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.
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