In recent years, leasing has emerged as a popular alternative method for financing municipal capital expenditures.
It is estimated approximately 80 per cent of public and private sector organizations lease IT assets.
Most municipalities of any size also lease several built facilities for the conduct of at least part of municipal operations, from community police stations to smaller library sites.
Numerous claims are often put forward with respect to the purported benefits of leasing.
Most of them are exaggerated. Where a lease does not cover the entire purchase cost of the asset (i.e., where the lease is an operation lease rather than a financing lease) a municipality can enjoy use of an asset at a lower monthly cost than would be the amount of the corresponding depreciation charge, were it to buy the asset.
In all other cases, the municipality is usually better off buying than leasing.
In Canadian commercial practice, there are two fundamental types of lease. The difference between them reflects the fact that a lease may be used either as a method of financing or refinancing, as a method of supply or, depending on the terms of relevant tax law in force at the time, may also be used as a tax planning vehicle.
A capital lease is any lease that will lead in effect to the purchase, or the equivalent to a purchase, of the equipment.
According the GAAP criteria, a lease will qualify as a capital lease primarily if the basis of the transaction is that the lessee will:
Acquire the asset (there must be a reasonable assurance that the municipality will obtain ownership of the leased property by the end of the lease term);
use the asset for most of its useful life. The municipality must receive substantially all the economic benefit expected to be derived from the use of the leased property over its lifespan; and
pay a significant portion of its cost during the lease term. The arrangements between the lessor and the municipal lessee assure the lessor will recover its investment in the leased property and earn a return on the investment because of the lease agreement.
In addition to the following forgoing considerations several secondary considerations may be taken into account in suitable cases.
These include whether the leased property is used to provide an essential government service and the asset is so specialized that it is likely that the municipality will use the asset throughout its economic life; whether the municipality provided financial assistance towards the cost of acquiring or constructing the assets; whether the municipality has a significant degree of control over the idle capacity of the asset; and the extent to which risks associated with the property are assumed by the municipality.
A capital lease is treated the same as a purchase and the equipment is shown as an asset and a liability on the lessee’s business sheet. Broadly speaking, capital leases are like conditional sales contracts.
In contrast, an operating lease is any lease under the terms of which the lessee may not be reasonably expected to acquire the asset, will not use the asset for most of its useful life, or does not pay a significant portion of its cost during the lease term.
In contrast to the capital lease, an operating lease is accounted for as a pure rental and the equipment is not shown as a liability nor an asset on the lessee’s business balance sheet. Instead, the rental payment is merely expensed.
Because of this accounting treatment, operating leases may sometimes appear attractive for budgetary reasons.
In addition, often municipalities utilize this type of lease to rent equipment such as computers so that they can regularly upgrade the equipment and not worry about disposal of technologically depreciated computers.
Stephen Bauld is a government procurement expert and can be reached at swbauld@purchasingci.com. Some of his columns may contain excerpts from The Municipal Procurement Handbook published by Butterworths.
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