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 4.1below). 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

Cash-flow effective

method for gaining

Outright asset Major capital outlay
access to assets as no No asset ownership.
ownership up-front.
major capital outlay up-

front.

Entity may not incur Assets may not be able to

Assets can be Entity incurs
repair and maintenance be modified to suit
modified at any maintenance and
costs as assets may fall changing business
stage to suit repairs costs which
under the warranty of the requirements without lessor
changing business typically increase as
lessor over the term of approval and attracting
requirements. assets age.
the lease. fees.

The entity may not incur Lease terms are generally

Entity incurs costs for
Asset can be costs associated with fixed so asset replacements
the replacement or
replaced or disposal and and early terminations at
disposal of assets at
disposed of at any replacement of assets at the request of the entity
the end of their useful
time. the end of their may attract penalties and
lives.
useful lives. fees.

Assets may be replaced

more frequently, allowing

the entity access to latest

technology for no

additional cost.

ossible access to Potential capital outlay at

knowledge, purchasing the end of the lease term if

power and discounts purchasing the asset at the

offered by the lessor. 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
Example of a Buy versus Lease comparison calculator worksheet

Asset Details

Asset purchase price Total price of the asset including directly

$200,000
attributable costs

Asset residual value to entity The higher of market value less costs to sell
$40 000
and value-in-use to the entity at lease end date.

Will ownership of the asset pass to the entity at lease end? Is there a
Yes
guaranteed residual payment amount?

Lease Details

Term of the lease Lease term in years as contained in the lease contract 10

Lease payment frequency The frequency with which lease payments are
Yearly
made

Total number of lease payments The total number of lease payments over
10
the life of the lease

Payment type Whether periodic lease payments are made at the start or
Arrears
end of the period

Discount rate The internal discount rate for the entity (usually based upon
the entity's weighted average cost of capital unless another rate is 6.50%
mandated by the regulatory environment)

Periodic lease payments amount The amount the entity is contractually

28,800
obliged to pay on a periodic basis throughout the life of the lease

Guaranteed residual payment The amount the entity is contractually

2,000
obliged to pay at the end of the lease term to secure asset ownership
NPV Analysis - total discounted cash outflow

Buy option $178 690.96

Lease option $186 794.72

Based upon discounted cash flows buying is cheaper by $8 103.76

Recommendation This asset should be PURCHASED subject to

consideration of qualitative factors

Net Cash - total undiscounted cash outflow

Buy option $160 000

Lease option $250 000

Based upon net discounted cash flows BUYING is cheaper by $90 000

Implicit interest rate of the lease The lessor's implicit interest rate in the
lease contract (used to assess the lessor's implicit interest rate against the 7.36%
entity's discount rate)