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You are here: Experts > People/Relationships > Retirement Planning > Accounting, Payroll & Pension Issues > Leasing-Finance or Operating Lease
Expert: Arthur Naman - 10/23/2009
Question
QUESTION: I own a business & doing the accounting myself.
I rent a photocopier machine from supplier,paying $100.00 as monthly rental. Had discussed with supplier, they told me that this transaction consider as leasing,i can't put the machine in my company account as asset, & I can't depreciate it also.
I had signed the contract with supplier,detail shown below : --
1) Lessee Term : 60 months (5 years)
2) Amount Financed : $6000.00
The supplier gives me 3 options AFTER i fully settle 5 years monthly rental: --
1) I can buy back the machine, in which I just pay one lump sum of $50.00 will do then i own the machine & not need to pay rental anymore.
2) I just need to pay one lump sum of $50 YEARLY(Rental turn into yearly term instead of monthly, & i don't own the machine as asset, still under leasing)
3) I can buy back the machine, in which i just pay one lump sum of $50.00 will do then i own the machine & then i can trade in this old machine. Supplier will provide a new machine, but i need to start a new contract again & paying monthly installment again.
My question is that : --
1) My understanding for leasing which is an expense, shown on Profit & Loss, while Hire Purchase allocates the machine as asset & do the depreciate yearly (shown on Balance Sheet) & monthly repayment shown on Profit & Loss. I just want to make sure that this contract should be considered as Leasing or Hire Purchase?
2)I'm doing the entries below monthly, am i correct ?
Dr. Rent a/c $ 100.00 (Profit %26 Loss)
Cr. Bank $ 100.00 (Balance Sheet)
3) I'm paying monthly rental but i don't own the machine & can't do the depreciate, is that fair to my company?
Thank you very much.
ANSWER: The question of whether or not you can depreciate the machine as an asset as opposed to writing off the lease payments as an expense is not determined by what the lease company says, rather the terms of the "lease." Your being able to purchase the machine at the end of the lease for $50 means that this is, in effect, a financed purchase and should be treated as such on your records -- capitalize and depreciate.
The size of the final payment, only $50, is of such a small amount both as a dollar amount and in relation to the initial purchase amount, is the reason for my conclusion.
With that said, the normal depreciate period for copier is, I believe, 5 years. Thus your being able to write off the lease payments is roughly the same as straight-line depreciation.
Accordingly, unless you choose to write off the machine in the year purchased as a Sec. 179 write off, then you might choose to simply write off the lease payments rather than go through the effort to depreciate the cost.
Note: at the end of the lease, you might purchase the machine for $50 and then sell on Craig's List or eBay.
---------- FOLLOW-UP ----------
QUESTION: As for your information, I'm located at Asia.
I did sign the "Equipment Lease Agreement" with supplier, critical point on agreement shown below as for your kind perusal : -
Capital Allowances -- The Lessee shall not be liable for fair wear & tear of the Equipment & burden of depreciation resulting from such wear & tear shall fall on the Lessor who shall be entitled to claim all capital allowances for and in respect of the Equpiment.
Actually my friend teaches me to do the transaction below :-
1) Put it as rental expenses for 5 years on my book.
Dr. Rent Expense (Profit & Loss)
Cr. Bank
2) On mature date (year 2013), i'm going to pay $50 to buy the machine & then only capture it as asset.
Dr. Asset
Cr. Bank
Are above transactions workable & recognize by normal accounting standard ?
Thank you very much.
ANSWER: There is nothing wrong with your treatment regarding expensing the annual lease payments as rent or lease expense. I would probably call the expense lease expense rather than "rent" but that is not significant.
As for the $50 payoff at the end of the lease, I would just write it off as an expense rather than capitalizing it. This is due to the small amount -- $50 -- of the final payment.
Please keep in mind that answers to the "correct" way to treat these issues depends on the country in which you are located. I would expect my suggestions to be appropriate, but I cannot guarantee it.
Hope all this helps.
Arthur Naman
Austin, TX USA
---------- FOLLOW-UP ----------
QUESTION: May i know that how to distinguish the difference between Finance Lease and Operating Lease ?
For my case should be Finance Lease or Operating Lease ?
Answer
For a financing lease, the lease term equals or exceeds 75% of the asset's useful life. And, the present value of the lease payments equals or exceeds 90% of the initial cost.
An operating lease does not have these characteristics. At the end of the lease term, the asset had relatively more significant useful life and purchase cost.
The $50 purchase price at the end of the lease says to me that this is a financing lease.
Since this a financing lease, you are really purchasing the asset.
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