The new lease accounting standards (ASC 842) have changed the game when it comes to lease vs buy decisions. With the updated standards requiring more lease liabilities on the balance sheet, companies need to take a closer look at the implications of leasing vs buying assets. Performing a detailed lease vs buy analysis can help you make the right decision for your business and financial strategy.

What changed under ASC 842 that affects lease vs buy decisions?

ASC 842 requires lessees to recognize right-of-use assets and lease liabilities on the balance sheet for most leases, meaning both operating and finance leases are now capitalized.

ASC 842 mainly impacts lessee accounting, bringing more transparency to the financial statement for users. The goal is to provide investors and other financial statement users with a clearer picture of a company's leasing activities.‍

Why does a lease vs buy analysis matter under the new accounting standards?

With more lease activity now reflected on the balance sheet under ASC 842, the lease vs buy decision directly affects financial metrics like EBITDA, balance sheet size, and reported liabilities.

Buying and owning an asset results in depreciation expense being recorded on the income statement. In addition, the purchased asset's fair market value the purchase will have an effect on the companies financial health. Leased assets often results in straight-line rent expense. A bigger security deposit down could help with negotiating lower monthly lease payments. The lease vs buy analysis provides an opportunity cost report which informs you on which option minimizes costs and optimizes your financial KPIs.

How do you perform a lease vs buy analysis step by step?

A lease vs buy analysis requires calculating the net present value of both options and comparing the results, then layering in qualitative factors before making a final decision.

Calculate the Net Present Value of Leasing

First, determine the net present value (NPV) of leasing payments over the term of the lease. This requires:

• The total lease payments
• The lease term
• The interest rate implicit in the lease or the incremental borrowing rate

Discount the total lease payments to their present value using the appropriate discount rate. This is the NPV of leasing.

Calculate the NPV of Buying

Next, determine the NPV of buying the asset outright. This includes:

• Purchase price
• Installation, delivery, tax costs
• Expected salvage value at the end of useful life

Discount the purchase price and other costs to find the NPV of buying. Subtract salvage value.

Compare NPV of Leasing vs Buying

Compare the two NPV calculations. The lower NPV is the more cost-effective option over the term.

If NPV of leasing < NPV of buying, leasing is financially advantageous. If NPV of buying < NPV of leasing, buying is the better option.

Consider Other Factors

The NPV analysis provides critical data, but also consider qualitative factors:

• Tax implications - Ownership may provide more tax deductions
• Maintenance costs - Leasing may include lower maintenance costs
• Obsolescence risks - Shorter lease terms reduce risks of changes in tech/needs
• Flexibility - Leasing may offer more flexibility to change assets
• Cash flows - Buying requires more upfront capital expenditure
• Business strategy - Align decision with strategic business goals

What does a lease vs buy analysis look like in practice?

The following example walks through an NPV comparison for a $100,000 equipment purchase against a five-year lease at $25,000 annually, using a 6% incremental borrowing rate.

• Equipment purchase price: $100,000
• Useful life: 5 years
• Salvage value: $10,000
• Lease term: 5 years
• Annual lease payment: $25,000
• Incremental borrowing rate: 6%

NPV of buying = $100,000 purchase - $10,000 salvage / (1.06)^5 = $85,194

NPV of leasing = $25,000 * (PV of Annuity Factor at 6% for 5 periods) = $107,170

In this example, the NPV of buying is lower than the NPV of leasing. Buying the equipment is the more cost-effective choice over the 5 year term with these assumptions.

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What are the key takeaways from a lease vs buy analysis?

The lease vs buy decision comes down to NPV comparison, qualitative factors, and alignment with business strategy, with ASC 842 making the analysis more critical than ever before acquisition.

• Calculate NPV for leasing and buying options
• Lower NPV is better financially over the term
• Consider qualitative factors beyond just NPV
• Align decision with business strategy
• ASC 842 makes the analysis more crucial pre-acquisition

Using this lease vs buy analysis process will lead to informed, strategic decisions for your asset acquisitions.

Frequently Asked Questions

Q: Should I use the incremental borrowing rate or the implicit rate in my analysis?

‍Use the rate implicit in the lease if it is readily determinable from the lease terms. If the implicit rate is not available, apply your company's incremental borrowing rate instead. ASC 842 follows the same hierarchy, so the same logic applies to your balance sheet calculations.

Q: Can I use a lease vs buy analysis for real estate leases?

‍Yes. The same NPV methodology applies to office space, warehouse, and retail leases, not just equipment. Real estate and finance teams should run the analysis before any major location decision, especially given the balance sheet impact under ASC 842.

Q: What discount rate should I use in a lease vs buy analysis?

‍Use the rate inherent in the lease if it is available and determinable. If not, use your company's incremental borrowing rate, which is the rate you would pay to borrow a similar amount over a similar term. Consulting an auditor when setting this rate is strongly recommended.

Q: What qualitative factors matter most in a lease vs buy decision?

‍The most important qualitative factors are tax implications, maintenance responsibility, obsolescence risk, operational flexibility, upfront capital requirements, and alignment with long-term business strategy. These factors can override a pure NPV comparison, particularly when flexibility or technology change cycles are a major consideration.

Q: Does the lease vs buy analysis change under ASC 842?

‍The core NPV methodology does not change, but ASC 842 raises the stakes. Because more leases are now capitalized on the balance sheet, the choice between leasing and buying has a more direct and visible impact on leverage ratios, EBITDA, and reported liabilities. Running the analysis before any acquisition is more important than ever.

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