The decision to lease or buy an asset has significant implications for your financial statements. Understanding how each option impacts your balance sheet, income statement, and cash flow statement can help you make an informed decision. This guide explains these effects in detail.
Balance Sheet Impact
Leasing
Operating Lease Assets and Liabilities Traditionally, operating leases did not appear on the balance sheet. However, under new accounting standards (ASC 842 and IFRS 16), most operating leases are recognized on the balance sheet.
RightofUse Asset The lease agreement is recorded as a rightofuse asset.
Lease Liability A corresponding lease liability is recognized, representing the obligation to make lease payments.
Finance Lease
Assets and Liabilities Similar to buying with a loan, a finance lease results in the recognition of a rightofuse asset and a lease liability on the balance sheet.
Depreciation and Interest The rightofuse asset is depreciated over the lease term, and the lease liability is reduced as payments are made, with interest expense recognized.
Buying
Assets The purchased asset is capitalized on the balance sheet, increasing the total asset value.
Liabilities If financed, a loan or note payable is recorded, increasing liabilities.
Equity The equity section may be affected depending on how the purchase is financed and the impact on retained earnings over time.
Income Statement Impact
Leasing
Operating Lease
Lease Expense Lease payments are recorded as operating expenses, reducing operating income.
StraightLine Expense Typically, lease expenses are recognized on a straightline basis over the lease term.
Finance Lease
Depreciation Expense Depreciation of the rightofuse asset is recorded.
Interest Expense Interest on the lease liability is recognized, similar to interest on a loan.
Dual Expense Both depreciation and interest expenses affect the income statement, usually resulting in higher expenses in the early years of the lease.
Buying
Depreciation Expense The asset is depreciated over its useful life, affecting operating income.
Interest Expense If financed, interest payments on the loan are recorded as interest expense.
Capitalization Initial purchase costs do not affect the income statement immediately but are capitalized and depreciated over time.
Cash Flow Statement Impact
Leasing
Operating Lease
Operating Activities Lease payments are recorded as cash outflows from operating activities.
Finance Lease
Operating Activities Interest payments are included in operating activities.
Financing Activities Principal repayments reduce cash from financing activities.
Buying
Investing Activities
Initial Outlay The purchase price is recorded as a cash outflow from investing activities when the asset is acquired.
Financing Activities
Loan Proceeds If financed, loan proceeds are recorded as cash inflows from financing activities.
Loan Repayments Principal repayments are recorded as cash outflows from financing activities.
Operating Activities
Interest Payments Interest payments on the loan are included in operating activities.
Key Ratios and Financial Metrics
Leasing
DebttoEquity Ratio For operating leases now recognized on the balance sheet, lease liabilities increase total liabilities, potentially affecting this ratio.
Return on Assets (ROA) Rightofuse assets increase total assets, potentially reducing ROA.
EBITDA Operating lease expenses can reduce EBITDA, while finance lease expenses (depreciation and interest) may affect it differently.
Buying
DebttoEquity Ratio If the purchase is financed, the increase in liabilities can affect this ratio.
Return on Assets (ROA) Purchased assets increase total assets, which may impact ROA.
EBITDA Depreciation and interest expenses affect net income but not EBITDA.
Tax Implications
Leasing
Operating Lease
Tax Deduction Lease payments are typically fully deductible as business expenses, reducing taxable income.
Finance Lease
Depreciation and Interest Depreciation and interest expenses are deductible, providing tax benefits over the lease term.
Buying
Depreciation Deduction Depreciation of the asset provides annual tax deductions.
Interest Deduction Interest on financed purchases is deductible, reducing taxable income.
Leasing and buying assets have distinct impacts on your financial statements. Leasing affects the balance sheet through rightofuse assets and lease liabilities, and influences the income statement via lease expenses or depreciation and interest expenses. Buying impacts the balance sheet with capitalized assets and possible liabilities from financing, and affects the income statement through depreciation and interest expenses. Understanding these impacts can guide your decisionmaking process, ensuring that you choose the option that best aligns with your financial strategy and business goals.
