Capital Lease Mess

by Ali
(BC, Canada)

Hello all,

We purchased a new mechanics service vehicle almost 6 years ago - Capital Lease financing - and after 5 years (June 2013), we purchased the vehicle for the $1 buy-out. We will be selling this vehicle (for about $80,000) in the next few months, and that is where I run into trouble.

The bookkeeper we were using at the time expensed this as an Operating Lease, and when the buy-out happened for the $1, I also expensed the final $1.07 due, to the Vehicle Lease Expense.

I now realize that this was done incorrectly (forehead slap,) and am wondering what my next steps should be to fix this before the sale of the asset occurs.

Should I "purchase" the vehicle for the $1 in order to get this asset back onto our books - as it currently is not there whatsoever - then record the $80,000 gain as income (since the full value has already been expensed) or as a credit to Gain on Sale of Asset?

Thank you in advance!

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Hey Ali,

Oh Boy ... capital lease mess is right.

This will get confusing. I'm going to assume you are a sole proprietorship. If this assumption is true, for tax purposes, there is no distinction between a capital lease and an operating lease. However, for accounting purposes there is a distinction.

Because your lease had a bargain purchase option buyout of $1, your vehicle should have been treated as a capital lease for accounting purposes.

Your tax returns (assuming you filed them all on time over the past 5 years) should be fine as you would have filled out your T2125 Chart C on page 6 which is included in line 9281 Part 5 of the T2125 on page 3.

After verifying that the above is true, I think I would do the following:

1. I would setup your vehicle on your books at the beginning of the current year as an asset with the offset to retained earnings.

2. I would then book the accumulated amortization to date again with the offset to retained earnings instead of amortization expense. To make it easy on yourself, you could match the amounts booked on your tax return. This will eliminate the timing difference between your accounting records and your tax records that would have occurred had your vehicle received the appropriate accounting treatment for accounting purposes.

These two entries effectively get the vehicle on your books with a net book value of $1 without affecting your current net income. Booking to retained earnings is usually not advisable but necessary here to adjust your prior years earnings.

3. Once you have sold the vehicle, record the entry as you would for the sale of any asset; record the capital gain to "below the line" in your other income section of your income statement (the section that usually has account numbers in the 7000 plus series). Remember as part of booking the sale, you need to remove the asset from the balance sheet.

4. On your tax return, you will show the sale of the asset in Area D on page 5 of the T2125.

P.S. I would like to remind you there is a difference between information and advice. The general information provided in this post or on my site should not be construed as advice. You should not act or rely on this information without engaging professional advice specific to your situation prior to using this site content for any reason whatsoever.

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