LPRS Blog: Leasing911

When an enterprise is considering leasing equipment, the type of equipment being leased makes a big difference when conducting lease vs. buy analysis, selecting the right leasing structure and related accounting treatment (operating or capital), and choosing leasing vendors.

For example, two of the most common leased asset types are trucks and IT equipment, but the best practices for truck leasing and IT equipment leasing aren’t the same.

Truck Leasing

With truck leasing, traditional operating leases are almost never a good idea. The risks are great to the lessee, and costs can escalate too easily.

Capital leases are an option for truck leasing, but they come with a higher rate than is necessary for an enterprise too pay. Instead, the enterprise can cap risk by insisting on a Term Rental Adjustment Clause (TRAC) in the truck leasing agreement. The enterprise won’t be able to keep the truck leasing expense off the balance sheet, but the rate will be lower than a capital lease and there is virtually no risk.

The key element of a TRAC is a pre-established residual value for the trucks.  At the end of the lease, the lessee can buy the equipment at that price or continue to lease by financing the predetermined residual value. With a properly structured TRAC, there are also provisions for returning or trading equipment, with adjustments made based on the equipment’s resale value vs. the residual value.

There’s an inverse relationship between the amount of the predetermined residual value and rental rates. In general, the higher the residual value, the lower the rates. This provides cash flow flexibility.  TRAC lease master lease and supporting documents can also be strucutred to provide a strong case for receiving off balance sheet accounting treatment.  The key lies in how the residual and term rental structures are defined.  Advice from accounting professionals is critical in evaluating such structures.

IT Equipment

Within IT departments, there’s a misguided notion that operating leases protect the lessee from the risk of technical obsolescence. It’s true that operating leases theoretically shift the risk of obsolescence to the lessor, but in reality, operating leases confine the lessee to the refresh cycle dictated by the term of the lease agreement. This can be a costly loss of flexibility.

When procuring IT equipment, buying it outright is actually and putting the assets on regular refresh cycles internally is actually the way to maintain the flexibility to upgrade at the most cost-efficient time.

But when a cash purchase isn’t feasible, lessees can still protect themselves against risk. The key is to focus on issues beyond the rate and cap exposure to interim rent, retainable deposits, extensions, end of lease buy outs and other events such as default and non-compliant equipment return. 

Conclusion

Equipment leasing decisions must take into account the asset type being leased. As this example of truck leasing vs. IT equipment leases illustrates, there are specific strategies that need to be employed for each type.