Our accountants have faced a plethora of lease questions in their time. Is leasing a good deal? How should you record the cost of a lease? Do leased items become assets? All valid questions, the answers to which depend on what kind of lease you are taking out.
What is a lease?
A lease is basically a way to use an asset without buying it in full. Seems simple enough, but it isn’t always clear exactly what kind of lease you’re entering into when you sign on the dotted line.
There are two kinds of leases you’ll probably run into in the course of running your business: an operating lease, and a finance lease.
You should think of an operating lease like a rental. If you’re looking for a new photocopier, you may opt for an operating lease. This means that the company offering the photocopier still owns it, is usually in charge of maintaining it, and replacing it once it has reached the end of its useful life.
In the case of an operating lease, your company does not own the asset and is not taking on any risk or reward of ownership. The cost of renting the asset is a business expense for as long as the lease lasts.
Finance leases are a little more complicated, and essentially amount to purchasing the item in question and taking on responsibility for it, but paying over a period of time with interest added on top.
Let’s take the example of a new van for your company. With a finance lease, the van would become a company asset just as if you had bought it outright. Your company can then claim capital allowance on the van at 20%, and claims only the interest paid on the lease as a business expense.
In accounting terms, a finance lease is quite similar to taking out a loan, except instead of getting a chunk of cash you are getting a company asset instead.
If in doubt
When entering into a lease, it’s important to find out what kind of lease you’re signing up for. It will usually be obvious, but there is some middle ground where both types of lease can be used. Laptops, for example, can be purchased from suppliers on either an operating or finance lease.
As always, if in doubt, consult your accountant, who can advise you on the best course of action for your business.