What
are the types of leases and how do they
work? top
The type of
equipment you want to lease, the term, and
whether you want to keep the equipment at
the end of the term will all be factors in
choosing a lease. Lessees may lease one
piece of equipment at a time or many items
with a single lease. Companies that
continually acquire equipment may use a
master lease (see Master Lease in the
glossary) to avoid executing a new contract
every acquisition. Two common types of
leases are operating leases and finance
leases.
Operating Lease
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With an operating
lease, the term is shorter than the expected
useful life of the equipment. Rental
payments do not cover the equipment cost for
the lessor during the initial lease term.
The operating lease will often contain a
fair market value purchase option. This type
of lease is popular for high-tech equipment
because shorter term leases help equipment
users stay ahead of equipment obsolescence.
The lessor uses its equipment remarketing
expertise to subsequently find other users
for the returned equipment, something the
typical equipment user does not have the
time or ability to do. The drawback to the
operating lease is that the monthly rental
payment will usually be the highest of any
other form of lease.
Finance Lease
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With a finance
lease the term is longer, more nearly
covering the useful life of the equipment.
Rentals tend to be lower because of the
longer term and less residual risk. From an
accounting standpoint, an operating lease is
the simplest type of lease for you to
account for because you only expense
rentals; there is no requirement to add the
asset to the balance sheet, as long as the
footnotes to the financial statements
indicate the amount of your firm's lease
rental obligations. Another lease product
you may find beneficial is the
sale-leaseback: You purchase the equipment
you need and use it for a period of time
before selling it to a lessor. After selling
the equipment, you then lease the equipment.
This is another way to free up your
operating capital. On smaller equipment
leases worth thousands of dollars, leases
tend to be more standardized. Above that
cost range - several hundred thousand into
the millions—variations appear more
frequently. A leveraged lease on a big
ticket acquisition such as an airplane, may
include several customized provisions and
options that would not appear in a typical
lease for a smaller amount. Therefore,
flexibility is a product of the size of the
lease.
Fair Market Value Lease
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A lease containing
an option to purchase leased property at the
end of the lease term at its then fair
market value. The lessor does not have the
ability to retain title to the equipment if
the lessee chooses to exercise the purchase
option.
Stated Purchase Option Lease
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A lease containing
a provision allowing the lessee, at its
option, to purchase the equipment for a
price predetermined at lease inception, that
is normally lower than the expected fair
market value at the date the option can be
exercised.
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