Capital Leases – Most Common Form Of Equipment Leasing
Most equipment leases that are put into place for Canadian based businesses are capital leases.
A capital lease is based on the commitment of the lessee to purchase the equipment at the end of the lease period for a nominal, pre-established price. The opposite to the capital lease is the operating lease where the lessee does not have an obligation to purchase at the end of the lease term. There are several variations around these two lease structures, but the underlying equipment lease would either be capital or operating by for accounting and taxation purposes.
Because the lessor doesn’t have any asset disposal risk at the end of the leasing period, the capital lease options will have lower effective costs of financing as compared to an operating lease for the same basic financing request. The smaller the projected resale value for the asset, the higher the effective cost of financing.
Capital leasing programs act very similar to an equipment loan in that they provide an amortized payment over the term of financing and at the end of the lease the borrower or lessee will own the asset. Because of this similarity, the accounting process for capital leases is comparable to what is required with an equipment loan.
Probably the biggest difference between a capital lease and an equipment loan is the amount of leverage that is available to the business owner seeking financing. In many cases, a capital lease can effectively be for 100% financing and can include installation and delivery costs as well as the cost of the asset where the lessee only has to provide one or two installment payments in advance.
From a lessor point of view, there are many leasing companies that only have capital leasing programs as they are not set up or prepared to deal with the higher amount of equipment reselling activity required with operating leases. Operating leases are also more suited to certain types of assets than others, which also factors into the capital versus operating lease decision process.
The situations where operating leases are more common is where the business owner estimates that the higher cost of financing offsets the long term maintenance costs associated with owning the equipment after the lease term. Operating leases make sense for equipment that undergo heavy use and depreciate quickly as a result, which also leads to more frequent replacement. Because the equipment can be returned at the end of the operating lease, equipment gets replaced more frequently, reducing the chances of large maintenance and repair bills.
In order to determine which equipment leasing structure makes the most sense for your equipment acquisition and your business overall, you should consider working with an equipment leasing specialist to go over all your options and help you decide the best course of action to take.
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