The cost of buying new equipment is a big concern if you’re starting or growing your business. Luckily, leasing offers a simple and flexible alternative to acquiring the equipment you need to operate and grow your business, serving as an alternative to paying cash, obtaining a loan, issuing debentures and other forms of financing.
There are many benefits to leasing equipment and it’s a great solution for many organizations. If you’re considering it, these are the different types of business leases you can choose from.
8 Types of Equipment Leases
A Capital Lease is one which transfers substantially all the risks and benefits of ownership of the leased property to the lessee. This may be your best choice if long-term equipment ownership is your goal. According to the Canadian Institute of Chartered Accountants handbook, a lease will be treated as a Capital Lease (i.e. be categorized on your balance sheet as a long-term liability, interest expense on your income statement) if it meets any of the following criteria:
Title passes automatically to the lessee at the end of the lease term.
The lease contains a bargain purchase option (i.e. less than Fair Market Value, any where from $1 to 10% of the original equipment cost).
The lease term is greater than 75% of the estimated economic life of the leased property.
The present value of the minimum lease payments is greater than 90% of the leased property’s Fair Market Value at the inception of the lease.
An Operating Lease is any lease that is not a Capital Lease, and does not transfer substantially all of the benefits and risks related to the ownership of property to the lessee. As such, Operating Leases are generally used for short term equipment leases, and can work to the lessee’s benefit for tax purposes as the payments may be deducted as an operating expense. An Operating Lease is considered to be an “off-balance sheet” liability, allowing the lessee to acquire equipment for just a fraction of the useful life of the asset, although it typically contains a provision to purchase the equipment at the end of the lease for Fair Market Value. Additional services, such as maintenance and insurance may be provided by the lessor.
A Stretch Lease offers the lowest monthly payments and largest tax benefits available, and is right for you if you want to take advantage of lower payments and an early purchase option. Stretch Leases offer the lessee an option, at the end of the primary lease term, to either extend the term or purchase the asset. Should the lessee choose to extend the term, no later purchase option will be available, as the present value of the extended lease payments is usually equal in value to the option price. For example, if you are approved for a lease over 24 months, this approved value can be taken and spread, or stretched, over 27 months, which has a direct impact on lowering your monthly payments.
Skip Payment Lease
A Skip Payment Lease allows the lessee to avoid payments during slow periods of the year, and contains a payment stream requiring the lessee to make payments on a payment plan tailored to fit a unique cash flow cycle. Matching the timing of revenues to expenses is an important financial strategy for businesses with fluctuating cash flow streams. For example, a lease with the first payment due in 90 days would be considered a “three-month skip payment”.
Step Payment Lease
A Step Payment Lease allows the lessee to tailor lease payment streams to match irregular revenue streams inherent to their business. A Step-Up Lease begins with lower amortized monthly lease payments that increase, or ‘steps up’, over the lease term, structured over virtually any interval, with three, six and 12-month steps being most common. Step-Down Leases follow the same process, only monthly payments are periodically reduced over the lease term.
A Master Lease is an agreement whereby the lessee is not only able to lease currently needed assets, but also to acquire other assets in the future under the same basic terms and conditions without renegotiating a new contract. This type of arrangement puts the lessee in control of future equipment purchases, making Master Leases a powerful tool for businesses planning to expand their capital infrastructure.
Sale and Leaseback
Need capital? Let your assets work for you. Sale and leaseback allows companies to free up capital tied up in their assets. You can use the money to strengthen your balance sheet, repay debts or invest in further development in your core business. A Sale Leaseback agreement is an arrangement whereby an asset owned by the Lessee is sold for cash to the Lessor, and is in turn rented back to the Lessee. The purpose of a Leaseback is to free up the Lessee’s capital while allowing them to retain possession and use of the asset. This also allows for tax benefits not otherwise available to the Lessee, such as a deduction of rental payments, rather than depreciation on the owned asset. This also benefits the Lessor, in that assets are typically acquired at a purchase price lower than market value, and come with a long-term lease at a premium rate, which provides periodic income.
Lease Line of Credit
The Lease Line of Credit allows your business to combine all of its equipment needs under a single, pre-approved master lease line of credit. Whether you need $20,000 or $5,000,000, you may be surprised by how easy it is and for how much your business qualifies. A pre-determined rate will be quoted based on the total value of the Lease Line of Credit.
Easylease offers lease financing for leasehold improvements and infrastructure development to qualifying applications, including:
Retail chain store remodeling and expansion;
Franchise update and refurbishment;
An add-on is a type of transaction that adds related equipment to an existing lease. Typically, the term add-on is used when additional equipment is being financed using the same terms such as $10 purchase option that was used for the original transaction. The only difference is that the length of the add-on is not the same as that of the original transaction. It is almost always a shorter period of time, expiring on the same date (that is, coterminous) as the lease for the original transaction.
The advance payments term refers to the one or more payments that must be paid at the beginning of the term of the lease. Such payments are also called ‘Advance rental payments.
Often used in connection with real estate financing, the term amortization refers to the breakdown of periodic loan payments into their two components: the portion of the payment that reduces the principal owed, and the portion that reduces the interest owed on the remaining balance.
Annual percentage rate, or APR
The term Annual Percentage Rate or APR indicates the true, or effective, rate of interest being paid on a loan when compounding of interest and the costs of various fees are taken into account. The term typically identifies the actual rate of interest being paid for a specified period, usually one year.
The term application number is a number assigned to an application after it has been completed and submitted by the customer.
Bargain purchase option
The term bargain purchase option refers to an option given to the customer leasing the equipment. Typically, this option gives that customer the right to purchase the equipment, on lease, at a bargain price, a price lower than the expected fair market value.
A basis point is a unit of measurement equal to 1/100th of a percent. Using this definition, 125 basis points equals 1.25 percent.
The term buyout indicates the amount a customer leasing the equipment must pay in order to terminate the lease in advance of the expiration date. This amount is calculated to include balance of payments, arrears, buyout and taxes.
A capital Lease meets at least one of the following criteria:
The Lease transfers ownership of the equipment to the lessee, by the end of the lease term.
The Lease contains a bargain purchase option.
The Lease term is equal to 75 percent or more of the estimated useful life of the leased property.
The present value of the minimum lease payments at the beginning of the lease term equals or exceeds 90 percent of the property fair market value at the start of the lease.
Therefore, the lease must be treated as a loan for accounting purposes. The customer leasing the equipment under a capital lease typically treats it, first, as the borrowing of funds; and, second, as the acquisition of an asset to be depreciated. As a result, the individual or organization records a capital lease as both an asset and a corresponding liability-a lease payable. Periodic expenses incurred by that person or organization consist of interest on the debt and depreciation of the asset.
The term coterminous refers to two or more leases that are linked so that both will terminate on the same date.
Depreciation is a tax deduction representing a reasonable allowance for exhaustion, wear and tear, and obsolescence. This type of deduction is claimed by the owner of the equipment so that the cost of the equipment can be allocated over a longer period of time. Depreciation lowers the company’s balance sheet assets and also is recorded as an operating expense over that extended period.
Fair market value
The term fair market value is defined as the price for which property can be sold in an “arm’s length” transaction-one that occurs between informed, unrelated, and willing parties, each of whom is acting rationally and in his/her/their own best interest.
Fair market value lease
This type of lease includes an option through which the person or company leasing the equipment has three choices. The individual or organization may either renew the lease at a fair market value renewal rate; purchase the equipment for its fair market value at the end of the lease term; or return the equipment. Though often referred to as tax leases, not all fair market value leases offer the same features or benefits that tax leases do.
A lease of this type is used to finance the purchase of equipment; it is not, therefore, a true lease. From an accounting perspective, finance leases generally are considered capital leases; while from a tax point of view, they are considered non-tax leases.
Fixed purchase option
This is an option that allows the customer to purchase the equipment at the end of the lease term for a fixed percent of the original purchase cost. A typical fixed purchase option may be 10% of the original purchase cost.
Incremental borrowing rate
The term incremental borrowing rate refers to the rate the customer leasing the equipment would have paid if the equipment had been purchased outright rather than leased, determined at the date of the inception of the equipment lease.
A lease is a contract through which the owner of equipment conveys the right to use its equipment to another party for a specified period of time (the lease term) for specified periodic payments.
Lease purchase agreements
These are full-payout net leases with a term reflecting the equipment’s estimated useful life. Because many lease purchase agreements include a bargain purchase option-providing for the purchase of the equipment for $1 at the expiration of the lease - lease purchase agreements often are referred to as ‘dollar-buyout’ or ‘buck-out’ leases. Lease purchase agreements generally are considered capital leases from an accounting perspective and non-tax leases from a tax perspective, due to their bargain purchase option features and the length of their terms.
The term lease schedule refers to the schedule attached to a master lease agreement, describing the leased equipment, rentals, lease term, and other terms applicable to the lease.
A lessee is the party to a lease agreement who is obligated to pay rental instalments to the lessor and is entitled to use and possess the leased equipment during the lease term.
A lessor is the the owner of the equipment rented to the lessee for the term of the lease. Title to the equipment does not transfer to the lessee until lease completion and the purchase option has been exercised.
A master lease is a continuing lease arrangement in which all terms and conditions of the original lease remain in force, permitting additional equipment to be added to the lease with a new equipment schedule executed by the parties to the original master lease.
This term refers to a leasing arrangement that qualifies as an operating lease for the financial accounting purposes of the person or company leasing the equipment. Such leases are described as ‘off-balance-sheet financing because they’re not included in the traditional balance sheet asset and debt presentation-except for that portion of each payment that is due in the current fiscal period. Full disclosure of these transactions typically is provided in an auditor’s notes on financial statements. Periodic payments are recorded as expense items on the income statement of the person or company leasing the equipment.
This lease is treated as a true lease rather than as a loan for accounting purposes. An operating lease is accounted for on balance sheets without showing the equipment as an asset or the lease payment obligations as a liability. Periodic payments are accounted for by the customer leasing the equipment as operating expenses for the period.
Payment in advance
The term Payment in advance refers to the periodic payments due at the beginning of each period.
Present value is the discounted value of a payment or stream of payments that will be received in the future, predicated on a specific interest or discount rate. Present value represents a series of future cash flows expressed in terms of today’s dollars.
The term payment in arrears refers to the periodic payments due at the end of each period.
A purchase option is an option that permits the customer leasing the equipment to purchase it outright from the owner, usually as of a specified date.
Purchase upon termination lease, commonly referred to as a PUT, is an agreement by the lessee to purchase the equipment at the end of the lease term for a fixed amount.
The term residual value refers to the book value to which a piece of equipment is depreciated during the lease term, typically based on an estimate of future value, minus an amount that provides a safety margin.
Sales - Lease Back
The term sale leaseback represents a type of transaction involving the sale of equipment to a leasing company and the subsequent leasing of the same equipment to the original owner, who continues to use the equipment.
Skip Payment Lease
A skip payment lease contains a payment stream requiring the person or company leasing the equipment to make payments only during certain periods of the year.
Step Up or Step Down
A lease feature that provides for a payment stream where individual payments may increase (step-up) or decrease (step-down) over the term of the lease.
Tax Lease is a generic term for a lease in which the owner of the equipment assumes the risks of ownership, and is thus entitled to the benefits of ownership, including tax benefits.
The term transaction number is the number assigned to an application prior to being completed by the lessee (also known as “partial application”). The transaction will be assigned an application number once the lessee has been approved and the lease has commenced. This application number will then be used for tracking a lease through to end of term.
This term, used interchangeably with the term ‘economic life', refers to the period of time during which an asset is usable and has economic value. To qualify as an operating lease, the property must have, at the end of the lease term, a remaining useful life of a minimum of 25 percent of its original estimated useful life.
The term upgrade is referring to a trade-in of leased equipment, during the term of the lease, for a newer, more advanced model.