Lease or Buy: How the accounting works

 

A description of how the accounting works for a “contract of sale” purchase, a capital lease, and an operating lease can be found in my article “Loans vs. Leases: What’s it all about?” But to give you an idea of what I am referring to, let me ask a question. Have you ever leased a piece of equipment where at the end of the lease term you had the option to purchase the item for $1.00 or some other ridiculously small amount?

If so, you should have treated that lease the same way you would have treated a normal purchase of equipment in your accounting records. In other words, the lease should have been capitaized. The equipment item should have been recorded in the Fixed Assets section of the Balance Sheet as a debit, and the down payment a credit to Cash, and the remaining balance owed set up as a Capital Lease or Lease Obligation in the liability section of the Balance Sheet. Interest and depreciation should be expensed as with any other purchase of an asset that has an installment loan associated with it.

It is important to understand what constitutes a “true” lease from a “dirty” lease (a capital lease). The accounting requirements are very different. Read the article and let me know if you have any questions.