USA Rent Purchase Options - How to capitalize asset

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I work for a small construction company. A lot of our equipment vendors will allow us to rent a piece of their equipment on a month to month basis, but if and when we say we want to buy the piece of equipment, they will credit either all of a high percentage of what we paid in monthly rent against the original purchase price. I'm not sure if this is their SOP, or if it's a biproduct of the strong relationship our Fleet Director has with these companies. We're under no obligation to purchase the piece of equipment, nor is there a defined term like there would be for a lease; we can choose to purchase the equipment or turn it back in at any time.

I'm struggling with how to account for these situations. I don't see this as a capital lease since there's no defined term or anything like that. I'd like to take the rent expense off the books to capitalize with the asset but that seems like having your cake and eating it too. Basically I see three different options:

1.) Treat it as a capital lease. Capitalize the purchase price of the asset when we start one of these agreements and put the liability on the books. Amortize the monthly payments and if/when we decide to purchase, extinguish the cap lease liability. My hang-up here is if we decide not to purchase the equipment, suddenly we're going to have to recognize a big rent expense.

2.) If/when we decide to purchase, go back and credit all of the rent expense and capitalize the full purchase price. This way seems too good to be true and could also result in big swings in rent expense, this time suddenly recording a large credit when we decide to buy.

3.) Expense the monthly rent and only capitalize the remaining balance if/when we purchase. This could result in capitalizing a $40K piece of equipment for $10K.

Any and all thoughts or information is greatly appreciated!
 
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Hi Thanson

Option 3 makes sense. It follows the actual events: first you rent, then you buy.

I know you worry about "capitalizing a $40K piece of equipment for $10K". However, at that point does it really have a value of $40K? If so, why would the vendor sell it for $10K? They might indeed like your Fleet Director but not enough to lose $30K on a sale. Further, I know they say they credit a high percentage of your rental payments toward the purchase, but again consider you are buying an older, used piece of equipment worth a lot less than when it was new. So, I suggest this "credit toward payment" is just marketing hype.

By the way, in option 2 you talk about a big credit to rent expense. But don't forget if you now assume the equipment was owned back in time, then you would have the related depreciation expense to catch up on.

Regards

Kat
 
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I am not sure if you come under the governance of US GAAP or IFRS.

If US GAAP - no idea.

If IFRS - Option 3 - its not the best option - its the ONLY option and method of accounting treatment.
 

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