‘Dark CapEx’ and ‘orphan’ business processes are top challenges as lease spend moves onto balance sheets, expert says

“There is a growing amount of ‘dark CapEx’ hidden in outsourcing contracts, ‘as-a-service’ arrangements and traditional leases,” said Ingemar Lanevi, LeaseAccelerator’s VP and GM of Global Sourcing Solutions, in an interview focusing on the problems with lease spend.

The issues with lease spend have been hot topics since accounting rules changed this year for some companies, and that change has exposed how businesses don’t really understand how much they’re spending on leases, how much they’re overspending and who in the business is in charge of all those deals.

In recent coverage, we’ve explored how leases lurk in businesses and leak money — which indicate that lease spend isn’t managed well. And we’ve looked at technology that can help procurement departments create a lease spend category to give businesses insight into leasing and offer the C-suite some control. Coverage of the issue even extended to a two-part series from sessions at the SIG Summit in California earlier this fall.

One of the presenters at SIG was Lanevi, who shared some insights now that public companies must put their leasing debt onto balance sheets for financial reporting. A key finding is that companies don’t have a handle on many areas of leasing, he said.

“Equipment leasing is an ‘orphan business process’ that begs for oversight and leadership,” said Lanevi, in a Spend Matters Q&A where we asked him about the issues with lease spend to shed light on the big picture.

Q&A with LeaseAccelerator

Spend Matters: How has the new accounting rule that began this year revealed the problems with leasing spend?

Ingemar Lanevi: Historically, companies have managed and accounted for their lease portfolios using a variety of decentralized systems. Spend data about leasing was scattered across the enterprise, with key fields stored in accounts payable, real estate administration, procurement and contract management systems. But with leases moving onto balance sheets as part of the new ASC 842 accounting change, most companies recently consolidated all their leasing data into a centralized repository in an enterprise lease accounting application.

With all the information about rent payments, contract terms and financing rates in a single database, procurement organizations can now finally gain an understanding of the spend dynamics for their lease portfolios. Many are discovering that the actual economics of their lease portfolios are not as strong as they might have expected. Companies are benchmarking the financing rates obtained for leases across different business units and finding that they are often not obtaining the most competitive rates or contractual terms and conditions for equipment leasing.

Another big area of spend leakage relates to managing the end-of-lease contract terms. At the end of an equipment lease, companies have the option to 1) renew the lease at a lower rent, 2) buy out the asset from the leasing company, or 3) terminate the lease, return the asset and either move on or do an asset replacement.

But many companies opt for a fourth option — to do nothing. The result is the lease contract effectively auto-renews at the original rent and the customer continues to pay — sometimes for several years. For example, we work with an oil and gas company that had rented equipment for a few weeks and still had the assets five years later. It is not uncommon for companies to pay two to three times more throughout the term of a lease what it would have cost them to purchase the assets upfront, which erodes all the economic benefits of leasing.

When do you think the law will begin for private companies in 2020?

The FASB, which defines the standards for U.S. GAAP, recently announced a one-year extension to the lease accounting standards for most private companies that are not SEC filers. The original deadline was December 2019 and has now been extended to December 2020. Public companies have found adopting the new lease accounting standard to be far more complex than other accounting changes, because historically the leasing process was highly fragmented at most companies with no centralized systems, standardized processes or clear organizational ownership. Private companies should expect a similar challenge and use the extra time to inventory their lease population, review the associated contracts and perform the necessary accounting work to move these assets and liabilities onto the balance sheet.

Seeing all of leasing spend across a company’s many departments seems a lot like the difficulty in answering which department (HR or procurement?) owns the hiring responsibility for freelance workers and services. Many departments lease goods and services. Why should procurement take charge of leasing spend?

That is a great comparison. Much as companies struggle to get a true picture of their extended workforce, they also struggle to maintain visibility to all the assets being used to run the business. There is a growing amount of “dark CapEx” hidden in outsourcing contracts, “as-a-service” arrangements and traditional leases.

As you said, “many departments lease goods and services,” which is perhaps the biggest challenge with leasing spend. No one in the organization is accountable for the leasing spend. The corporate real estate department leases retail, industrial and office space. Transportation leases cars, vans and trucks. IT leases laptops, servers and networking devices. Supply chain leases forklifts, rail cars and shipping containers. But each category is managed independently with no consistent business processes, financial controls or information systems.

Back-office functions touch leases as well. Accounts payable handles monthly rent invoices. Corporate treasury manages relationships with leasing companies. Accounting prepares financial reports and SEC disclosures. But no headquarters function truly owns equipment leasing. Contrast this against real estate leasing, which tends to be “owned” at the corporate level, with a dedicated leader. Equipment leasing is thus an “orphan business process” that begs for oversight and leadership.

With leases now capitalized on balance sheet, the portfolio really needs an owner. Additional processes, controls and governance need to be added to leasing programs comparable to those that exist for other balance sheet items to protect the interests of shareholders. Financial planning, accounting and treasury organizations would be the natural stewards for these programs. However, finance, accounting and treasury are not in a good position to manage the leasing program because they are typically not involved in the contract lifecycle for capital expenditures. But procurement is!

And we believe procurement is a natural candidate to take a leadership role across the enterprise equipment lease portfolio. With their central role in contract lifecycles, procurement is well positioned to lead the negotiations for new leasing contracts, partnering with the budget holders and category experts across the business to define requirements, select vendors and finalize terms.

Leasing companies have a reputation for using predatory contract terms that force customers to pay excessive fees at the end of the lease. For example, many lease contracts allow for renewals or buyouts at a fair market value, a price mutually agreed upon by both parties, which really means whatever price the leasing company wants to charge. In some cases, the contract will even state that the lessor sets the fair market value. Other lease contracts stipulate that equipment must be returned in the original packaging and shipped to a destination provided by the leasing company, which could be in Alaska, for example.

Procurement could help to ensure that the organization is not entering into contracts with unfavorable terms and conditions or excessive fees. Furthermore, they can apply best practices such as RFPs, competitive bidding and spend consolidation to extract better financing rates and contract terms from leasing companies.

We’ve seen early adopters of these strategies realize savings of 6% to 12% on leasing costs.

What technology is LeaseAccelerator using to address the new accounting rules and gain visibility on all leasing, as well as save money on financing terms and sourcing the deals overall?

We call it “Enterprise Lease Accounting.” It’s a new category of software that has experienced explosive market growth rates over the past few years.

Just as every organization has a CRM application suite to manage the customer lifecycle and an HR application suite to manage the employee lifecycle, we envision that every large company will someday have an Enterprise Leasing application suite to manage the lifecycle of leased assets like real estate, vehicles and technology.

There are three key applications that we offer:

Lease Sourcing — Designed for procurement groups, a Lease Sourcing application enables organizations to perform lease-versus-buy analysis, automate RFP generation, competitively bid financing opportunities and analyze spend for the lease portfolio. This particular capability comes along with an assigned leasing expert that will help the customer navigate the leasing process and maximize the ROI on the software investment. The lease domain expertise is very often missing in most of our customers.

Lease Management — Designed for operations team, a Lease Management application enables organizations to proactively track and manage leased assets throughout their lifecycle. Users can process invoices for real estate leases, automate end-of-term workflows for equipment leases and generate dashboards to measure lease portfolio KPIs.

Lease Accounting — Designed for finance teams, a Lease Accounting application enables companies to generate the financial reporting and disclosures required under the new U.S. GAAP and IFRS standards.

What’s your favorite story of companies finally seeing all of their leasing spend and being able to get it under control? Did they have an “a-ha!” moment or an “oh-no!” moment?

We worked with an industrial manufacturing company a few years back. This particular company was very proactive and started to get their leasing business processes in order long before the deadline for the new accounting standards emerged. One of the first steps they took was to inventory their global population of leases around the world. While the headquarters team believed the lease population to be approximately 2,500, the actual number was three times that.

They discovered that thousands of people around the business were authorized to enter into leasing contracts with very little governance on the spend. Leasing was often used as a means to circumvent budget restrictions and approval thresholds. The lease inventory revealed hundreds of leases that had automatically renewed at the end of the term resulting in a high dollar value of recurring, evergreen (think overpayment) expenses. This was both an “a-ha” and “oh-no” moment that motivated them to introduce new levels of governance, process and controls into the leasing program with the use of technology to automate the sourcing, management and accounting processes for leasing.

Your solution is a cloud-based, procurement-as-a-service offering. Like all of the XaaS subscriptions for software these days, that’s basically a lease. Does LeaseAccelerator track itself and track other XaaS subscriptions as well???

That’s a great question. Leases for software assets and other intangibles fall outside the scope of the new lease accounting standards. However, you are correct in that most technology assets are rented rather than owned these days — whether it is hardware such as storage and servers running in the cloud or software applications offered on a subscription or as-a-service model.

But to answer your question: Yes, we do track our real estate and equipment leases in our application and are in the process of moving our XaaS applications into the system as well.