When a company needs an asset, it can choose to lease or to buy it. In each case, there are costs involved, and each decision has relative advantages and disadvantages. Leasing or buying are not only two choices, since the company can also sometimes produce an asset. Choosing between leasing and buying is indeed similar to choosing between buying and making a certain product on one’s own. In both cases, the company is primarily interested in which case it will be better off. To understand whether leasing is better than buying or vice versa, the company has to consider “present value of after-tax costs” (WSU, n. d. ).
If the company buys an asset with a loan, it has to consider that taxes will be lower because interest will provide a tax shield. Alternatively, in case of an operating lease, the company will receive a tax shield in the form of tax exemption for lease payments, because these are treated as expenses. In any given nation, the attractiveness of the lease or buy decision will therefore depend on the taxation system. If lease payments are higher than interest on the loan, in countries with high taxes it may be better to lease than to buy.
Thus, in the US the firms have an incentive “to disguise the use of the asset as a lease rather than as an instalment purchase to be depreciated” (WSU, n. d. ). Although this is considered an accounting trick, some companies will want to do it to minimize their expenses and realize tax savings. This shows that leasing is preferable to many US companies. Similarly, in the buy vs. make decision, the accountant has to calculate all the costs including tax advantages or disadvantages of the decision. This decision will involve cash flows from the decision and the tax shield offered by various scenarios that include different expenses.
The decision to lease or buy can also depend on the industry and technical characteristics of the asset. For instance, in case of equipment that soon becomes obsolete, the lessee may not be interested in purchasing this equipment, preferring to lease it (Jones, 2000, p. 2). This may be one of the reasons why this option is becoming more common in commercial agriculture at this point (Jones, 2000, p. 1). This, too, can in some ways be similar to the buy vs. make decision, because the company will not probably want to start manufacturing a product or component that can soon become obsolete. The buy vs.
lease decision will also include the consideration of the possibility to build equity in the asset. When one owns a building in a dynamically developing neighborhood, it is to be expected that this building will appreciate in the short term. Alternatively, the building that is leased will appreciate, but the lessee does not get any benefits from this appreciation because one’s hold of the asset is only temporary. The whole appreciation then goes to the lessor who is the owner (Jones, 2000, p. 2). In buy vs. make decision, the managers do not have to consider appreciation normally because in any case they end in the possession of the asset.
Another difference in the two decisions, buy vs. lease and buy vs. make, is that the company considering a lease has to pay attention to the fact that the leased asset is only available for the term of the lease (Jones, 2000, p. 2). Unless it is specified in the terms of the lease, the company cannot retain the asset after the end of the lease term without the permission of the owner. In buy or make scenarios, the company will in any case retain the asset after it purchases or manufactures it. In conclusion, both lease and buy scenarios have their advantages.
In general, lease agreements offer greater flexibility and do not tie up company funds in long-term projects like a loan. Buying an asset offers stability and sure prospects for owning the asset in the future. The company can then decide between the two options based on its individual situation and industry environment. Works Cited Jones, Bruce L. (2000, April). Leasing As An Option. 3 February 2006 <http://cdp. wisc. edu/pdf/leasevbuy. pdf. >. Washington State University. (n. d. ). Session 4: Other Sources of Finance. 3 February 2006 <http://cbdd. wsu. edu/kewlcontent/cdoutput/TR505r/page33. htm>.