There is an upcoming trend that mandates all equipment leasing to be capital leasing so there will be no more “off balance sheet” operating leases.
Part of the reason why this trend is being adopted is due to certain changes in accounting standards that have eliminated the treatment of monthly lease payments as operating costs. Another reason why leasing exercise equipment is moving towards capital leases is that they are low risk leases.
Capital leases have long been considered to be relatively low risk and high rate while lessors who want high risk and low risk leases turn to operating leases to make a profit. The current accounting rules require leases to be termed as capital leases even if they are high risk.
Equipment leasing companies that previously relied on the risks of operating leases to make a profit are now offering lessees capital leases inbuilt with the same risks. When you think about it, a capital lease is just a lease that does not meet the FASB13 operating lease criteria. Below are some of the risks included in a capital lease.
Risks In A Capital Lease
Fair Market Value Buyout
This means that you will eventually purchase the exercise equipment at an inflated fair market value price. Thankfully, you can avoid this by negotiating a lower fair market value or establishing a fixed fair market value price.
Most equipment leasing companies like to include a clause in the lease agreement that allows them to set the fair market value. This provision is obviously not in your best interest. Even when the lease agreement proposes a mutual agreement on the fair market value of the exercise equipment, your lessor will still be in a better position because the lease will continue while you are still negotiating.
Contract Language
When leasing exercise equipment, lessors like to include language that will make you default. This not only provides your lessor with leverage in all other negotiations in your lease but it may lead to penalties.
Take the example of IT equipment, which has very low residual value. In such a situation, your lessor will have very little motivation to collect the equipment so they will allow your lease to continue as the payments pile up.
You may not even realize you have gone into default because the default conditions in capital leases can be so strict and complicated. Your lessor is not obligated to tell you that you have defaulted so they will allow the costs of the default to accrue.
Notice Requirements
When leasing exercise equipment, capital leases require you to give notice in a timely manner using the right communication channel and failure to do so can lead to costly consequences.
More often than not, one of the consequences includes an extension of the lease contract. If you are using equipment that needs regular updates, your lessor may not be as enthusiastic to collect it because it has very little residual value.
You may also need to give notices for other events such as when you need to move the equipment, update it or repair it. Some of the requirements can be onerous and difficult to comply with and missing some of the notices can have negative consequences.
What To Do When Leasing Exercise Equipment
To avoid some of the risks involved with capital leases when leasing exercise equipment, it is best that you thoroughly evaluate the leases to determine the risks. Hiring a legal counsel may not be enough because you will still need to hire an expert in capital leasing agreements to help identify pitfalls in your contract.
Why Leasing Exercise Equipment Is Appealing
There are numerous benefits of leasing exercise equipment despite the many risks it comes with. Some of them include:
- Improved cash flow projections
- Avoidance of covenant issues as seen when applying for a bank loan
- Elimination of ownership liability
- Capital preservation
- Tax benefits
Before you can realize any of these advantages, you have to understand the intricacies of leasing equipment. Without equipment leasing expertise, you might enter into a lease that will expose you to significant risk. It doesn’t matter what type of a lease agreement you get into; they all contain lingo that can expose you to costly risks.
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