Is Your Vehicle Lease An Expense, An Asset or A Liability?
.... Hmmm Good Question
When doing small business accounting, you need to watch out for capital leases ... also known as equipment or auto (vehicle) leases ... which are often conditional sales agreements.
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Capital Leases If the lease allows you to own the asset at the end of the lease for a nominal amount, you must capitalize it ... turn the lease into an asset with an associated liability. (There is a list of criteria to help you decide in the accounting bible ... and it's the same whether you are doing big business or small business accounting.)
The formal reason for this type of treatment is due to the reporting principle, the matching principle and cost principle. The reporting principle of full disclosure says that you should report all assets and liabilities at inception ... while the cost principle states that you account for purchases at cost ... a fancy way of saying exclude the trade-in allowance and the imputed interest component when determining the initial liability. Record the asset at its conditional purchase price. Informally, what you are trying to do here is assess who has the risk and material ownership. The fact that you can transfer ownership at the end of the lease suggests that you are carrying most of the risks ... and rewards of ownership ... so the lease was really more of a loan. Capitalized lease entries recognize the acquisition at the beginnning of the lease, not at the end when the ownership transfers. The procedure or bookkeeping entries to record transactions relating to a capital lease are found in the article How to Record Common Bookkeeping Entries. A vehicle lease with a trade-in is used as an example.
Mary asked, " Can you record a capital lease (conditional sales agreement) as a vehicle operating lease if you don't intend to purchase the vehicle at the end of the lease?" It turns out that lease obligations have different accounting treatment in the U.S. than in Canada. Join the debate in the community bookkeeping forum by posting a comment or rating the answers.
Operating LeasesUnlike capital leases, operating leases have no ownership at the end of the lease. A good example of an operating lease would be your lease payment on business space. At the end of the lease, you will not own the working space. What you get is temporary use of the space. Leasing high tech equipment like computers that become obsolete quickly is another example. You turn it back in at the end of lease and get the newest model for your next lease. You don't assume the risk of the equipment becoming obsolete. The small business accounting procedure to book an operating lease payment is easy. You would record this entry each and every time you make a payment: Debit Lease expense (income statement)
Debit GST payable (balance sheet)
Credit Cash in Bank (current asset on balance sheet)
Now let's complicate this ... just a bit. In the Ask a Bookkeeping Question Forum, the question was posed as to whether you can classify the lease as an operating lease if you don't intend to purchase the vehicle at the end of the lease. In Canada, if your intent is to not purchase the vehicle at the end of the lease (even though you have the option) ... you can record it as operating lease if you treat any deposit as a prepaid expense (the matching principle dictates this) ... particularly if you have a past history of treating other similar transactions in the same manner where you did not purchase at the end of the lease. Accounting is supposed to be practical ... so professional judgement with regards to the substance / intent of the transaction is allowed (which means your accountant, who has studied and has knowledge of all the rules, should be making this call not you). Your accounting policy should be clearly disclosed in your financial notes. Lease obligations are more than basic debit and credit bookkeeping ... so make sure you bring your treatment of the lease to your accountant's attention at year-end ... to ensure you have the right accounting treatment (GAAP or GPE or tax). See the answers to Mary's question (the link above) for more on the discussion of capital leases vs operating leases.
Lease Versus Buy Financial Calculators Here are links to very useful calculators that help you decide whether it is better to buy or lease that piece of business equipment. U.S. calculator Canadian equipment calculator - lease vs. buy Canadian vehicle calculator - lease vs. buy
Vehicle and Equipment Purchases
Did you buy instead of lease? Well that's handled a bit differently ... of course! The big thing to remember is that capital assets are NOT operating expenses ... they're .. well ... assets. :0) I'll go into more detail on expensing vs capitalizing in the future. It's enough for now to watch out for these special bookkeeping transactions and ask your bookkeeper or accountant for help booking them ... Small business accounting can be complicated! :O)
Other Pages That May Interest You
Watch Out For These Special Transactions
Common Bookkeeping Entries
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