Leasing is effective renting. You do not own the underlying piece of equipment or asset, but merely rent it for a defined period for a monthly or quarterly lease rate.
In a lease, the business is called the Lessee and the provider of the equipment, the lessor.
A Lease Agreement is generally entered into between the parties which defines or describes the Lessee’s obligations to perhaps insure and maintain the equipment. Some leases include the provision that the lessee can purchase the equipment at the end of the lease at the fair market value of the equipment.
Businesses utilize leasing for a number of reasons:
It does not generally constitute Debt or Borrowings
When you purchase an asset and borrow the money to pay for it, we call this Financing. In this scenario, a business actually purchases and owns the underlying asset and has a corresponding bank loan which it repays. Both the asset and the amount owed to the Bank, the liability, is not recorded on the books of the business. The loan therefore forms part of the businesses borrowing.
In a lease scenario, a business does not own the equipment, but merely has a right to use it. It therefore does not record the equipment as an asset on its books and does not record the full amount owed under the Lease on it either.
The equipment lease operates much like a lease that a business would have with its Landlord in that you just record your monthly rent as an expense but have certain rights to use and obligations to pay under the realty lease.
Leasing can therefore be a solution or technique used where a business does not wish to continue to borrow money. This may be important if the business has strict borrowing covenants with its bank.
This is sometimes referred to as : Off Balance Sheet Financing.
It’s important to note that in some circumstances, where the intent of both the lessee and the Lessor is really a financing type of arrangement, accounting rules require the lease to be accounted for as a Capitalized Leased Asset. This is generally common where at the end of a lease, the equipment can be purchased for a nominal sum of $1.00.
We recommend you seek the guidance or input of a Chartered or Certified Accountant when considering the accounting implications of leasing.
Income tax benefit
The amounts paid persuant to a lease are generally deductibalbe for income tax purposes (assuming the item being leased is for business purposes).
Preserves Working Capital
The ability to finance equipment or assets with a lease helps businesses preserve available cash flow and does not tie up much needed working capital (or Lines of credit)
Little or No Downpayment needed
Most leasing can be done with little or no requirement to put down a deposit of any sort.