Finance Lease - Not an Ordinary Lease

Managing a business is not a simple thing to do. Aside from investing big amount of money, you'll make sure of its smooth operations. Money is the number one consideration in running a business. A lot of investment is needed. It's OK if you have lots of ready cash in your account. What if you're just a struggling businessman with minimal capital? There are lots of things to purchase especially if you're engaged in the manufacturing industry. For example, running a bottling plant requires specific machinery in order for the business to be operational. The cost of the machinery involves big amount of money.
Because your business is just starting, you don't want to obtain the needed money from the company's fund. If you can't afford to purchase in cash basis, you have many options to choose from. You can rent the equipment and just pay for the monthly rentals. There are two types of leasing- either operating or finance lease. However, it is advisable to rent through finance lease. This kind of leasing is not just an ordinary lease you know. Finance lease, which is known also as capital lease allows the lessee to finance the purchase of the asset even though there is no sale involved.
It gives the lessee control over the asset in proportion to the asset's useful life. It will also provide benefits and risk of ownership to the lessee. Strictly speaking, the company can own an asset without really investing big amount of money. Like just an ordinary type of leasing, you will be paying monthly rentals. The payment though will be deducted from the purchase price. It's like buying a machine through installment. In substance, finance lease is a purchase but in form it is still considered as leasing. In order to determine whether it is operational or finance, certain criteria should be met.
Under US accounting standards, it can qualify as finance lease when it meets the following criteria. First, the ownership of the asset should be transferred to the lessee when the term ends. Second, it contains a bargain purchase option in buying the asset at less than the fair market value. Third, the term of the rent should equal or exceed the estimated useful life of the asset. Lastly, the present value of the payment equals or exceeds the original cost of the asset. Thus, you will be recognizing an asset account in your books rather than an expense account. Actually, there are two types of finance lease.
There is sales leaseback and direct leasing. In sales leaseback, the owner of the property will sell it to the buyer and leases it back from the buyer. The owner will still retain the asset and continue using it. On the other hand, in direct leasing, there is a contractual arrangement whereby the lessor buys the asset from the maker and leases it to the lessee. Asset financing can be obtained from various leasing companies. Just choose a leasing company which is beneficial to you. In financial lease, you won't have to automatically disburse big amount of cash in order to purchase equipment.
By Rick Goldfeller