing services will need to be unbundled
- Re-assessment of the lease liability
- Assessment of the lease term
Read more in-depth information from the IASB report regarding these changes here.
Commercial Finance Group Has Your Off-Balance Sheet Alternatives!
While it may be disappointing to learn that you can no longer utilize off-balance sheet techniques as a lessee, it’s important to remember that there are other viable techniques that can still be capitalized upon. Let The Commercial Finance Group show you how receivables financing can provide you with access to much-needed capital without altering your on-sheet liabilities. We have offices all over the United States, including Atlanta and Los Angeles, and we’d be more than happy to have a consultation with you about our services. Please don’t hesitate to contact us today! Our financial experts are standing by to help you achieve your future.
