Leasing 101: A Fundamental Course in Leasing Companies typically have two options for acquiring fleet vehicles: purchasing or leasing. Each of these options offer different advantages, so it is important to evaluate if your company is using the method that best fits your financial and administrative needs. When you choose to lease your fleet, the lessor purchases vehicles on your behalf, leases them to your company and then remarkets them at the end of the lease term. When leasing a vehicle, you pay for your company’s usage of the vehicle. Depending on the type of lease you choose, there will be different funding options and accounting procedures. Recognizing that the procedure and business impact of leasing differs from other choices is essential to finding the best fleet option for your business. Leasing 101: A Fundamental Course in Leasing How is Leasing Different from Buying? During the term of the lease, the lessor maintains ownership of the vehicles, which can alleviate several administrative hassles associated with managing a fleet. You may also choose to select other services offered by the leasing company, such as maintenance and fuel monitoring for an additional cost. This can further enhance efficiency. Businesses that lease their commercial fleets keep their vehicles in good condition while minimizing administrative responsibilities. You might find that this model is the best fit for your business. Before making the decision to lease or buy, you should understand how each option will affect your business’s goals and fleet needs. Because monthly lease payments are based on the rate at which the vehicle depreciates and not the market value of the vehicle, leasing often enables businesses to use premium vehicles while lowering their monthly costs. Because the lessor purchases a vehicle on behalf of the lessee, and then remarkets it at the end of the lease term, the lessee pays only for the use of the vehicle during that period of time. When leasing a vehicle, you pay for the usage of the vehicle, a lease rate, an administrative fee and any additional services that the leasing company provides. The usage of the vehicle is calculated from its depreciation during the term of the lease. For example, if the capitalized cost of the new vehicle is $20,000, and the estimated value of the vehicle at the end of the lease term is $15,000, then the lessee will pay the difference of $5,000 broken up into monthly payments. Added to this is the lease rate, often called a money factor or lease factor. The lease rate, the fee that covers the interest paid by the lessor, is expressed as a percentage of the capitalized cost of the vehicle. In other words, it is the way that you compensate the leasing company for using its funding to get the vehicle. The administrative fee is a small percentage of the lease rate covering ancillary costs associated with account maintenance. Different Types of Leases There are two basic forms that your lease can take: open-ended or closed-ended. In a closed-end lease agreement, the term of the lease is set in the original contract. The monthly payments are fixed based on the estimated residual value of the vehicle at the end of the lease term. The leasing company estimates the market value of the vehicle at the end of the term and sets restrictions on the mileage and wear of the vehicle. At the end of the lease term, provided that the lessee has not exceeded the maximum mileage or wear and tear parameters, the lessee can walk away with no further liability. The lessor sells the vehicle and assumes any profits or losses caused by fluctuations in the market value of the vehicle. Open-end leases are more common than the closed-end lease in today’s U.S. market. In an open-end lease, there is generally a minimum lease term on the lease of one year, after which, the lessee can choose when to terminate the lease. At that point, the lessor sells the vehicle. If the vehicle is sold for a higher price than what was estimated in the lease agreement, the lessee is reimbursed for the profit. Likewise, if the vehicle is sold for less than the estimated price, the lessee must reimburse the lessor the difference. There are no mileage restrictions on this type of lease, because the lessor is guaranteed recovery of the full depreciated book value of the vehicle. For this reason, open-end lease agreements are often more attractive to companies whose mileage is unpredictable. In an open-end lease, it is the lessee who assumes the risk/reward for the resale value of the vehicle at lease termination. While most commercial fleet leases are open-ended, you must decide what best fits the needs of your company. What are the Responsibilities of the Lessor and Lessee? Because the lessor owns the leased vehicles, the leasing company will likely be accountable for several administrative responsibilities, including: • Initial license and title • Registration • Acquisition and Disposal of Vehicle • Tag and taxes The lesse is responsible for: • Educating drivers as to policies • Repairs • Preventive maintenance • Insurance • Fuel Often leasing companies will offer additional fleet management services to help further manage your fleet. This can mean less paperwork and more money saved for your company. Because of their volume and expertise, leasing companies are better equipped to get higher returns for remarketed vehicles. Other programs provided by leasing companies include maintenance management, collision repair and driver safety programs. It is important to remember that each contract and leasing company is different, so understand the terms of your contract and your responsibilities under the agreement. Funding Your Fleet An important aspect of vehicle leasing and fleet management is the type of financing you select for your lease. The lease rate paid to the leasing company is essentially the interest you pay for using the company’s money to acquire the vehicles. Just like the interest you pay on purchases, there are different types of financing available. The most common types are fixed, floating, adjustable and prime. Understanding how these rates will affect your payment is important because it will impact the amount you pay each month. five reasons to lease: 1. Pay only for usage of vehicle 2. Avoid diverting capital away from business objectives 3. Possible off-balance sheet reporting 4. Predictable budget; one lower monthly payment 5. Tax benefits Prime rate is what large commercial lending companies are charging their clients with the highest credit ratings. A fixed rate locks in a single rate for the entire term of the lease. For example, if you fix a rate of 6.5 percent, then that is the rate you will pay for the term of the lease. A fixed rate can be the prime rate offered at the time, or it can be higher. A fixed rate is considered desirable if the rates offered to you are exceptionally low, or if you do not want the risk associated with fluctuating rates. Floating and adjustable rates can fluctuate over time. If you choose an adjustable rate, then your lender can adjust your rate at predetermined intervals. If, for example, your contract states that you pay 2 points above the prime rate, then each year they will adjust your interest rate to 2 points higher than the current prime rate. A floating rate differs because the lessor will recalculate your rate each time the prime rate changes. So if your contract stipulates that your rate is 2 points above prime, then you will always pay 2 points above the current prime rate. Although floating and adjustable rates might leave you vulnerable to interest rate spikes, they are often attractive because they can start lower than a fixed rate you are offered. While your business accountant will advise you as to what type of financing is best, you should know what options are available and what advantage each can offer. Final Thoughts on Making the Decision to Lease Leasing provides the ability to use vehicles without diverting capital away from you business or accumulating more debt. Although leasing will not change your company’s debt-to-equity ratio, it can have other financial impacts. Although not owning your fleet may have tax implications, there are other tax deductions available if you record leases as an operating expense. Leasing and owning each have distinct impacts on administration and accounting. Reviewing your decision to lease or own and understanding these impacts can help maximize your company’s benefits. When deciding if leasing is appropriate for your business needs, consider the goals of your business and the purposes that your fleet serves. Leasing vehicles is not just a financial transaction. It will affect soft costs as well. Leasing can free your employees from administrative hassles associated with company vehicles and allow them to focus on other business objectives. It is best to have a thorough understanding of the differences between leasing and buying before choosing which one is best for your company. Know what your company stands to gain or lose from each option. Once you have a comprehensive understanding of what leasing can offer your business, you can make an informed choice that will contribute to your company’s bottom line. For more information on your fleet leasing options, please contact LeasePlan USA at 1-800-951-9024. Accounting Principles of Leasing Leasing has several implications on accounting beyond making the monthly payments. According to U.S. Generally Accepted Accounting Principles (GAAP), open-end/TRAC and closed-end leases can be considered operating leases. This is important because an operating lease, as opposed to a capital lease, does not have to appear on a company’s balance sheet. This reduces the amount of visible debt that a company has and can thus make the company more attractive to investors and lenders. If your company is not completely owned and operated in the United States, then you might have to adhere to International Financial Reporting Standards (IFRS). According to this set of standards, only closed-end leases that meet certain criteria can be kept off the balance sheet. Open-end leases are treated as finance or capital leases and must be kept on the books. In 1976, the Financial and Accounting Standards Board (FASB) issued FAS 13, a standard that allowed open-end leases to be considered operating leases if they contained a terminal rental adjustment clause (TRAC), essentially guaranteeing the lessee a certain residual value for the vehicle to the company when they turn it in to the lessor. According to FASB, the TRAC is enough to limit the lessee’s liability, and thus treat the lease as an operating expense. FAS 13 has set a leasing standard for U.S. companies for the past few decades, however there is a possibility this will change in the near future to meet global standards. It’s easier to leaseplan 1165 Sanctuary Parkway Alpharetta, GA 30009 800-951-9024 www.us.leaseplan.com T H E W O R L D L E A D I N G F L E E T A N D V E H I C L E M A N AG E M E N T CO M PA N Y @ 2011 LeasePlan USA. All rights reserved.