4.3 Lease versus purchase considerations
Overview
An entity's non-financial assets can be acquired
either through outright purchase or leasing
arrangements. When making a ‘lease or buy’ decision
an entity must not only consider the financial
implications of the options including the
government's procurement criterion relating to ‘value
for money’, but consideration must also be given to
long-term strategic priorities and to qualitative
factors (see Table 4.1 below). It is important to
understand the implication of both options for the
service delivery needs of the entity when determining
the most appropriate option.
When leasing an asset the entity only pays for the
use of the asset over the term of the lease and
ownership of the asset does not pass to the entity at
any stage unless the lease contract specifically
states it. Leases where substantially all the risks
and rewards incidental to ownership are transferred
are usually classified as finance leases. When buying
an asset, the entity pays the full cost of the asset
at acquisition date and has full ownership over the
asset.
A finance lease is recorded as an asset when the
transaction (contract) is entered into and, similar
to the outright purchase option, will give rise to
depreciation expense as would be the case of other
assets controlled by the entity. If there is no
reasonable certainty that the lessee will obtain
ownership by the end of the lease term, the asset is
required to be fully depreciated over the lease term
or its useful life, whichever is shorter.
An operating lease on the other hand, will usually
specify a period over which an entity will have the
right to use the goods, and have them replaced if
they stop working during the lease period, but will
then return the goods to the lessor at the end of the
lease.
Better practice entities will usually undertake a
risk assessment and cost benefit analysis to assess
the implication of the operating lease vs finance
lease vs outright purchase decision when considering
key asset acquisitions.
Assessment of advantage and disadvantages
The table below outlines the advantages and
disadvantage of buying and leasing options to assist
entities in considering the most appropriate option
for their circumstances.
Table 4.1: Advantages and disadvantages of buying and
leasing options
|
Buying
|
Leasing
|
|
Advantages
|
Disadvantages
|
Advantages
|
Disadvantages
|
|
Outright asset ownership
|
Major capital outlay up-front.
|
Cash-flow effective method for gaining access
to assets as no major capital outlay up-front.
|
No asset ownership.
|
|
Assets can be modified at any stage to suit
changing business requirements.
|
Entity incurs maintenance and repairs costs
which typically increase as assets age.
|
Entity may not incur repair and maintenance
costs as assets may fall under the warranty of
the lessor over the term of the lease.
|
Assets may not be able to be modified to suit
changing business requirements without lessor
approval and attracting fees.
|
|
Asset can be replaced or disposed of at any
time.
|
Entity incurs costs for the replacement or
disposal of assets at the end of their useful
lives.
|
The entity may not incur costs associated with
disposal and replacement of assets at the end
of their useful lives.
|
Lease terms are generally fixed so asset
replacements and early terminations at the
request of the entity may attract
penalties and fees.
|
|
|
|
Assets may be replaced more frequently,
allowing the entity access to latest technology
for no additional cost.
|
|
|
|
|
ossible access to knowledge, purchasing power
and discounts offered by the lessor.
|
Potential capital outlay at the end of the
lease term if purchasing the asset at the end
of the lease.
|
The decision to either lease an asset or purchase it
outright not only requires consideration of the broad
advantages and disadvantages outlined above, but also
requires an analysis of the financial implications of
the decision. Financial parameters, such as the
interest rate which may be charged on the financed
amount as well as the implied opportunity cost of
using the entity's own cash resources, may have a
significant impact on the lease versus purchase
decision. To assist entities in their analysis of the
financial implication of the purchase versus lease
decision, comparison calculator worksheets are often
available through bank or finance company websites.
An example of such a worksheet is included below in
Figure
4.2.
Figure 4.2: Example of a Buy versus Lease comparison
calculator worksheet