FINANCIAL WATCH By Scott Thacker, Alda M. Rodrigues and Toni Knudson What You Need to Know About Vendor Guarantees Potential Impacts of New Lease and Revenue Accounting Standards EASING OFFERS A WAY for a vendor (manufacturer) to increase market share and margin and provides the end-user with a lower payment versus a loan, while providing full margin to the vendor, when equipment is sold at list price. A lease may be offered by a vendor or its captive, a dealer, bank or independent lessor. If the lease is with an unrelated end-user and is a direct financing or sales-type lease, then the vendor has passed substantial risks and rewards of ownership to the lessee and a sale may be recognized. L A vendor guarantee program promotes leasing and equipment sales at full margin, while assisting a lessor to mitigate risk. A common type of assistance is a residual value guarantee since vendors are skilled at predicting their equip-ment’s value at lease-end. As a result, they are most comfort-able providing the guarantee. Current Accounting Guidance Today leases can be categorized as capital, operating or lever-aged. From a lessor’s perspective, classification depends on whether the lease agreement transfers substantially all of the risks and rewards of ownership of the asset. To be consid-ered a capital lease, both lessees and lessors must consider whether the lease agreement meets any one of the four criteria in ASC 840-10-25-1 at inception. Residual value guarantees are considered in the minimum lease payments (the 90% test) criteria. From a lessor perspective , minimum lease payments include any guarantee of the residual value or of rental pay-ments beyond the lease term by a third party unrelated to either the lessee or lessor. To record a sale, a vendor cannot retain sub-stantial risks of ownership by providing var-ious arrangements that assure the end-user’s or the purchaser’s recovery of the investment [ASC 840-10-55-14 and EITF 95-1]. Under ASC 840-20-40-3, a vendor of property cannot recognize a sale if the vendor retains substantial risks of ownership in the leased property. Substantial risk is generally determined under the principles of the FAS 13 “90% test.” Consequently a vendor cannot pro-vide more than 10% support in a guarantee without being considered to have retained substantial risk of ownership. Support may be in the form of being obligated to guarantee a residual value, reacquire the property, provide a substitute asset or secure a replacement lessee. New Leases Proposal and Interaction with New Revenue Standard The tentative decision in FASB/IASB lease accounting re-deliberations is to refer to the revenue recognition standards for guidance on determining whether a transfer meets the conditions of a sale. Under the new standard issued in May 2014 [ASC 606], companies recognize revenue when a per-formance obligation is satisfied. This generally occurs when or as the entity transfers promised goods or services to a cus-tomer. A transfer occurs when the customer obtains control of the good or service. Three ASC’s discuss satisfying a performance obligation and transferring control. ● ● ASC 606-10-25-23—An entity shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (that is, an as-set) to a customer. An asset is transferred when (or as) the customer obtains control of that asset. ● ● ASC 606-10-25-25—Control of an asset refers to the abil-ity to direct the use of and obtain substantially all of the remaining benefits from the asset. Control includes the ability to prevent other entities from directing the use of and obtaining the benefits from an asset. ● ● ASC 606-10-25-26—When evaluating whether a customer obtains control of an asset, an entity shall consider any agreement to repurchase the promised asset or a compo-nent of the promised asset. Under this guidance, allowing the vendor to have a repur-chase option to reacquire the property would be an indicator that control has not been transferred. Including such an op-tion could jeopardize sale treatment (even with Type A lease). 50 JANUARY/FEBRUARY 2015 EQUIPMENT LEASING & FINANCE MAGAZINE ISTOCK A vendor guarantee program promotes leasing and equipment sales at full margin, while assisting a lessor to mitigate risk. A common type of assistance is a residual value guaranty since vendors are skilled at predicting their equipment’s value at lease-end.