Description/Scope: This is about leasing -
Purpose: To learn whether the user of the equipment has rent expense, or depreciation and other expenses. To learn whether the lessor has rent income or repayment of principal and interest income.
Who This Applies to: Either party in a lease, and all business types including the self-employed
When to Apply this: Before you sign the lease!
Special Circumstances:
General Benefits: Making the best deal, reducing tax costs and lease costs, understanding what you are signing. Keeping debt low and net-worth or equity high.
There may be instances in which you must determine whether your payments are for rent or for the purchase of the property.
You must first determine whether your agreement is a lease or a conditional sales contract. If, under the agreement, you acquired or will acquire title to or equity in the property, you should treat the agreement as a conditional sales contract. Payments made under a conditional sales contract are not deductible as rent expense.
Whether the agreement is a conditional sales contract depends on the INTENT OF THE PARTIES. Determine intent based on the facts and circumstances that exist when you make the agreement.
Why this is important - |
| Whether a transaction is treated as a lease or as a purchase for
tax purposes is important in determining who is entitled to deductions for
business expenses (depreciation, rent and interest expense). For most leases,
the rules for determining whether a transaction is a lease or a purchase evolved from a series of court decisions and IRS rulings. Basically, the rules look to the economic substance of a transaction, not its form, to determine who is the owner of the property for tax purposes when the parties characterize it as a lease. |
Who gets depreciation; Tax Impact of what is signed; What to look for in a lease; Keeping debt low and net-worth high; Finding the IRS viewpoints; Protecting yourself and compliance;
Purchase Price of the equipment
Copy of the contract and any incidentals or addendum
Price Comparison of competitors equipment and leases
Your estimate of what your expenses are or - what you can pay monthly
Additional costs - sales tax, etc.
Cost of loans -interest rates, from your bank
If this is a new endeavor, list the expected income to be generated; If this is replacement property then list the added income, the decrease in expenses and increase in production.
Being safe about what you sign - keeping your hard earned money and - knowing what IRS will expect
DETERMINING THE INTENT.
In general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true.
* The agreement applies part of each payment toward an equity interest that you will receive.
* You get title to the property upon the payment of a stated amount required under the contract.
* The amount you pay to use the property for a short time is a large part of the amount you would pay to get title to the property.
* You pay much more than the current fair rental value for the property.
* You have an option to buy the property at a nominal price compared to the value of the property when you may exercise the option. Determine this value when you make the agreement.
* You have an option to buy the property at a nominal price compared to the total amount you have to pay under the lease.
* The lease designates some part of the payments as interest, or part of the payments are easy to recognize as interest.
| What is a General "Rule of Thumb"? (Memo from Letter Ruling 9313001 (TAM)) |
| Section 4.05 of Rev. Rul. 55-540 provides that in the absence of compelling factors indicating a different intent, it will be presumed that a conditional sales contract was intended if the total of the rental payments and any option price payable in addition thereto approximates the price at which the equipment could have been purchased at the time of entering into the agreement, plus interest and carrying charges. |
There are some new rules for
installment sales. IF the IRS determines the transaction (Lease) is in fact
a sale/purchase, then there may some other tax treatments that can bankrupt the leasing
company. Be sure, if you are the lessor, you watch the 20% rule and compare that to
the terms of the contract including the purchase option. The 20% rule is in addition
to the fair market rule.
What is a Conditional Sales Contract ? |
| This is an agreement that after all the conditions of the contract are met, the title will be transferred to the lessee. |
In the case of equipment rentals or leasing, there is a very well-defined set of standards published by the IRS to enable the taxpayer to determine whether a "leveraged lease" is a sale or a lease. 58 These standards are based upon a determination of the intent of the parties, as evidenced by all of the facts and circumstances of the transaction. 59 A "leveraged lease" is created, for example, in a sale-leaseback situation when the purchaser (lessor) finances some or all of the purchase price with a small amount of cash, or where the lessor finances the transaction through loans from third parties or by purchasing the property subject to an existing mortgage. 60
/Footnote/ 58 Rev. Proc. 75-21, 1975-1 C.B. 715, modified by Rev. Proc.
76-30, 1976-2 C.B. 647, Rev. Proc. 79-48, 1979-2 C.B. 529, and Rev. Proc. 81-71, 1981-2
C.B. 731.
/Footnote/ 59 See Rev. Rul. 55-540, 1955-2 C.B. 39.
/Footnote/ 60 See §1 of Rev. Proc. 75-21, 1975-1 C.B. 715.
| What is the law about Rent or Lease Deductions ? |
| SECTION 162. TRADE OR BUSINESS EXPENSES (a) IN GENERAL There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including-- (1) a reasonable allowance for salaries or other compensation for personal services actually rendered; (2) traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business; and (3) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity. |
LEVERAGED LEASES.
Leveraged lease transactions may be considered leases. Leveraged leases generally involve three parties: a lessor, a lessee, and a lender to the lessor. Usually the lease term covers a large part of the useful life of the leased property, and the lessee's payments to the lessor are enough to cover the lessor's payments to the lender.
If you plan to take part in what appears to be a leveraged lease, you may want to get an advance ruling. The following revenue procedures contain the guidelines the IRS will use to determine if a leveraged lease is a lease for federal income tax purposes.
* Revenue Procedure 75-21, in Cumulative Bulletin 1975-1.
* Revenue Procedure 75-28, in Cumulative Bulletin 1975-1.
* Revenue Procedure 76-30, in Cumulative Bulletin 1976-2.
* Revenue Procedure 79-48, in Cumulative Bulletin 1979-2.
In general, the revenue procedures provide that, for advance ruling purposes only, the IRS will consider the lessor in a leveraged lease transaction to be the owner of the property and the transaction to be a valid lease if all the factors in the revenue procedures are met, including the following.
* The lessor must maintain a minimum unconditional "at risk" equity investment in the property (at least 20%) during the entire lease term.
* The lessee may not have a contractual right to buy the property from the lessor at less than fair market value when the right is exercised.
* The lessee may not invest in the property, except as provided by Revenue Procedure 79-48.
* The lessee may not lend any money to the lessor to buy the property or guarantee the loan used to buy the property.
* The lessor must show that it expects to receive a profit apart from the tax deductions, allowances, credits, and other tax attributes.
A leveraged lease is considered a valid lease (and the lessor considered the owner of the property) if the following conditions are all met:
• The lessor has made a minimum unconditional "at risk" investment in the property at the beginning of the lease which continues for the duration of the lease and exists at the end of the lease. 61
• The lease term contains all of the renewal and extension periods (except those options of the lessee at the fair rental value at the time of exercise). 62
• Neither the lessee nor any member of its affiliated group has a contractual right to purchase the property from the lessor at a price which is less than its fair market value at the time the right is exercised. 63
• The lessee (and its affiliates) has not furnished any part of the cost of the property or the improvements or additions (except for the improvements or additions owned by the lessee which can be readily removed without causing material damage to the property). 64
• Neither the lessee nor its affiliates may lend any of the funds necessary to acquire the property or guarantee any indebtedness created in connection with its acquisition. 65
• The lessor must expect to receive a profit from the transaction, apart from the value of (or benefits derived from) the tax deductions and other tax attributes arising from the transaction. 66
/Footnote/ 61 §4(1) of Rev. Proc. 75-21, 1975-1 C.B. 715, modified by Rev. Proc. 76-30,
1976-2 C.B. 647, and Rev. Proc. 79-48, 1979-2 C.B. 529, and Rev. Proc. 81-71, 1981-2 C.B.
731. For this purpose, a "minimum investment" includes only consideration paid
and personal liability incurred by the lessor to purchase the property (provided the net
worth of the lessor is sufficient to satisfy such liability). The initial minimum
investment must be equal to at least 20% of the cost of the property and must remain so
throughout the entire lease term. Finally, the residual value must also be 20% of the cost
at the end of the lease term.
/Footnote/ 62 Id. at §4(2).
/Footnote/ 63 Id. at §4(3).
/Footnote/ 64 Id. at §4(4).
/Footnote/ 65 Id. at §4(5). In this case, a "guarantee" does not include a
guarantee of the lessee's obligation to pay rent, properly maintain the property, or pay
insurance premiums or other similar conventional obligations of a net lease.
/Footnote/ 66 Id. at §4(6). This requirement is considered to be met if the aggregate
amount required to be paid by the lessee to the lessor over the lease term plus the value
of the residual investment exceeds an amount equal to (1) the sum of the aggregate
disbursements required to be paid by the lessor in connection with the property's
ownership, and (2) the lessor's equity investment in the property, including direct costs
to finance it and the aggregate amount by which the amount to be paid to the lessor over
the lease term exceeds the reasonable amount of aggregate disbursements required to be
paid in connection with the ownership.
IRS - Revenue Ruling 75-21
SEC. 4. GUIDELINESUnless other facts and circumstances indicate a contrary intent, for advance ruling purposes only, the Service will consider the lessor in a leveraged lease transaction to be the owner of the property and the transaction a valid lease if all the following conditions are met:
(1) MINIMUM UNCONDITIONAL' AT RISK INVESTMENT.
The lessor must have made a minimum unconditional "at risk" investment in the property (the "Minimum Investment") when the lease begins, must maintain such Minimum Investment throughout the entire lease term, and such Minimum Investment must remain at the end of the lease term. The Minimum Investment must be an equity investment (the "Equity Investment") which, for purposes of this Revenue Procedure, includes only consideration paid and personal liability incurred by the lessor to purchase the property. The net worth of the lessor must be sufficient to satisfy any such personal liability. In determining the lessor's Minimum Investment, the following rules will be applied:
(A) Initial Minimum Investment. When the property is first placed in service or use by the lessee, the Minimum Investment must be equal to at least 20 percent of the cost of the property. The Minimum Investment must be unconditional. That is, after the property is first placed in service or use by the lessee, the lessor must not be entitled to a return of any portion of the Minimum Investment through any arrangement, directly or indirectly, with the lessee, a shareholder of the lessee, or any party related to the lessee (within the meaning of section 318 of the Internal Revenue Code of 1954) (the "Lessee Group"). The lease transaction may include an arrangement with someone other than the foregoing parties that provides for such a return to the lessor if the property fails to satisfy written specifications for the supply, construction, or manufacture of the property.
(B) Maintenance of Minimum Investment. The Minimum Investment must remain equal to at least 20 percent of the cost of the property at all times throughout the entire lease term. That is, the excess of the cumulative payments required to have been paid by the lessee to or for the lessor over the cumulative disbursements required to have been paid by or for the lessor in connection with the ownership of the property must never exceed the sum of (i) any excess of the lessor's initial Equity Investment over 20 percent of the cost of the property plus (ii) the cumulative pro rata portion of the projected profit from the transaction (exclusive of tax benefits).
(C) Residual Investment. The lessor must represent and demonstrate that an amount equal to at least 20 percent of the original cost of the property is a reasonable estimate of what the fair market value of the property will be at the end of the lease term. For this purpose, fair market value must be determined (i) without including in such value any increase or decrease for inflation or deflation during the lease term, and (ii) after subtracting from such value any cost to the lessor for removal and delivery of possession of the property to the lessor at the end of the lease term In addition, the lessor must represent and demonstrate that a remaining useful life of the longer of one year or 20 percent of the originally estimated useful life of the property is a reasonable estimate of what the remaining useful life of the property will be at the end of the lease term.
(2) LEASE TERM AND RENEWAL OPTIONS.
For purposes of this Revenue Procedure, the lease term includes all renewal or extension periods except renewals or extensions at the option of the lessee at fair rental value at the time of such renewal or extension.
(3) PURCHASE AND SALE RIGHTS.
No member of the Lessee Group may have a contractual right to purchase the property from the lessor at a price less than its fair market value at the time the right is exercised. When the property is first placed in service or use by the lessee, the lessor may not have a contractual right (except as provided in section 4(1)(A) above) to cause any party to purchase the property. The lessor must also represent that it does not have any present intention to acquire such a contractual right. The effect of any such right acquired at a subsequent time will be determined at that time based on all the facts and circumstances. A provision that permits the lessor to abandon the property to any party will be treated as a contractual right of the lessor to cause such party to purchase the property.
(4) NO INVESTMENT BY LESSEE.
No part of the cost of the property may be furnished by any member of the Lessee Group. Nor may any such party furnish any part of the cost of improvements or additions to the property, except for improvements or additions that are owned by any member of the Lessee Group and are readily removable without causing material damage to the property. Any item that is so readily removable must not be subject to a contract or option for purchase or sale between the lessor and any member of the Lessee Group at a price other than its fair market value at the time of such purchase or sale. However:
(A) Cost Overruns and Modifications. If the cost of property exceeds the estimate on which the lease was based, the lease may provide for adjustment of the rents to compensate the lessor for such additional cost (but see section 5.01 concerning uneven rent payments).
(B) Maintenance and Repair. If the lease requires the lessee to maintain and keep the property in good repair during the term of the lease, ordinary maintenance and repairs performed by the lessee will not constitute an improvement or addition to the property.
(5) No LESSEE LOANS OR GUARANTEES.
No member of the Lessee Group may lend to the lessor any of the funds necessary to acquire the property, or guarantee any indebtedness created in connection with the acquisition of the property by the lessor. A guarantee by any member of the Lessee Group of the lessee's obligation to pay rent, properly maintain the property, or pay insurance premiums or other similar conventional obligations of a net lease does not constitute the guarantee of the indebtedness of the lessor.
(6) PROFIT REQUIREMENT
The lessor must represent and demonstrate that it expects to receive a profit from the transaction, apart from the value of or benefits obtained from the tax deductions, allowances, credits and other tax attributes arising from such transaction. This requirement is met if: the aggregate amount required to be paid by the lessee to or for the lessor over the lease term plus the value of the residual investment referred to in section 4(1)(C) above exceed an amount equal to the sum of the aggregate disbursements required to be paid by or for the lessor in connection with the ownership of the property and the lessor's Equity Investment in the property, including any direct costs to finance the Equity Investment, and the aggregate amount required to be paid to or for the lessor over the lease term exceeds by a reasonable amount the aggregate disbursements required to be paid by or for the lessor in connection with the ownership of the property.
SEC. 5. OTHER CONSIDERATIONS
.01 Leveraged lease transactions that satisfy the guidelines set forth in section 4 hereof nevertheless may contain uneven rent payments that result in prepaid or deferred rent. The Service ordinarily will not raise any question about prepaid or deferred rent if the annual rent for any year (i) is not more than 10 percent above or below the amount calculated by dividing the total rent payable over the lease term by the number of years in such term, or (ii) during at least the first two-thirds of the lease term is not more than 10 percent above or below the amount calculated by dividing the total rent payable over such initial portion of the lease term by the number of years in such initial portion of the lease term, and if the annual rent for any year during the remainder of the lease term is no greater than the highest annual rent for any year during the initial portion of the lease term and no less than one-half of the average annual rent during such initial portion of the lease term. Any ruling request involving uneven rent payments that do not satisfy the above exceptions must contain a request for a ruling as to whether any portion of the uneven rent payments is prepaid or deferred rent. Any ruling issued by the Service as to the existence of a lease may contain an appropriate ruling or caveat as to such prepaid or deferred rent.
.02 The Service has not decided whether rulings will be issued with respect to property that is expected not to be useful or usable by the lessor at the end of the lease term except for purposes of continued leasing or transfer to any member of the Lessee Group. Prior to the final decision, consideration will be given to any comments pertaining thereto that are submitted in writing (preferably six copies) to the Commissioner of Internal Revenue at the address in Section 7 below by May 30, 1975. Designations of material as confidential or not to be disclosed, contained in such comments will not be accepted. Thus, a person submitting written comments should not include therein material that is considered to be confidential or inappropriate for disclosure to the public. It will be presumed by the Internal Revenue Service that every written comment submitted to it in response to this request is intended by the person submitting it to be subject in its entirety to public inspection and copying in accordance with the same procedures as are prescribed in 26 CFR 601.702(d)(9) for public inspection and copying of written comments received in response to a notice of proposed rule making.
SEC. 6. EFFECTIVE DATE
The provisions of this Revenue Procedure are effective with respect to those requests received after May 5, 1975..
From Letter Ruling 9338002 (TAM)
LAW AND ANALYSIS
Whether a transaction is a sale or a lease depends on the intent of the parties.
<<ENDNOTE 1>> Haggard v. Comm'r, 24 T.C. 1124, 1129 (1955), aff'd 241 F.2d 288 (9th Cir. 1956).
This intent, however, is the intent to create the particular legal relationship embodied in the contract. What the parties label the contract, or even what they honestly believe it to be, does not control. If the contract creates a legal relationship that is a sale, then the contract is a sale.
Sun Oil Co. v. Comm'r, 562 F.2d 258, 262 (3rd Cir. 1977), cert. denied 436 U.S. 944 (1978); Osterreich v. Comm'r, 226 F.2d 798, 801-802 (9th Cir. 1955); Bowen v. Comm'r, 12 T.C. 446 (1949); Mills v. Comm'r, 11 T.C. 25 (1948).
(IRS DECIDES) Thus, the economic substance of the transaction, and not its label, determines whether it is a sale or a true lease. Gregory v. Helvering, 293 U.S. 465 (1935). ("
What the parties label the contract, or even what they honestly believe it to be, does not control. If the contract creates a legal relationship that is a sale, then the contract is a sale.")The key to determining whether a contract is a conditional sale or a true lease is whether the transferee acquires something of value in addition to the mere use of the property:
A lease contemplates only the use of the property for a limited time and the return of it to lessor at the expiration of that time; whereas, a conditional sale contemplates the ultimate ownership of the property by the buyer, together with the use of it in the meantime.
Revenue Ruling 55-54
SEC. 4: Determination Whether an Agreement Is a Lease or a Conditional Sales Contract.
.01 Whatever interest is obtained by a lessee is acquired under the terms of the agreement
itself. Whether an agreement, which in form is a lease, is in substance a conditional
sales contract depends upon the intent of the parties as evidenced by the provisions of
the agreement, read in the light of the facts and circumstances existing at the time the
agreement was executed. In ascertaining such intent no single test, or any special
combination of tests is absolutely determinative. No general rule, applicable to all
cases, can be laid down. Each case must be decided in the light of its particular facts.
However, in the absence of compelling persuasive factors of contrary implication an intent
warranting treatment of a transaction for tax purposes as a purchase and sale rather than
as a lease or rental agreement may in general be said to exist if, for example, one or
more of the following conditions are present:
(a) Portions of the periodic payments are made specifically applicable to an equity to be acquired by the lessee. (Truman Bowen, 12 TC 446, Dec. 16,877 (Acq.).)
(b) The lessee will acquire title upon the payment of a stated amount of "rentals" which under the contract he is required to make. (Robert A. Taft, .5524, below; Truman Bowen, supra.)
(c) The total amount which the lessee is required to pay for a relatively short period of use constitutes an inordinately large proportion of the total sum required to be paid to secure the transfer of the title. (Truman Bowen, supra.)
(d) The agreed "rental" payments materially exceed the current fair rental value. This may be indicative that the payments include an element other than compensation for the use of property. (McWaters, .5511, above; Truman Bowen,
supra.)
(e) The property may be acquired under a purchase option at a price which is nominal in relation to the value of the property at the time when the option may be exercised, as determined at the time of entering into the original agreement, or which is a relatively small amount when compared with the total payments which are required to be made. (Holeproof Hosiery Co., .5501 above. Compare H.T. Benton, .5515, above.)
(f) Some portion of the periodic payments is specifically designated as interest or is otherwise readily recognizable as the equivalent of interest. (Judson Mills, .5511, above.).02 The fact that the agreement makes no provision for the transfer of title or specifically precludes the transfer of title does not, of itself, prevent the contract from being held to be a sale of an equitable interest in the property.
.03 Conditional sales of personal property are, in general, recordable under the various State Recording Acts if the vendor wishes to protect its lien against claims of creditors. However, the recording or failure to record such a sales contract is usually discretionary with the vendor and is not controlling insofar as the essential nature of the contract is concerned for Federal tax purposes.
.04 Agreements are usually indicative of an intent to rent the equipment if the rental payments are at an hourly, daily, or weekly rate or are based on production, use, mileage, or a similar measure and are not directly related to the normal purchase price, provided, if there is an option to purchase, that the price at which the equipment may be acquired reasonably approximates the anticipated fair market value on the option date. Thus, agreements of the type described in section 2.02(a) and (b), above, will usually be considered leases, in the absence of other facts or circumstances which denote a passing of title or an equity interest to the lessee.
.05 In the absence of compelling factors indicating a different intent, it will be
presumed that a conditional sales contract was intended if the total
of the rental payments and any option price payable in addition thereto approximates the
price at which the equipment could have been acquired by purchase at the time of entering
into the agreement, plus interest and/or carrying charges. Agreements of the type
described in section 202(c), above, will generally be held to be sales of the equipment.
.06 If the sum of the specified "rentals" over a relatively short part of the expected useful life of the equipment approximates the price at which the equipment could have been acquired by purchase at the time of entering into the agreement, plus interest and/or carrying charges on such amount, and the lessee may continue to use the equipment for an additional period or periods approximating its remaining estimated useful life for relatively nominal or token payments, it may be assumed that the parties have entered into a sale contract, even though a passage of title is not expressly provided in the agreement. Agreements of the type described in section 2.02(d), and (e), above, in general, will be held to be sales contracts.
Example of Purchase Classification for a Lease
The taxpayer leased a used tractor with dozer. It was to pay for all necessary repairs,
taxes and insurance, and was given an option to purchase
the equipment by paying the balance of the monthly rentals due under the contract plus
$1.00. The taxpayer exercised the option. The payments were not rental payments, but were
partial payments of the purchase price.
Quartzite Stone Co., 30 TC 511, Dec. 23,012, aff'd on other grounds, (CA-10) 60-1 USTC ¶9211, 273 F2d 738.
This example is plainly a purchase because of the low purchase price at the end. However, most leases are written in a more questionable range of a 10% residual. The law is written that the 10% price/residual is still considered a nominal amount. The old rule for the 10% residual is not effective for the leveraged lease.
Leasing is not always the best choice. Sometimes the "lease" in fact is a very expensive method of financing a purchase. The "Tax Killers" are always important. However - place all tax planning in perspective. That perspective is the tax reduction may not off-set the extra cost of the plan. The important thing to remember is to structure the transaction to minimize the overall costs - both tax and other costs.
The cost killers are an important focus - just as the Tax Killers. Reducing the costs and risks of the equipment transaction is crucial to your increasing your net-worth.
If the equipment is very costly for you, then the planning for the cost killers must be more detailed and it must include some computations of alternatives, including the alternative of not purchasing the equipment or property.
The usual agreement for a Conditional Sales Contract will transfer ownership of the property to the lessee after the lessee has completed the actions required in the agreement. The lessee will usually be responsible for all the ordinary costs and burdens of ownership. In most states the agreement will be subject to state sales taxes on each monthly payment. This has an upward force on the total costs of ownership because the sales tax is charged on the entire amount of monthly payment. Therefore the lessee will be paying the sales tax on the imputed/implied interest in the Conditional Sales Contract. (Notice that the sales tax authority is using this to find a method to tax the "sale" so that the nomenclature does not circumvent the state's sales tax code.)
Click here to read a copy of a sample Equipment Lease with an option to purchase. After reading the lease press the back button on your browser to return to this section.
The person taking possession and using the equipment:
The person providing the funds to get the equipment:
If the lease is for a passenger vehicle, then the IRS Rules require the lessor/driver to add back to income an amount determined from tables the IRS uses for leased passenger vehicles.
The lease is deductible, but it is limited by the "inclusion amount tables".
Indicators of a Sale and Purchase (the lessee will deduct the depreciation):
- The property will have a very low price in relation to its cost or be worthless at the end of the lease
- The length of the lease is less than the useful life of the equipment
- The lease is more than the cash sales price of the equipment
- There is a schedule for which the lease payoff is reduced, or the lessee gains equity in the equipment
- If the total rental payments plus any option price payable approximate the price at which the property can be bought when the agreement is made plus interest will generally be treated by the IRS as a sale in the absence of compelling factors indicating a different intent.
- The fair market value at the end of the lease, including ALL lease periods, is less than 20% of the original cost.
Financial accounting is based upon the contractual arrangement.
If the agreement is a Conditional Sales Contract, then the accounting standards require the purchaser/lessee to record the item as an asset, making certain the line is labeled to disclose the asset is leased, and the agreement as a liability - just as though it were a loan from a bank. There will be some mathematics to compute the liability net of the imputed interest. Furthermore a statement (in the form of notes to the financial statements) must be attached to the financials disclosing the minimum lease payments for each of the next five years, the terms of the lease and the total amount of minimum lease payments required. If there are sub-lease rentals, then note the minimum sub-lease if the sub-lease is noncancelable. If there are any contingencies, the contingencies must be presented in the note. Accumulated amortization must be computed and shown as a subtraction from the cost of the property.
The entry to record the Conditional Sales Contract or any lease which is classified as a purchase by the user, or any other form of "financing" arrangement will be to record the asset by a debit to the asset account and record the lease by a credit to the Long Term Lease Payable account. The computation of the amount to record can be complex and tedious without the proper software, therefore you will want to contact and discuss this with your accountant. Bob Parrish CPA PC
If the agreement is a lease then some different accounting rules apply. The lease is not a "loan" and therefore does not need to be recorded on the books as a loan, neither should the equipment be recorded on the books as an asset. However, the accounting rules mandate the disclosure on the financial statements as a note at the end of the financials. You must disclose the lease and its terms, along with the annual amounts of the lease for each of the next five years and the description of the property. The following must also be shown in the note:
- Annual lease payments for each year for the next five years
- Rental expense for each period for which an income statement is presented
- Contingent Rentals
- A general description of the arrangement including
- The basis upon which any contingent rentals are determined
- The existence and terms of renewal or purchase options and escalation clauses
- Restrictions imposed by lease agreements such as restricted dividends, incurring subsequent liabilities, and further leasing.
The entries to record the true will be to debit the rental cost each time a payment is made. The remainder of the information is a part of the financial statements, but is not recorded on the books.