Are you a firm that needs leasing equipment? If yes, there are two kinds of leases – capital leases and operating leases. Which one should your business choose to use?
Grant Capital Management is here to help you make the right choice for your business by showing you the differences between a capital lease and an operating lease. Read to learn the advantages these leases can offer you and which one will best serve your needs.
Capital leases and Operating leases are each used for different purposes and treated differently on the accounting books of your business.
The main difference between capital leases and operating leases is that capital leases transfer ownership of leased products while operating leases only transfer the right to use the technology.
Choosing the correct lease structure is critical because it affects how your finance department records the lease on your books.
Capital leases are reported on your balance sheet and operating leases are not. Even if you are a privately held company your finance team still keeps good accounting records and communicates on a regular basis with your major creditors.
The most important concept to understand about a capital lease is the word capital, as in cash or credit. The accounting treatment of a capital lease is similar to an outright purchase. As the lessee, you are obligated to report a capital lease as an asset and a liability on your balance sheet. As such, your organization may claim depreciation on the assets.
-In a capital lease, your organization only assumes some of the risks of ownership. The lessor (leasing company or bank) purchases an asset on your behalf.
-The lessee (you) will have use of the asset during the lease term.
-You make rental payments (including tax and interest) to the lessor that covers a large portion or all of the original cost of the asset.
-Your organization records the capital lease on balance sheets as an asset and a liability.
At the end of term, you have many options available. You may choose to purchase the asset outright, return the asset to the lessor, or extend the term of the lease and continue to make payments.
At the end of the lease, if you choose to purchase the asset, the cost to take ownership may be low, sometimes as low as $1. Keep in mind that a capital lease does not imply $1 out; a capital lease may have a fair market value (FMV) buyout. A FMV buyout may be cost prohibitive. Capital leasing is a creative way to acquire a bundle of technology products and services over a period of time. This option may be more attractive than using a bank credit line or paying cash.
Capital leasing is a creative way to acquire a bundle of technology products and services over a period of time. This option may be more attractive than using a bank credit line or paying cash.
The most important concept to understand about an operating lease is the word operating, as in operating expense. In an operating lease, only the right to use the technology is transferred from the lessor to the lessee. When leasing IT products and service, it is harder to qualify for an operating lease due to the increased risk the lessor takes on.
Operating Lease Requirements (Statement of Financial Accounting Standards – FASB 13)
-The lease does not transfer ownership of the property to the lessee by the end of the lease term.
-The lease does not contain a bargain purchase option (unlike the capital lease, where you are often able to purchase the asset at lease end).
-The lease term is equal to less than 75% of the estimated economic life of the property.
-The present value of the minimum lease payments, assuming an appropriate discount rate must be less than 90% of the fair value of the property at lease inception.
Operating Lease Basics:
-The lessor (leasing company or bank) purchases an asset on your behalf.
-The lessee (you) has use of the asset during the lease term.
-You make rental payments (including tax and interest) to the lessor, which only covers the use of the asset for the term.
-Your organization records the operating lease as an operating expense on income statements.
At the end of term, the lessee has many options available. The lessee can choose to purchase the asset outright, return the asset to the lessor, or extend the term of the lease and continue to make payments. At the end of the lease, if you choose to outright purchase the asset, the cost to take ownership can be very high. The FMV in an operating lease cannot be pre-negotiated. Hence, operating leases are a creative way to utilize a bundle of technology products and services over a period of time, typically followed by a refresh of the technology. Extending the lease term typically converts the lease to a capital lease for the new term. This option may be more attractive than capital leasing, using a bank credit line, or paying cash.
Grant Capital Management is available to help you make the right lease-financing choice.
Take advantage of our track record and experience.
Grant Capital Management is a leading provider of tax-exempt lease-financing to the public sector. We finance almost any type of essential-use capital equipment, real property or Energy Performance Contract. Since 2000, we have funded over $3.7 billion in lease financings. Grant Capital designs master leases, taxable and tax-exempt lease-purchase agreements and operating leases from $500,000 to $60 million and beyond with terms in excess of 20 years to meet our clients’ specific requirements.
If you need lease-financing services to finance a project, contact Grant Capital Management at 410. 715.9135 or click here today!