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Want to negotiate the best type of lease for your business? Here's what to do...

by , 19 November 2013
Have you considered that your lease agreement may put your business in a poor financial position? But is there any way to control the type of lease agreement a business signs? And what factors should you consider when evaluating a lease agreement? Today, we look at this vital business issue.

Below, the experts at the Practical Accountancy Loose Leaf explain how to negotiate the type of lease that's best for your business.

How to get the best lease for your business

Once you've signed and concluded an agreement, you can no longer choose how it's classified. You can't change it from one type of lease to another. But you do have some choices when it comes to the actual lease terms. Understanding these choices means you can negotiate with the asset supplier, to get the best deal.

But be warned: This is a high-risk and very controversial area!

You may be tempted to manipulate the financial statements, to keep debt off the Statement of Comprehensive Income. Many people do this to improve the net asset position of the business. That's why it's important for you to negotiate and sign the correct type of lease agreement. You can only use the income statement accounting recognition if the lease is classified as an operating lease.

Once you've signed the lease agreement, you must assess it carefully to classify it correctly as either a finance lease or an operating lease.

You could be signalling a red flag for a qualified audit if you record your lease expense incorrectly on your Statement of Comprehensive Income. You could have problems when you want to apply for financing.

Here are the four key differences between the two types of leases – knowing them will help you make sound decisions when negotiating the lease.

What to consider before you choose your lease agreement type

Consideration Finance lease Operating lease
How the asset is capitalised The asset involved'scapitalised to theStatement of Financial Position (i.e.the assets acquired in substance,
which may be different to the legalform). For example, when you 'buy'a car and it's financed, legally, if youdon't keep making the payments thebank will repossess the car (i.e. thebank owns the car). In substance,however, you've purchased the carand the bank's given you a loan tofinance the purchase.
The asset isn't capitalised and allpayments are accounted for in theStatement of Comprehensive Income(i.e. the asset never becomes yours).
The debt related to the asset The debt or financing liabilityrelating to the acquisition of theasset's shown on the Statement ofFinancial Position.
 
The debt or financing of the asset'snever shown on the Statement ofFinancial Position. The onlydisclosure's in the notes to thefinancial statements showing thefuture minimum lease payments.
The expense relating to the asset The depreciation expense shownagainst the asset, and the interestexpense arising from the lease debtobligation's shown as expenses inprofit and loss. The rental expense is the only profitand loss item shown in the financialstatements.
Lease payments Lease payments are generally basedon the value of the asset. Lease payments aren't necessarilylinked to the value of the asset, butwill have a profit portion added to thepayments to reimburse the lessor forthe risks of not transferringownership.
 
Now that you know how lease agreements differ, make sure you pick the right one for your business. 


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