As a business grows it might need to draw upon different kinds of debt to help it succeed. Startups often rely on debt to help them get up and running, but established businesses do too. If you own a business and are looking at different kinds of finance leases to help you grow, this article should be helpful to you. Here we look at the finance lease, the accounting treatment of finance leases and how, when used properly, they can benefit your business growth potential.
The Finance Lease Explained
So, what is a finance lease? There are, under lease standard ASC 842, five criteria and if one of them are hit, the lease in question is considered a finance lease. This is applicable under US GAAP (generally accepted accounting principles). So, what are the five criteria:
- Transfer of title/ownership to the lessee
- A purchase option the lessee is reasonably certain to exercise
- Lease term is over a major part of the economic life of the asset
- Present value equals or exceeds substantially all of the fair value of the asset
- Asset specialization: Would it provide any value to the lessor after the lease term?
If a lease has those, it’s finance. Likelihood is that if you’re entering into a lease it’ll be a finance lease but it’s always worth checking just in case because each list might have a different accounting treatment, which we’ll look at later.
What’s A Capital Lease
This is where some complexity comes into play. A capital lease is the same as a finance lease. Capital leases are now known as finance leases. So, the two sometimes are used interchangeably however, today, the right terminology is “finance lease”. Under ASC 842, a capital lease is referred to as a finance lease. Under IFRS 16 they’re essentially leases with characteristics of an owned asset.
How To Find A Good Finance Lease For Your Business
To find a good finance lease for your business, you should first determine the specific equipment or vehicle your business needs and how it will be used. This will help you determine the budget and terms you need to look for in a finance lease. Next, you should compare rates and terms from multiple finance companies to find the best deal for your business. Be sure to read the fine print and understand any fees or penalties that may be associated with the lease. It’s also a good idea to consult with a financial advisor or accountant to ensure that the lease is a good fit for your business’s financial situation.
Finance Lease Accounting
Not too much has changed from accounting for finance leases under ASC 842 compared to accounting for capital leases under ASC 840 (the previous treatment). In short, the right of use asset and lease liability have to be established at the commencement of the lease and then reduced over the term. The right of use asset is now reduced by amortization expense, whereas capital lease assets were reduced by depreciation. They’re small changes but it’s worth checking with your accountant or accounting software provider if something is confusing you.