What is a capital lease?
While an operating lease can be viewed as similar to renting, a capital lease is more like a financed purchase. In fact, for accounting purposes, a capital lease is considered a purchased asset. A capital lease is recognized as both an asset as well as liability on your balance sheet. You get to claim depreciation on the asset and deduct the interest expense each year. At the end of a capital lease there is a nominal payment to take full ownership of the asset, much lower than the fair market value.
The Financial Accounting Standards Board requires leases be treated as capital if any of the following four conditions are met:
- if the lease life exceeds 75% of the life of the asset
- if there is a transfer of ownership to the lessee at the end of the lease term
- if there is an option to purchase the asset at a “bargain price” at the end of the lease term (opposed to fair market value purchase in an operating lease).
- if the present value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of the fair market value of the asset.
Benefits of capital leases
- Build equity with each payment
- Depreciate balance sheet assets
- Claim interest expenses
- Nominal purchase cost at lease end
Disadvantages of capital leases
- Higher monthly payments
- Own device at lease end making upgrades more costly
- Risk of equipment obsolescence
- Liability on balance sheet
What’s the bottom line?
In a capital lease, you assume some of the risks of ownership but also enjoy some of the benefits. If you don’t have significant debt (showing on your balance sheet) and want the benefits of depreciation and interest expenses, then a capital lease may be the right option for you. However, most of our customers prefer the benefits of an operating lease. If you have questions about which financing option is right for you, contact us and we would be happy to discuss your options.