Leasing in the Queensland Public Sector Policy
Guidelines
Policy Guidelines for public sector entities considering entering
into lease arrangements
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1. INTRODUCTION ...3
2. POLICY ISSUES ...3
2.1 Responsibilities of Public Sector Entities in the Acquisition of an Asset ...3
(a) Prudent Financial Management in the Lease v Buy Decision ...3
(b) Distinction between Operating and Finance Leases ...4
(c) Operating Leases – Transfer of risk in the residual value of an asset ...5
(d) Consideration of all Costs in the Lease v Buy Analysis ...5
(e) Bundling of Services in Lease Transactions ...6
(f) Understanding the Calculations in the Lease v Buy Analysis ...6
(g) The Lease v Buy Decision ...7
(h) Sale and Leaseback Arrangements ...8
2.2 Power to Lease ...9
(a) Legislative Powers ...9
(b) Fiscal Policy Principles ... 10
(c) State Borrowing Program ... 10
2.3 Procedures and Approval Requirements ... 11
(a) Departments ... 11
(b) Local Governments ... 11
(c) Statutory Bodies other than Local Governments ... 12
(d) Government Owned Corporations ... 13
2.4 Lease Documentation Issues ... 13
2.5 Budgetary Treatment of Lease Payments ... 14
2.6 Role of Queensland Treasury and Trade and Queensland Treasury Corporation ... 14
2.7 Whole-of-Government Lease Facility ... 14
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1. INTRODUCTION
There is a risk that asset lease arrangements may involve significant financing costs and contain provisions weighted heavily in favour of the lessor. Accordingly, Queensland Treasury and Trade (Treasury) has formulated these policy guidelines for the public sector regarding asset leasing and related issues. The guidelines apply to every lease of an asset, other than a tenancy lease of real property and a lease of a passenger motor vehicle or a commercial motor vehicle (comprising a standard four wheel drive vehicle or utility) obtained from Q-Fleet by a tied client.
For the purposes of these policy guidelines, public sector entities are entities funded from the Consolidated Fund (usually government departments), statutory bodies and Government Owned Corporations (GOCs). However, in the case of GOCs, the application of these guidelines should be determined having regard to the Code of Practice for Government Owned Corporations’ Financial Arrangements.
The policy guidelines address issues regarding asset leasing, including:
the responsibilities of public sector entities to ensure prudent financial management with regard to the lease v buy decision;
the distinction between an operating lease and a finance lease and the methodologies which should be used to classify a lease;
the transfer of risk in the residual value of an asset associated with the use of operating leases; the powers of public sector entities to enter into lease arrangements;
lease documentation and other associated issues; bundling of services in lease transactions; and
the correct budgetary and accounting treatment of expenditures and future commitments under lease arrangements.
These policy guidelines were updated in November 2014 to remove the requirement for Queensland Treasury Corporation (QTC) to bid on leases, and to update references to related legislation and policy documents.
2. POLICY ISSUES
2.1 Responsibilities of Public Sector Entities in the Acquisition of an Asset
(a) Prudent Financial Management in the Lease v Buy Decision
Public sector entities must ensure that any acquisition decision is consistent with the Government’s overall fiscal and financial management principles and framework.
These include the Queensland Procurement Policy, which is based on six foundation concepts: value of money; one government; leaders in procurement practice; advancing Government priorities; stakeholder confidence; ensuring probity and accountability for outcomes.
When making decisions regarding the acquisition of an asset, public sector entities should satisfy themselves that the best-cost alternative is used. An acquisition should represent the best return and performance for the money spent from a “total costs of ownership” or “whole-of-life costs” perspective.
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Leasing arrangements cannot be used as a way to alleviate the impact of pressure on budget allocations. Failure to adhere to this principle has the potential to constrain future budget flexibility (by creating expenditure commitments in future years) and to significantly compromise Queensland’s financial position.
The responsibilities of public sector entities to ensure prudent financial management requires that a decision to enter into either a finance lease or an operating lease be based on a detailed net present value and cost/benefit evaluation of the lease proposal relative to other acquisition alternatives. In order to achieve consistency in the decision making process, it is essential that the evaluations are conducted on a uniform basis across all Queensland public sector entities. The approach outlined in these policy guidelines and the assistance available to public sector entities from QTC will assist in this area.
(b) Distinction between Operating and Finance Leases
Where a lease proposal is being considered as an acquisition alternative, it is important to understand the distinction between an operating lease and a finance lease and the methodologies which should be used to classify a lease. A lease should not be classified as finance or operating merely because it is labelled as such by the lessor. The classification of a lease depends on the substance of the transaction rather than the form of the contract.
Australian Accounting Standard 117 Leases (AASB117) requires leases to be classified as either operating or finance leases and specifies accounting treatments and disclosures appropriate for each type of lease. AASB117 states that a finance lease can be distinguished from an operating lease by determining which party bears the risks and benefits of ownership of the asset and provides guidance in ascertaining which party assumes the risks and benefits of ownership. Details of the requirements of AASB 117 are set out in the Attachment.
Public sector entities must ensure that leases are appropriately classified in accordance with AASB117. General guidelines based on AASB117 are provided below. Additional assistance is available from the relevant Treasury Analyst and the lease administration manager at QTC to enable public sector entities to classify leases in accordance with AASB117.
The International Accounting Standards Board expects to issue a new international accounting standard on leasing in 2015. The new requirements propose a substantial change to the accounting for leases and may require all leases to be recognised on the balance sheet. Public sector entities should undertake a comprehensive review of the new standard as soon as practicable after its release to determine any potential consequences.
(i) Finance Lease
A finance lease generally is an agreement which covers most of the useful life of the asset. The agreement is typically non-cancellable (or cancellable at a significant penalty) and is based on the lessee effectively guaranteeing the residual value of the leased asset at the end of the lease term. The lessor usually allows the lessee to buy the formerly leased asset upon payment of a pre-determined residual value.
Because the lessee has to make guaranteed lease payments and has to support a guaranteed residual value under a finance lease, the lease is equivalent to debt financing the whole cost of the leased asset. The finance lease structure ensures that the lessor recovers the full cost of the asset and earns its required rate of return over the lease term. Consequently, it is considered similar to a secured borrowing because substantially all the risks and benefits incidental to ownership of the leased asset rest with the lessee, despite legal ownership remaining with the lessor.
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A finance lease is thus analogous to a loan and outright purchase for accounting and credit analysis purposes with the leased asset and corresponding liability (being the obligation to make lease payments) being capitalised in the Balance Sheet of the lessee. The lessee’s Statement of Comprehensive Income will show finance lease charges (being the implicit interest rate equivalent) and lease amortisation (equivalent to depreciation) as expense items. (See section 2.2(b) for whole-of-Government implications of finance leases.)
(ii) Operating Lease
An operating lease essentially is a rental agreement. In accordance with AASB117 and depending on individual circumstances, an operating lease may have a shorter term than a finance lease and may be cancellable without a significant penalty. The lessee does not guarantee any residual value, and at the end of the lease term, the lessee usually must return the asset to the lessor, who will either sell the asset or redeploy it to other end users.
In an operating lease, substantially all the risks and benefits incidental to ownership of the leased asset remain with the lessor. The lessee therefore enjoys the use of the asset without bearing any residual or obsolescence risk. This transfer of risk away from the lessee usually is reflected in higher lease rentals. The lessor also is entitled to any upside or resale or re-lease of a formerly leased asset.
Because an operating lease is considered to be a true hiring rather than being analogous to a loan, the leased assets and corresponding lease liabilities do not appear on the balance sheet of the lessee. Under an operating lease, the lessee’s Statement of Comprehensive Income will show lease rentals paid during the relevant period as an expense item.
(c) Operating Leases – Transfer of risk in the residual value of an asset
Lease payments under an operating lease ordinarily include a premium for the acceptance of the risk in the asset by the lessor. As such, an operating lease generally would be more expensive than a borrowing or finance lease for the same asset in net present value terms.
There can be benefits in the transfer of asset risk to another party, even though the residual risk transfer will be reflected in higher lease rentals. This is particularly so where there is high obsolescence risk or an unpredictable secondary market in the asset class (for example, information technology equipment). However, in some cases lessors have developed specialised distribution channels for specific asset classes. In such cases, lessors may be able to realise a higher resale price for those assets than the lessee could. The benefit obtained through a higher disposal value for the asset at the end of the term is typically passed through to lessees in the form of reduced lease rentals.
(d) Consideration of all Costs in the Lease v Buy Analysis
Consideration of all relevant costs necessitates a careful perusal of a prospective lease agreement for any restrictive terms regarding matters such as the timing, method and cost of the return of the asset or equipment.
Failure to comply with lease requirements may result in unintended extensions of the lease term or additional upfront rentals. Where this occurs, lease payments over the extended time period may be calculated on the original price, rather than the value of the asset at the end of the lease, resulting in increased total cost. (For other important documentation issues affecting costs - see 2.4 below.) Existing leases must be continuously monitored for their appropriateness. Appropriate asset management systems must be in place to remove the incidence of extensions of lease terms. However, extension may be allowed where a valid reason exists.
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When calculating the cost of the different acquisition alternatives, including leasing and purchasing, any costs involved in installing, operating, maintaining, removing, disposing of or returning an asset, must be taken into account. In the case of Taxation Equivalent Regime (TER) taxpayers, such as GOCs, any associated taxation and depreciation issues also should be taken into account.
(e) Bundling of Services in Lease Transactions
Lessors often attempt to bundle additional services (maintenance being one of the most prominent) together with the finance component of their lease transactions under one costing and one contract. These services typically are not provided by the lessor, but by a third party, often under an agency agreement.
There are two main concerns with the bundling of lease arrangements with additional services:
lessees would not be in a position to assess costs or benefits and competitiveness of the services and the finance component of the lease independent of one another; and
lessees could lose their ability to seek recourse to the service provider where a problem arose.
Public sector entities can address these concerns by carefully examining the cost of, and contractual relationship between, the lease component and each of the services in any documentation relating to the lease.
Accordingly, lease quotes should be obtained on an unbundled and separate basis to allow for separate evaluation of each of the components (eg. the lease of the asset and the maintenance of the asset). Also, the actual lease agreement/document should only relate to the finance component of the lease. Where a lease proposal includes bundled services, the finance component and the bundled services should be documented separately or, alternatively, incorporated as distinct severable sections within the lease documentation. This will ensure that the bundling of different services with the lease does not restrict recourse to the individual providers of the services.
Also, if a lessor wishes to provide a bundled quote on the basis that a single costing for a complete package of the lease and related services may be cheaper, the quote must include a breakdown outlining the proportions of the quote attributable to the finance component and each of the individual services. The main purpose of this is to specify the cost of individual services for the purpose of recourse under the lease documentation and, if applicable, to enable a net present value comparison between various bundled and unbundled quotes, rather than to require services to be provided on a separate contractual basis or to allow substitution of service providers.
(f) Understanding the Calculations in the Lease v Buy Analysis
The responsibilities of public sector entities to ensure prudent financial management requires that any decision to enter into a lease be based on a detailed net present value and cost/benefit evaluation of the lease proposal relative to other acquisition alternatives. This evaluation must include a calculation of all cash flows and costs associated with each of the relevant acquisition alternatives.
The cost of the lease first must be compared (on a net present value basis) with other leases to ensure the best value lease is identified. In this regard, lease proposals provided on a bundled basis should be unbundled to be compared with other quotes.
The best value lease proposal then should be compared (again on a net present value basis) with the cost of alternative acquisition methods, including borrowing (where permitted by policy) or outright purchase. When comparing bundled lease proposals, the service aspects of the bundled quote would have to be incorporated into the cost calculations of the alternative methods of acquisition.
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QTC has developed a lease versus buy analysis spreadsheet to assist public sector entities in evaluating the financing alternatives for the acquisition of an asset. This resource is available to public sector entities free of charge. Please contact QTC for information and advice about the use of this resource. Discount Rate - For public sector entities, the appropriate discount rate to apply in calculating the net present value of future cash flows relating to the lease is the QTC cost of funds applicable to the term of the proposed lease. Details of the QTC cost of funds can be obtained from QTC.
Debt Finance - For public sector entities, where the purchase price is funded by debt finance, the QTC cost of funds also should be used in determining the net present value of future cash flows, including the debt repayments and the residual value, over the life of the loan.
Budget Appropriation - Where the purchase price is fully funded upfront from one budget appropriation, all cash flows, including the residual value (net of disposal costs) and the cash flow arising from the immediate and full payment of the purchase price, should be taken into account in the net present value calculations.
Purchase by Instalments - In the case of a purchase by instalments, where the purchase price is funded over time from budget appropriations, the net present value of all cash flows, including the future payment obligations and the residual value, would need to be calculated using QTC cost of funds.
(g) The Lease v Buy Decision
Public sector entities should only enter into a leasing arrangement when it represents the best-cost alternative. As detailed in 2.1(f), the decision to enter into either a finance lease or an operating lease must be based on a detailed net present value and cost/benefit analysis.
(i) Finance Lease
A decision to enter into a finance lease should be made only when the net present value of future cash flows under the best value lease proposal is less than the net present value of cash flows under alternative methods of acquisition.
A finance lease will usually involve a greater level of administration than debt financing and the lessor may build a margin into the final price to reflect this. Lessees also tend to underestimate their administration and documentation costs. Therefore, it is common for finance leases to be more expensive than debt for lessees.
Because finance leases are effectively loan arrangements, the built-in cost of funds obtained from lessors is often greater than could be provided under a Government loan arrangement. Treasury and QTC are able to provide information and assistance with respect to Government funding options.
(ii) Operating Lease
Lease payments under an operating lease normally include a premium for the acceptance of the risk in the asset by the lessor. As such, an operating lease generally is more expensive than a borrowing or finance lease in net present value terms.
It is possible to quantify the amount of the premium in an operating lease, so that the lessee may weigh up the value of risk transfer. The premium for an operating lease can be calculated by dividing the difference between the net present value of the lease and purchase alternative by the capital cost of the equipment.
An operating lease will represent value for money if the cost premium is commensurate with the risk transfer. For public sector entities a premium of up to 5% of the capital cost of the equipment is generally considered an acceptable cost for the transfer of risk from the lessee to the lessor.
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In cases where an operating lease carries a premium over the purchase option of greater than 5%, there should be sound reasons for further consideration of the proposed transaction. High cost premiums are often associated with non-competitive lease pricing or with items that are not suitable for leasing i.e. equipment that does not retain any future value (eg. IT software and cabling).
QTC has developed a lease versus buy analysis spreadsheet to assist public sector entities in calculating/quantifying the premium for an operating lease. This resource is available to public sector entities free of charge. Please contact QTC for information and advice about the use of this resource.
Where a public sector entity wishes to undertake a lease proposal (finance or operating) which does not meet the assessment criteria outlined above, it is the responsibility of the administering department to ensure that there are sound reasons for further consideration of the proposal. If the relevant department is satisfied as to the appropriateness of the proposed transaction, the proposal will require Treasury’s approval. The application for approval must be lodged by the relevant department with Treasury with complete details of all acquisition alternatives and the reasons for seeking exemption from the above requirements. In addition to the Treasurer, the Treasury officers authorised to give approvals are the Under Treasurer, Deputy Under Treasurers and Assistant Under Treasurers.
The Treasurer also may delegate power to issue approvals under these guidelines to another Minister.
(h) Sale and Leaseback Arrangements
Where a public sector entity proposes to sell and lease back currently owned assets, the arrangement also must be the best cost alternative.
The net present value of the future payment obligations under a lease should be less than the net present value of the cash flow arising from the sale of the asset, adjusted for:
(i) the present value of the asset’s estimated residual value at the expiry of the lease calculated net of disposal costs (if any); and
(ii) other costs incidental to the continued ownership of the asset which would otherwise be included in the lease payment (eg. maintenance, insurance).
In instances where such difference is positive (ie. there is no net present value benefit from leasing) and the lessor bears the residual risk in the asset (ie. the lease is an operating lease), consideration should be given to whether such premium is commensurate with the residual risk transferred to the lessor. A sale and lease back proposal may be the best cost alternative, where there can be benefits in the transfer of asset risk to another party. This is particularly so where there is high obsolescence risk or an unpredictable secondary market in the asset class (for example, information technology equipment). In the event that a sale and leaseback proposal is the best-cost alternative, administering departments also will need to obtain all the necessary approvals, as outlined below. Where the entity proposing a sale and leaseback transaction is a department or part of a department (as distinct from a statutory body, local government or government owned corporation), the entity must discuss and reach agreement on the application of the sale proceeds with their relevant Treasury Analyst.
(i) Copy Cost Plans and Service Contracts
Suppliers of photocopiers and multi-functional devices may promote leases/rentals of their products as “copy cost plans” and “service contracts”.
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Under a copy cost plan, equipment rental is charged on a cost per copy basis. All running costs (other than paper) are included in the agreed cost per page. Similarly, with service contracts, equipment rental is based on annual usage, with running costs (other than paper) included in the contract price.
Such transactions may be financially disadvantageous to the State because they can involve an aggregate cost in net present value terms significantly higher than the value of the asset (ie. the capital cost of outright purchase of the asset).
Public sector entities should only enter into an arrangement such as a copy cost plan or service contract when it represents the best-cost alternative on a whole-of-life basis.
(j) Short-term Hire Arrangements
Technically, a short-term hire is an operating lease and is regulated by the leasing policy guidelines. Whether short-term hire arrangements require approval under (or exemption from) these guidelines will depend on the circumstances of each case. Factors to be considered by Treasury will include:
purpose;
value for money;
operational efficiency; and the term of the arrangement.
Any decision to enter into a short-term hire arrangement should be readily justifiable and documentation regarding the decision process should be retained for audit purposes.
Public sector entities should contact the relevant Treasury Analyst for assistance and advice on the application of the leasing policy guidelines to short-term hire arrangements.
2.2 Power to Lease
The power of public sector entities to enter into leasing arrangements depends primarily on the classification of the lease and the entity concerned.
Public sector entities may be classified for the purposes of these policy guidelines as:
entities funded from the Consolidated Fund (usually government departments); local governments;
statutory bodies other than local governments; or
Government Owned Corporations.
Relevant powers by which each class of entity can enter into leases are detailed below:
(a) Legislative Powers
Departments - The financial powers of departments are determined by the Financial Accountability
Act 2009 (FA Act). The Financial and Performance Management Standard 2009 (the Standard) provides the framework for a department to develop and implement systems, practices and controls for financial management.
Section 23 of the Standard requires agencies to manage their assets in accordance with the asset management system which must provide for identifying, acquiring, managing, disposing, valuing, recording and writing off assets. Also, section 23 of the Standard requires agencies to prepare an evaluation or review of a completed significant asset, if requested.
When entering into leasing arrangements, departments are obliged under the Standard to have regard to the requirements of the Queensland Procurement Policy. The FA Act requires departments to prepare financial statements in accordance with the prescribed requirements (s 62(1)). The prescribed
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requirements include the Australian Accounting Standards and therefore compliance with AASB 117.
Local Governments - The financial powers of local governments generally are derived from the
Statutory Bodies Financial Arrangements Act 1982 (the SBFA Act). Subject to compliance with the SBFA Act and the Local Government Act 2009 or the City of Brisbane Act 2010, a local government has power to enter into a lease arrangement.
Statutory Bodies other than Local Governments - The financial powers of statutory bodies generally
are derived from the SBFA Act. Subject to compliance with the SBFA Act and its authorising Act, a statutory body has power to enter into a lease arrangement.
Government Owned Corporations - GOCs derive their financial powers from the Government Owned
Corporations Act 1993 (the GOC Act) and, in particular, from their individual Statements of Corporate Intent.
In exercising their powers, GOCs must refer to the provisions of the particular legislation or regulations by which they are established and the company’s constitution.
GOCs generally have power to enter into leases. However, there may be restrictions on the permissible nature and type of leasing or other financial arrangements that a GOC may enter into, including, for example, in its Statement of Corporate Intent.
(b) Fiscal Policy Principles
The Government’s core fiscal policy principles are:
Stabilise and then significantly reduce debt
Achieve and maintain a General Government Sector fiscal balance by 2014-15
Maintain a tax competitive environment
Target full funding of long term liabilities such as superannuation in accordance with actuarial advice
It is inherent in the fiscal policy principles that a public sector entity must not enter into either an operating lease or a finance lease arrangement that does not represent the best-cost alternative. Failure to adhere to this principle has the potential to constrain future budget flexibility (by locking in ongoing expenditure commitments over a number of years) and to significantly compromise Queensland’s financial position.
General Government Sector agencies should be aware that the commencement of a finance lease impacts negatively on the whole-of-Government fiscal balance and all agencies should be aware that a finance lease borrowing is classed as debt in terms of the first fiscal principle.
(c) State Borrowing Program
In addition to consideration of legislative power and the Government's core fiscal policy principles, any public sector funding arrangements generally must be accounted for within the relevant administering department's borrowing limit approved by the Treasurer under the State Borrowing Program for the particular financial year.
The State Borrowing Program is the vehicle by which the State coordinates and manages the funding arrangements of all public sector entities (both budget and non-budget) to ensure that the aggregate of all funding arrangements is consistent with the State’s Loan Council Allocation (LCA).
The LCA is a figure which represents the State's aggregate call on financial resources and is the principal means by which the Australian Loan Council monitors the funding activities of the Commonwealth, State and Territory Governments, as part of overall national macroeconomic policy management.
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Each year, departments submit a request to Treasury for an allocation under the State Borrowing Program for the coming financial year. For this purpose, public sector entities are required to provide details of future funding requirements to their administering departments. The administering departments are required to analyse the funding requests in accordance with the Cost-Benefit Analysis guidelines available under the Project Assurance Framework to determine whether the proposed arrangements are financially prudent and to determine the ability of the entity to meet its obligations under the arrangements.
On the basis that finance leasing is analogous to a borrowing, it is the responsibility of each public sector entity to contact its relevant administering department in order to seek approval under the State Borrowing Program to enter into any finance leases, the amount of which is calculated using the net present value of future payments related to the lease.
Similarly, each public sector entity, via its relevant administering department, must seek approval under the State Borrowing Program for any operating lease where the total net present value of base lease rental payments exceeds $2 million. The $2 million threshold applies to the total value of an individual lease.
For assistance on State Borrowing Program issues contact the relevant Treasury Analyst.
2.3 Procedures and Approval Requirements
The following section details the approvals required by public sector entities when entering into leasing arrangements.
(a) Departments
As a matter of prudent financial management and commercial practice, any lease arrangement entered into by a department or other entity funded from the Consolidated Fund, must proceed through QTC, unless otherwise approved by the Treasurer.
(i) Finance Lease
A department must seek approval under the State Borrowing Program to enter into a finance lease. Where a department wishes to enter into a finance lease with a cost premium, the lease will also require Treasury’s approval.
(ii) Operating Lease
A department must seek approval under the State Borrowing Program to enter into any operating lease where the net present value of base lease rental payments exceeds $2 million.
A department is also required to obtain Treasury’s approval to enter into an operating lease where the cost premium of the lease over the purchase alternative is greater than 5% of the capital cost of the equipment.
(b) Local Governments
Local governments are responsible for considering and assessing proposed lease arrangements. In any lease or tender process for the provision of a leasing facility, a local government must ensure that the most cost effective financing option for the acquisition is adopted.
If a local government intends to enter into a lease arrangement, it is required to approach its administering department with complete details of the proposal and request that the department seek any necessary approvals on its behalf.
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(i) Finance Lease
A local government must seek approval under the State Borrowing Program and the SBFA Act to enter into a finance lease.
In addition, where a local government wishes to enter into a finance lease with a cost premium, the lease will require Treasury’s approval.
(ii) Operating Lease
A local government must seek approval under the State Borrowing Program to enter into any operating lease where the net present value of base lease rental payments exceeds $2 million. The Treasurer has implemented an operating lease approval framework for local government under the SBFA Act and the leasing policy guidelines.
Under the approval framework, a local government is required to obtain the Treasurer’s approval to enter into an operating lease where:
the cost premium of the lease over the purchase alternative is greater than 5% of the capital cost of the equipment; and
the capital cost of the equipment is greater than $10,000.
Generally, a local government will require approval for all operating leases where the debt capacity assessment process of the Department of Local Government, Community Recovery and Resilience (DLGCRR) indicates that the local government is approaching the maximum acceptable limit of its debt servicing capacity. In particular, if a proposed transaction will result in a local government’s annual interest and redemption payments exceeding 35% of its annual rates and charges, DLGCRR will more closely examine its borrowing capacity and debt policy.
(c) Statutory Bodies other than Local Governments
If a statutory body intends to enter into a lease arrangement, it is responsible for approaching its administering department with complete details of the proposal and requesting that the department seek any necessary approvals on behalf of the body.
The administering department is responsible for considering and assessing the proposal, and for determining (having regard to the requirements of prudent financial management) whether it is appropriate for the approvals to be given. This determination would form the basis for an appropriate recommendation by the department to Treasury regarding approvals.
In any lease or tender process for the provision of a leasing facility, a statutory body and its administering department must ensure that the most cost effective financing option for the acquisition is adopted.
(i) Finance Lease
A statutory body must seek approval under the State Borrowing Program and the SBFA Act to enter into a finance lease. In addition, where a statutory body wishes to enter into a finance lease with a cost premium, the lease will require Treasury’s approval.
(ii) Operating Lease
A statutory body must seek approval under the State Borrowing Program to enter into any operating lease where the net present value of the base lease rental payments exceeds $2 million. A statutory body must also seek approval under the SBFA Act to enter into an operating lease that the body is not clearly empowered to enter into under its authorising Act in the ordinary course of performing its functions.
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In addition, a statutory body is required to obtain Treasury’s approval to enter into an operating lease where the cost premium of the lease over the purchase alternative is greater than 5% of the capital cost of the equipment.
(d) Government Owned Corporations
If a GOC intends to enter into a lease arrangement, it must do so only in accordance with its corporate governance arrangements (for example, a Board approved financial policy for leasing as contemplated in the Code of Practice for Government Owned Corporations’ Financial Arrangements).
(i) GOCs with a Board Approved Leasing Policy
A GOC with a Board approved financial policy for leasing that has been reviewed by shareholding Ministers will enter into leasing arrangements in accordance with the Board approved policy.
A GOC must seek approval under the State Borrowing Program to enter into:
a finance lease; or
any operating lease where the net present value of base lease rental payments exceeds $2 million.
(ii) GOCs without a Board Approved Leasing Policy
GOCs without a Board approved financial policy for leasing must comply with these guidelines and the requirements of the GOC Act. In any lease or tender process for the provision of a lease facility, a GOC must ensure that the most cost effective financing option to the GOC for the acquisition is adopted.
Finance Lease – A GOC must seek approval under the State Borrowing Program to enter into a
finance lease. In addition, where a GOC wishes to enter into a finance lease with a cost premium, the lease will require Treasury’s approval.
Operating Lease – A GOC must seek approval under the State Borrowing Program to enter into
any operating lease where the net present value of base lease rental payments exceeds $2 million. A GOC is also required to obtain Treasury’s approval to enter into an operating lease where the cost premium of the lease over the purchase alternative is greater than 5% of the capital cost of the equipment.
2.4 Lease Documentation Issues
Many operating leases contain a variety of clauses that either are inappropriate for public sector entities (such as requirements for insurance, onerous rights of entry and the right to use the lessee’s name in legal actions) or could dramatically increase the cost of leasing for the lessee, thus affecting the outcome of the cost/benefit analysis.
In particular, key documentation issues that should be considered during preliminary cost analysis, tender negotiations and subsequent drawdowns include:
(a) Commencement Date - The commencement date generally is the date the lease agreement commences and the date from which the lessee must pay lease rentals. It is common market practice for lessors to set the commencement date in a manner that maximises the amount of any interim rentals (see below).
(b) Interim Rentals - Lessors commonly nominate payment dates that preclude the commencement of rental terms on days other than the specified payment dates. Where a lessee takes delivery of equipment prior to a nominated payment date, an interim rental (above the base lease rental) will be required.
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(c) End of Term Provisions (Inertia Rentals) - As with interim rentals, the end of term provisions in a lease can provide lessors with an additional mechanism for mitigating their residual risk in the leased asset. These provisions generally are drafted such that the lessee must continue to lease the equipment if the asset return provisions are not met.
(d) Upgrades - Despite the claims of lessors, there generally are no specific provisions within lease documentation regarding the upgrade of leased equipment. Upgrading effectively involves a termination of the existing lease, after which the lessee leases back the upgraded equipment for an extended term. A termination in this manner can allow the lessor to make windfall profits.
(e) Termination Value - The termination value is the amount due from the lessee where the lease terminates prior to the end of the normal lease term. The major concern is that the lessee often has no method for verifying its calculation. Accordingly, potential exists for the lessor to exploit lessees when an early termination occurs.
(f) Indemnities - Some lessors require lessees to provide non-standard indemnities relating to any changes in the treatment of the lease for tax purposes.
The provisions within lease documents dealing with these issues can give the lessor the potential to either increase the cost of the lease to the lessee, or unreasonably restrict the lessee’s ability to use, maintain or operate the leased equipment.
2.5 Budgetary Treatment of Lease Payments
There is evidence that leasing expenditures are being met from incorrect budget allocations, such that capital expenditure is being funded from recurrent allocations and recurrent expenditure is being met from capital allocations.
This reduces the comparability, relevance and reliability of information provided in the budget papers and the accountability with which public sector entities carry out their roles.
As stated previously, a finance lease is analogous to a borrowing or deferred payment arrangement for outright purchase. Accordingly, finance leases should be capitalised and the relevant expenditure should be funded from capital budget allocations. Conversely, an operating lease effectively constitutes a rental agreement, for which the relevant expenditure should be met from recurrent budget allocations.
This treatment is in accordance with accrual accounting principles and should be applied by all public sector entities (including entities funded from the Consolidated Fund, Statutory Bodies and Government Owned Corporations).
2.6 Role of Queensland Treasury and Trade and Queensland Treasury Corporation
Public sector entities should be aware that officers of Treasury and QTC are available to assist with the provision of leasing facilities.
Officers of Treasury and QTC also are available to provide the necessary advice and systems to enable public sector entities to appropriately and consistently classify leases in accordance with AASB 117 and to assist public sector entities in calculating the best cost alternative in the lease v buy analysis. The first point of contact at QTC is the Lease Administration Manager and, at Treasury, the relevant Treasury Analyst.
2.7 Whole-of-Government Lease Facility
The whole-of-Government lease facility is a leasing and advisory service that has been established by Treasury and QTC to standardise Government leasing activities on competitive terms acceptable to the Government and to remove the need for public sector entities to obtain and assess lease quotes
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independently.
The facility is administered by QTC. The facility provides both finance and operating leases to public sector entities and extends to all asset types, other than passenger motor vehicles and light commercial vehicles (comprising standard four-wheel drive vehicles and utilities).
As part of the facility arrangements, Treasury and QTC have established a Lease Participation Panel, comprising private sector leasing organisations and/or equity providers who bid for equity or debt and equity participation in individual operating leases. However, where appropriate, a lease agreement may be entered into with a leasing organisation outside the Lease Participation Panel.
To ensure that all lease pricing is undertaken on a consistent basis, QTC and Treasury have formalised standard master lease documentation (with slight variations to suit different classes of equipment) upon which all lease quotations and transactions are based. Only providers willing to accept the standard lease documentation have been accredited to the Lease Participation Panel. The uniform documentation, which has been drafted with public sector entities in mind, should ensure that any benefits of leasing are passed through to the Government end users.
The whole-of-Government lease facility is based on a sale and leaseback structure whereby public sector entities purchase equipment from suppliers, and then enter into a sale and leaseback arrangement through QTC. Under this structure, the equipment selection decision remains with the entities, to be undertaken in accordance with the procurement procedures under the Queensland Procurement Policy or the Local Government Act 2009.
Public sector entities remain responsible for specifying, ordering, obtaining and acceptance testing any equipment to be leased through the facility. When a lease is ready to proceed, the entity provides QTC with the relevant equipment details. QTC is then responsible for paying the equipment supplier once all lease documentation has been completed.
3. SUMMARY OF PROCEDURAL GUIDELINES
Public sector entities, in conjunction with QTC should formalise the procedural steps required to undertake a lease transaction. The following summary provides guidance on some of the issues to consider:
(a) In the first instance, public sector entities should determine whether they have the requisite power to enter into the lease arrangement.
(b) The total cost of the lease must be compared (on a net present value basis) with other leases (based on the non-cancellable component of the lease arrangement) to ensure the best value lease is identified. (c) The best value lease proposal must be compared (again on a net present value basis) with the cost of alternative acquisition methods, including borrowing or outright purchase.
(d) An operating lease will represent value for money if the cost premium is commensurate with the risk transfer. For public sector entities a premium of up to 5% of the capital cost of the equipment is generally considered an acceptable cost for the transfer of risk from the lessee to the lessor.
(e) QTC has developed a lease versus buy analysis spreadsheet to assist public sector entities in evaluating the financing alternatives for the acquisition of an asset. This resource is available to public sector entities free of charge. Please contact QTC for information and advice about the use of this resource.
(f) Public sector entities must determine whether the lease is finance or operating in accordance with the guidance provided by Australian Accounting Standard (AASB 117) Leases.
(g) Public sector entities must liaise with their relevant department to ensure that any requisite approvals are obtained, such as State Borrowing Program approval and Treasury approval under these
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guidelines (refer section 2.3).
(h) Public sector entities also must ensure the correct budget and accounting treatments are applied to the lease transaction.
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Attachment
Australian Accounting Standard 117 - Leases 1
The classification of leases is based on the extent to which risks and rewards incidental to ownership of a leased asset lie with the lessor or the lessee. Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return because of changing economic conditions. Rewards may be represented by the expectation of profitable operation over the asset’s economic life and of gain from appreciation in value or realisation of a residual value.
A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership.
Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract.2 Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are:
(a) the lease transfers ownership of the asset to the lessee by the end of the lease term;
(b) the lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised;
(c) the lease term is for the major part of the economic life of the asset even if title is not transferred; (d) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and
(e) the leased assets are of such a specialised nature that only the lessee can use them without major modifications.
Indicators of situations that individually or in combination could also lead to a lease being classified as a finance lease are:
(a) if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee;
(b) gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for example, in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and
(c) the lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.
The above is not an exhaustive list of indicators. There may also be other features of the lease arrangement that indicate that the lease transfers substantially all risks and rewards incidental to ownership to the lessee. Further guidance can be obtained from AASB Interpretations: ‘Determining whether an Arrangement contains a Lease' and Urgent Issues Group Interpretation 127 'Evaluating the Substance of Transactions Involving the Legal Form of a Lease'.
A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred.
An operating lease is a lease other than a finance lease.
Fair value is the amount for which an asset could be exchanged or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.
1 Extract from AASB 117 Leases. For full standard, see http://www.aasb.com.au. 2 Guidelines are correct as at time of printing and should be used as a guide only. Reference should be made to the relevant accounting standards to ensure utilisation of current accounting principles. The specific principles contained in AASB117 need to be applied to determine the existence of either a finance lease or an operating lease. Internal accounting and auditing advisors should be able to provide assistance in this regard.
