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Leasing Vs Buying. How Do You Decide?

Leasing, a contract for the use of an asset for a specified term, has become a popular means of financing equipment acquisitions, and can be an attractive alternative

Typical advantages to leasing include:

Low up front cost
The asset acts as security for the debt
Payments are fixed and certain
There is some flexibility in the lease structure
You may be able to easily exchange outdated equipment

Typical disadvantages include:

Leasing is generally a higher cost alternative
A lease is generally not cancellable
Lease terms are generally complex
It is generally difficult to compare alternatives

There are two basic types of leases. The classifications are important because they are treated differently for accounting purposes.

An Operating Lease is one that everyone typically associates with the word leasing. The term is generally less than the useful life of the asset, there is no automatic or "induced" transfer at the end of the lease term, and some of the risks of ownership remain with the lessor. If you have a lease of this type, the lease payments are written off for tax purposes.

A Capital Lease is where all conditions and terms indicate that, for all intents and purposes, a sale has taken place and the "lease" is merely a means of financing the sale. This would normally be the case when a bargain purchase option exists, the asset is automatically transferred to the lessee at the end of the lease (normally for nominal consideration), or where the total lease payments, adjusted for an appropriate interest rate, approximate the normal selling price of the asset.

For income tax purposes, there is no distinction between the two, unless both parties agree. So unless the parties properly elect to treat the transactions as an effective sale, the lessee writes off the monthly lease payment. If the election is made, the transaction can be treated as a sale so that the lessee can claim capital cost allowance and interest instead of the monthly lease payment.

Whether to lease or buy is a unique solution for everyone. Typical considerations include:

Available acquisition options
Timing and amounts of cash outflows
Alternative uses for available cash
The eventual true cost
Residual values of assets leased
Tax consequences
The risk of technological obsolescence
Attractiveness of financial terms
Attractiveness of specific lease options

Due to the many different options that exist in leasing, always ensure you are comparing apples to apples. One way to ensure this is to create a bid sheet. Typical information to record on the bid sheet is your name, the product name, model and manufacturer, any additional options, best quoted sales price and suggested list price, desired tax impact and your preferred lease terms, ie start date, payment frequency and length of the lease.

Distribute this document to the bidder and compare the bids. Odds are you can quickly spot the best deal.

If you are looking for a quick, numerical analysis, you can use this calculator. It was created for vehicle leases, but the analysis is largely the same for all types of leases.

© 2015 John B Voorpostel

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