Leasing or a bank loan: which way of acquiring equipment works out cheaper?

Dilshod, the director of «Ipak yo'li tikuv» LLC, wants to acquire a new automatic cutting line. The line costs 300 million soum. There are two offers on his desk: one from a bank, one from a leasing company. The bank manager says "our rate is lower", the leasing manager says "our down payment is smaller". Both are telling the truth. Only a calculation will show which offer is actually cheaper.

All terms, rates and amounts are hypothetical and compiled by the author. The calculation is simplified: payments are made once a year, and taxes, insurance and paperwork costs are ignored. We assume the line needs no installation and starts working on the day it is delivered. Amounts are in thousand soum.

How do the two offers differ?

How much money is paid in total?

Loan schedule. The principal is repaid at 240 000 : 3 = 80 000 a year, and interest is charged on the balance at the start of the year.

Lease schedule. The equal annual payment is found with the annuity formula: 255 000 × 0.23 : (1 − 1.23⁻³) ≈ 126 779. Part of each payment is interest, and the rest pays off the principal.

Now let us add up all the money: - loan: 60 000 + 2 400 + 345 600 = 408 000; - lease: 45 000 + 380 337 = 425 337.

By simple addition the loan is 17 337 thousand soum cheaper. But this calculation contains one mistake: a soum today and a soum three years from now are valued the same.

How does the time value of money change the result?

Every soum not paid out today works in the company's business: fabric is bought, an order is fulfilled, profit comes in. That is why future payments need to be brought to today's value, that is, discounted. As the discount rate we take the return the company usually earns on its own money (the opportunity return).

Dilshod's accountant worked out two cases.

Case 1: there is spare cash, with an opportunity return of 18%. Discount factors: 1 : 1.18 = 0.8475; 1 : 1.18² = 0.7182; 1 : 1.18³ = 0.6086.

In today's money the loan is 3 574 thousand soum cheaper.

Case 2: cash is scarce, and every soum in the business brings in 30%. Factors: 0.7692; 0.5917; 0.4552.

Now the lease comes out 1 899 thousand soum cheaper. The reason: with the lease, 17 400 thousand soum less leaves the company at the start (45 000 instead of 62 400), and the principal is paid off later. The more expensive money is, the more a deferred payment pays off. In this example the two routes break even at a discount rate of about 25%.

What should you look at besides the figures?

• Collateral. The bank may ask for additional collateral. With leasing, the asset itself remains the lessor's property until the end of the contract, so the demand for additional collateral may be lower: check this with both organisations.
• Speed. Ask both organisations in advance which route can be arranged faster: if the line arrives a month late, the lost orders may cost more than the difference in interest.
• Early repayment. Compare the terms for repaying the loan early and for buying out the lease early: they are set out in the contract.
• A level playing field. Compare both offers on the same basis: the same term, the same payment frequency, with all fees included.

How is the loan route recorded in the accounts?

The line is ready for use when it is purchased, so it is not a qualifying asset (NAS No. 24, paragraph 6), and the loan interest becomes a financial activity expense of the period in which it is incurred (paragraph 9). Purchases of equipment that needs no installation are collected directly on account 0820 (NAS No. 21, paragraphs 63 and 69).

In practice interest is accrued month by month; the table shows the annual total.

There are two approaches to the one-off fee of 2 400 thousand soum. Paragraph 412, line 12 of NAS No. 21 gives the pattern Dr 9430 – Cr 6990 for "payments for banking and audit services", but it does not mention a loan fee separately. Paragraph 3 of NAS No. 24, on the other hand, calls the "interest and other costs" incurred in connection with obtaining borrowed funds borrowing costs, and paragraph 9 requires them to be recognised as financial activity expenses. Set out in your accounting policy which approach you apply, and apply it consistently every year.

How is the leasing route recorded in the accounts?

The contract runs longer than 12 months and at the end of the term the line passes into the company's ownership, so one of the conditions in paragraph 6 of NAS No. 6 is met: this is a finance lease (leasing). The lessee recognises a finance lease in its own books as an asset and a liability (paragraph 25). In this example the 23% lease rate makes the discounted value of the minimum lease payments equal to the line's fair value of 300 000, so both the asset and the liability are 300 000.

Under paragraph 34 of NAS No. 21 the asset received is recorded on the debit of 0310 and the credit of 6950 and 7910. The standard does not state in figures how the amount is split between the two accounts. In this example the author, going by the name of 6950 ("current portion"), put the principal payable in the next 12 months on 6950 (advance 45 000 + year 1 principal 68 129 = 113 129) and the rest on 7910 (300 000 − 113 129 = 186 871). Set the splitting method in your accounting policy.

No interest expense is recorded when the line is received (NAS No. 6, paragraph 41): it is allocated to periods according to the payment schedule, with a constant rate applied to the outstanding balance in each period (paragraphs 29 and 30). Depreciation is charged by the lessee (paragraph 33).

When the contract ends and the line passes to the company, two entries are made: the asset's value Dr 0130 – Cr 0310 (paragraph 40, line 2; paragraph 23, line 3), and the accumulated depreciation Dr 0299 – Cr 0230 (paragraph 32, line 9).

Where does the difference show in the statement of financial results?

On both routes the line is the same and so is the depreciation. Over three years the difference lies only in the debt-related expenses:

In the statements the lease looks more expensive, but we saw above that a cash flow analysis can lead to the opposite conclusion for a company short of cash. Advice for Dilshod: make the decision not on the interest in the statement of financial results but on the present value of the payments, and take the discount rate from the real return of your own business.