Vehicle Operating Leases

by Mary
(United States)


Thank you for posting your bookkeeping tips. I have found your topics and solutions to be very helpful. I do have a question though and I know you can help me.

If a corporation leases a vehicle and does not intend to purchase the vehicle at the end of the lease, how is this treated?

Do you record it just like a capital lease?

There is a purchase option on the lease agreement but the corporation does not want to purchase the vehicle at lease end. They will just return the vehicle.

A down payment was paid at the lease inception. There was no trade in of any old vehicles.

Would you still record depreciation in this case? Or do you just expense the lease payments only?

Also, what do you get to writeoff on the corporations tax return for this auto lease? Just the interest charged?

Thank you! I look forward to hearing from you!

image of fancy scroll lines

Hi Mary ... I'm thrilled you are finding this site helpful ... WOW with a question like that ... I think you have more faith in me than ... well ... I do! But I'll give it my best shot ... keeping in mind the rules may be different in the Unites States than Canada.

From an accounting perspective, if it were me, I would book the entry as an operating lease not a capital lease ... if the intent is to truly not purchase it at the end of the lease.

I would treat the down payment as a Prepaid Rental Expense ... to be amortized (depreciated) over the life of the lease ... to match revenue and expense for the periods.

My reasoning is that an operating lease is like a rental agreement. You don't have any of the associated risks of ownership that a capital lease does ... and when you turn it in at the end of the lease ... there should be no residual value.

The next time you enter into a transaction like this, ask if you can actually enter into an operating lease ... which I think is available if you are a business. I believe they would then structure the contract with no residual value or option to purchase unlike a capital lease.

At year-end, I would definitely bring this transaction to your accountant's attention.

From a tax perspective, I can't tell you what your tax deductions would be because I'm not familiar with U.S. income taxes.

I'll try to find out if it is okay to approach it from this perspective. If I find out differently, I'll make another post here.

Have a fabulous day Mary!

Updated: Feb 21, 2010

I am currently taking John Day's Real Life Accounting for Non-Accountants as a way to study for my Certified Professional Bookkeepers exam in March ... P.S. I passed! My mark was 90% :0)

This course is written from a U.S. accounting perspective ... so some of the topics ... like equity ... are a bit different than in Canada.

One item that was discussed in the Long Term Liabilities section of the Balance Sheet were lease obligations. At first, it seemed to be treated differently in the U.S. ... but upon closer examination this was not the case.

U.S. Lease Obligations

In the U.S., "a True Lease (an operating lease) states that at the end of the lease term the lessee (person leasing the equipment) has an option to purchase the item for at least a 10% residual amount or to return the item."

This means payments are expensed to an equipment lease account. The bookkeeping entry is Dr Equipment Lease and Cr Cash in Bank.

In John Day's blog on operating leases ... I had an "aahaa now I remember" moment when he explained ...

If an operating lease has a 10% buyout at the end of the lease, this does not constitute a bargain purchase option ... one of the criteria used to determine whether a lease is capital or operating.

John listed the US criteria ... which is the same as the Canadian criteria (listed below).

The logic is that you may not purchase the item at the end, even if there is a purchase clause ... which means you won't own the item at the end of the lease if you do not pay the residual amount owing.

The Real Life bookkeeping lesson does says if the lease contract actually states you will own the equipment after all the payments are made ... then treat it like a Capital Lease.

Canadian Lease Obligations

In Canada, the treatment is similar. We also "test" to determine if the lease is a capital lease ... see section 3065 of the CICA Handbook. If the answer to any one of the following three criteria is "yes", then treat it like a Capital Lease.

1. Transfer of ownership - does the lease explicitly state ownership at the end of the lease ... OR is there a bargain purchase option?
2. Lease term - is the term equal to 75% or more of asset's remaining useful service life?
3. Minimum lease payment - is the discounted value of net minimum lease payments at least 90% of FMV?

If you answer "no" to ALL of these questions, then the lease is an operating lease and it is expensed.

Now, just to muddy the waters ... in the CBA bookkeeping forum, it was brought up that for tax purposes, CRA (the Canadian equivalent of IRS in the U.S.) no longer distinguishes between a capital and operating lease.


I have studied and practiced under Canadian rules ... so always followup. Get advice from a professional knowledgeable in your place of residence.

The information on this website is just that ... information not advice ... which helps inform and point you in the right direction ... or at least gives you an idea of what questions to ask when you seek specific advice from a professional.

Revised and consolidated information May 15, 2010

Comments for Vehicle Operating Leases

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Apr 12, 2015
Lease Vehicle
by: Anonymous

I have a full disclosure lease with purchase option

Zero interest on the lease for the first three yrs - 37507.45 Net lease price (capitalized amount)

Residual Value of Vehicle 18188.53

Amount to be amortized 19318.92

Payment is 557.15 per mo (20.51 GST)

So lease end purchase option is 18688.53 - how should I be looking at this?

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