mAccounting

Is Equipment Leasing Right for My Business? - Part II

January 25, 2009

As a general rule, you should consider leasing equipment that (1) has a significant cost, (2) will be needed for a short period of time or (3) will become obsolete rather quickly. Due to finance charges and other related costs, it is often better to purchase small items rather than lease them, since the costs of leasing often outweigh the reduction in short-term cash outlay. Similarly, the company may also want to lease a piece of equipment that has a long life, using a "financing-type" lease. In this case, the lease agreement calls for the transfer of ownership at the end of the lease term, usually for a relatively low payment amount. This financial planning approach avoids having to enter into a new loan when the first one expires in order to retain possession of the equipment.

The company should always evaluate other pros and cons of leasing, which are normally included in the lease contract. These would include the leasing company’s policy on repairs, upgrades, early terminations, and end of lease buyouts. Also, because leases are essentially financing instruments, they contain an implicit interest rate. The approximate implicit rate can usually be calculated, given the equipment cost, least term, monthly payments, and estimated residual value at the end of the lease. Look for a competitive implicit rate.

The final accounting consideration, and the one you should consult with your tax advisor about, is whether the lease is an operating lease or financing lease for tax purposes. If the lease is an operating lease, it will have no effect on the balance sheet and the payments will be considered operating expenses which can be deducted for tax purposes. If the lease is a finance lease, the lease will show up as debt on the balance sheet and the accounting of depreciation of the asset can be deducted on the company’s taxes.