Proper equipment is essential for performing your work and delivering on your contracts.  However, the high cost of equipment can hamper your bottom line in the long-term if you haven’t chosen the right avenue of financing for your situation. Don’t become consumed with the old concept of buying all of your equipment upfront.  As a part of your construction accounting strategy, the construction CPAs at Doeren Mayhew recommend analyzing whether to rent, lease or buy. A hasty equipment purchase can lead to a lengthy financial burden, so take the time to evaluate and get the most bang for your buck.

Choosing the Best Alternative

Before deciding whether to rent, lease or buy equipment, there are several considerations to make:

  • Determine the longevity of equipment: Knowing the life cycle of machinery is crucial. If equipment is being temporarily used, then renting can be more cost effective.
  • Develop a line of credit: Rental and leasing rates can fluctuate depending on credit, so considering a line of credit ahead of time may lead to more flexible and favorable rates.
  • Research properly: As with any business decision, prior research and due diligence is necessary. Track leasing and rental companies’ performance via the Better Business Bureau or through a credit rating company.

Once research has been conducted, you can make a more conscious decision as to whether it is economically savvy to buy, rent or lease equipment.

When to Lease Equipment

With the current economic climate in the construction industry, leasing has evolved as the most favorable of the three acquiring options. This is in part due to lower-than-normal interest rates. Leasing is an interval-based payment option, usually lasting at least one year and offering incentives such as:

  • No down payment requirements, so having to tap into your liquid cash is not an immediate issue
  • No direct debts are taken
  • Flexibility to purchase equipment in full at the completion of the lease or return equipment, commonly referred to as an “open-end lease”

Accounting for Leases

When considering leasing equipment, it is important to know that there are two types of leases that can be recognized for accounting purposes:

  1. A capital lease is similar to a purchase, although not legally deemed as such. It has the economic attributes of owned assets, thus for accounting purposes, consider it a purchase. As part of this lease, you are viewed as the owner of the equipment, meaning your equipment will be accounted for as an “on the balance sheet” asset on your financial statement. Tax deductions are made regularly until the leasing period is complete or the lease has been paid in full. These deductions for the equipment are limited to the depreciation of the equipment.
  2. As opposed to a capital lease, an operating lease acts as a rental agreement – a contract that allows you to use equipment without conveying ownership rights. It is accounted for as an “off the balance sheet” asset for financial statements. Since it is not held as a liability, you can maintain a low debt-to-equity ratio and increase your ability to borrow more equipment with ease. Payments on equipment under an operating lease are eligible for annual tax deductions.

While many prefer operating leases, standards have been established by the Financial Accounting Standards Board (FASB) that qualify equipment under a capital lease or an operating lease. Each of these types of leases requires different accounting treatments. If equipment does not fall under at least one of the four criteria established by FASB for a capital lease, then it automatically qualifies under an operating lease.  The criteria set by FASB are as follows:

  1. The life of a lease is 75 percent or more of the asset’s useful life
  2. The lease contains a purchase agreement for less than market value
  3. The lessee owns the equipment at the end of the lease period
  4. The current value of the lease payments is greater than 90 percent of the asset’s market value

In either case, ensuring that you will be able to use the equipment the entire period of the lease is extremely important. Early turn-ins often result in additional fees that you didn’t originally anticipate.

It’s no surprise that making incremental payments as opposed to buying outright is more affordable upfront. However, it’s common for rates and fees to fluctuate depending on the lease. Be very aware of the term agreements you sign and how that might influence interest rates and additional fees that you originally may not have anticipated.

When to Rent Equipment

For those not intending to use equipment for a long period of time, or simply wanting to cut costs, renting is another alternative providing several incentives, including:

  • Short-term agreements in comparison to leasing, with monthly, weekly or daily contractual agreements established between the renter and a rental company
  • Fewer financial constraints than buying and leasing
  • More options if you have poor credit to rent equipment without a rigorous prequalification process
  • Ability to test out machinery before renting to ensure it is in good condition

Accounting for Rented Equipment

As opposed to taking out a loan to buy equipment and affecting your credit-to-debt ratio, renting is considered a separate transaction and will not count against current debt. It enables you to expense costs immediately and is applied against your taxable income. In addition to no tax on rental equipment, there are no hefty guidelines aligned with accounting for equipment, as with leases. While there is less hassle to renting when it comes to accounting for payments, your equipment is at the mercy of a rental company, meaning less control over rates, fees and maintenance. Relying on a rental company to repair and monitor equipment can be an advantage as well as a disadvantage for this reason.

When to Buy Equipment

If you are convinced that having complete control of your equipment is the only way to go, then buying is the best alternative for you for a few reasons:

  • Ability to manage how equipment is maintained
  • A cost savings of 20 percent to 30 percent over leasing in the long run, since there are no related fees attached to buying
  • Tax breaks are also given on purchased equipment. By deducting some of the purchase price on a tax return, some of the payment can be reimbursed. See below for more details.

Accounting for Your Purchase

Due to several new tax laws, buying can prove to be profitable this year, especially for smaller construction companies and contractors. The following are effective in 2012 under Section 179 and can be applicable toward purchased equipment:

  • Bonus depreciation at 50 percent: This pertains to new equipment as well as equipment with a recovery period of 20 years or less, excluding certain computer software and water utility equipment.
  • Deduction limit increase: Previously capped at $25,000, deduction limits have now increased to $139,000.
  • Capital Purchase Limit increase: The threshold for equipment that can be purchased is now $560,000, up $360,000 from the prior threshold.

The Final Step: Acquiring Equipment

Weighing all three choices, you can now make a sound decision when obtaining your next piece of equipment. But do not feel the need to take on this critical decision alone. Hire a construction accounting professional and attorney to help you review and understand the accounting implications and contractual agreements.

For assistance analyzing rental, leasing and buying options as part of your construction accounting strategy, contact our construction CPAs in Michigan, Houston or Ft. Lauderdale.