Many businesses choose to use some sort of financial arrangements for purchasing their assets.
There are many ways that these can be structured such as through hire purchase or finance leasing and the tax and accounting treatment of these will need consideration for annual reporting and compliance.
There has been a relatively recent move by the creators of accounting standards that all assets where the business has a right to use these (hence the name “Right-of-use asset) must be shown as capitalised on the balance sheet with a corresponding liability on the balance sheet. The asset is then depreciated over its useful life (or length of the lease where that is shorter).
From a tax perspective, the treatments of these types of financing arrangement differ by jurisdiction where each taxing authority decides these themselves. The summary below shows the respective treatments in Australia and New Zealand.
Types of fixed assets leases
Before getting into the treatments of these kinds of asset, it is worth breaking the asset types down into categories. The main two types that are relevant are:
Hire purchase assets where title of the asset transfers to the lessee at the end of the lease; and
Finance lease assets where there is no expectation or some degree of uncertainty over whether the title will pass to the lessee when the lease concludes.
There are also what are called “operating leases” which tend to be shorter term leases for the right to use the asset.
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In general, the accounting treatment for all types of Right-of-use assets is now the same and requires the asset to be capitalised and depreciated as usual with a corresponding liability on the balance sheet for the amounts repayable.
When a business enters into a lease, there is a schedule of payments that often (but not always) shows the total amount to be paid on each date with the split of the payment amount between capital repayments and interest on the outstanding capital. Where a payment schedule is not listed, one can be derived from the interest rate specified in the contract.
Then there are two types of cost that need to be accounted for at the start of the lease and throughout the life of the asset/lease. The accounting entries required at each stage are:
- At the start of the lease:
- The total amount of capital to be repaid over the life of the lease (ie total payments – total interest) is capitalised as the cost of the asset (and depreciated from that value); and
- The same amount is recorded as a liability (net of any deposits/trade in values)
- During the life of the lease:
- The asset is depreciated through normal depreciation journal entries;
- The interest due is recognised in the P&L as it accrues with a corresponding liability going to the balance sheet until the interest is paid; and
- When payments are made, this is paid against interest due and in reducing the capital outstanding on the lease.
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As noted above, different tax jurisdictions apply different rules to lease assets. The two main countries that AssetAccountant deals with at the moment are Australia and New Zealand and their tax treatments are:
- Hire purchase assets are treated under the same principles for accounts in that:
- the assets are capitalised for tax purposes and depreciated under normal rules; and
- a tax deduction is available for the interest components of payments made (although note there is a restriction on this for where the leased asset is a luxury car)
- Finance lease assets are not capitalised for tax which means the following:
- there is a mismatch between tax and accounts assets on the balance sheet;
- no tax depreciation is available on these assets; and
- instead, tax deductions are permitted for the payments made under the terms of the lease.
As one might imagine, there are too many complexities in relation to accounting and tax treatments for leased assets to cover them all here.
In a later blog, we will look at some of these more complex matters and how to handle changes to leases during the course of their lives.