Leasing and Borrowing: Finance Options for Businesses
Leasing: A Comprehensive Understanding
Leasing contracts typically involve three parties:
- The lessor: Usually a financial institution or leasing company that owns the asset.
- The seller: The company that sells the asset to the leasing company.
- The lessee: The company that rents the asset.
Types of Leasing
Operating Lease: This is a typical lease agreement where the lessee has the right to use the asset during the contract period but has no intention of purchasing it later. Accounting codes: 621 (Rents and Royalties), 472 (HP), 572 (Bank VAT).
Financial Lease: In this type of lease, the lessee agrees to pay regular installments. At the end of the contract, it is generally understood that the lessee will acquire the leased asset by exercising the purchase option included in the contract.
Valuation Rules
The General Chart of Accounts (PGC), in the recording and valuation standard 8, “Leases and other transactions of a similar nature,” states that when there is no reasonable doubt that the call option will be exercised (as is the case with financial leasing), the lessee should record an item of tangible or intangible assets, depending on the nature of the asset, and a liability for the same amount. This amount will be the lesser of the fair value of the asset (market value) and the present value of the agreed-upon payments, including the purchase option.
Identification of Accounts
- 174: Creditors for long-term leases
- 524: Creditors for short-term leases
Tax Implications of Leasing
For any company, leasing offers several tax advantages. The interest portion of the lease payments, within certain limits, is deductible for tax purposes. The company can offset the input VAT against output VAT, making it a good way to finance capital equipment. However, companies should carefully examine all available funding options. Despite these tax advantages, leasing can have a higher overall cost due to interest payments, which may be higher than those of other financing methods. Therefore, it is crucial to explore all options and determine the most advantageous one.
Borrowing: Short-Term and Long-Term Debts
Companies often acquire assets by taking on debt, which requires repaying the loan principal plus the agreed-upon interest.
- Long-term financial resources: When the duration is more than one year.
- Short-term financial resources: When the maturity does not exceed one year.
Accounting for Short-Term and Long-Term Borrowings
Loans: These are financial transactions where companies receive funds and undertake to return them within a set period, along with interest. Borrowings can have long or short maturity terms. Long-term loans are usually sought to finance the fixed structure of the company, such as acquiring fixed assets, while short-term loans are typically used to finance the operating cycle, such as buying raw materials.
Identification of Accounts
- Subgroup 17 (172, 173, 175): Long-term debt from borrowing, loans, and other items.
- Subgroup 52 (520, 521): Liabilities for borrowings and other items.
Valuation Rules
In the second part of the PGC, we find the recording and valuation standard 9, “Financial Instruments.” The third section of this standard is devoted to financial liabilities and tells us that non-trade debts will be initially recorded at fair value, which will generally be the nominal value less the costs of the transaction.
Understanding Leasing as a Form of Funding
Leasing is a specific form of funding for companies. If a company needs to use a particular asset but lacks the necessary funding, it can opt for a finance lease instead of purchasing it outright. Through this instrument, formalized in a contract, a financial institution acquires the asset the company needs and leases it to them. The company can then use the asset in exchange for periodic lease payments over a set period. Typically, this contract includes an option to purchase the leased asset at the end of the contract term. This arrangement allows the company to utilize an asset without a substantial initial investment while potentially benefiting from certain tax advantages, as previously discussed.