Lease Payment

Lease payments refer to the payments where the lessee under the lease agreement has to pay monthly fixed rental for using the asset to the lessor being the owner of such asset and asset is generally taken back by the owner after the expiration of lease term.

What is Lease Payment?

The term “Lease Payment” is analogous to the rental payment. It refers to the payment made, as per the contract agreed, between the lessor and lessee for granting use of an asset. It may include real estate, equipment, or other fixed assets, for a specific period.

Components of Lease Payment

The calculation of lease payment is dependent on three components, which are depreciation fee, finance fee, and sales taxSales TaxThe government levies sales tax on the consumption of various goods and services as the percentage added to the product and services from which the government earns revenue and does the company's welfare. In the United States, 38 different states have different taxes, from Alaska (1.76%) to Tennessee (9.45%).read more. Now, let us have a look at each of the components separately:

Types of Lease payment

#1 – Depreciation Fee

The depreciation fee is analogous to the principal payment of a loan. It is what the lessee pays the lessorThe LessorA lessor is an individual who legally owns the asset granted on a lease (rented for a long tenure) to the lessee who pays a single lump sum amount or regular payments for using that asset.read more for the loss in value of the asset, which is spread throughout lease or the time for which the lessee will use the asset. The depreciation fee is expressed as equal periodic payment which is derived by dividing the total depreciation by the term of the lease as shown below,

Depreciation Fee = (Net Capitalized Cost – Residual value) / Term of Lease
  • Net Capitalized Cost is the addition of the selling price, any additional dealer fees, taxes that are not paid up-front, and outstanding loan balances (if any) minus any down payment and rebates.
  • Residual value is the resale value of the asset at the end of the lease.
  • Term of lease is the length of the lease contract (usually in months).

#2 – Finance Fee

The finance fee is analogous to the interest payment on loans, and it is what the lessee pays the lessor for using their money. It is to be kept in mind that the finance charges are paid on the total of depreciation and residual valueResidual ValueResidual value is the estimated scrap value of an asset at the end of its lease or useful life, also known as the salvage value. It represents the amount of value the owner will obtain or expect to get eventually when the asset is disposed.read more. The finance fee is mathematically represented as below,

Finance Fee = (Net Capitalized Cost + Residual value) * Money Factor

The money factor can be calculated based on the interest rate mentioned in the lease agreement which is mathematically expressed as shown below,

Money Factor = Interest rate (%) / 24

#3 – Sales Tax

It is the state or local tax charged on the sale price. It is usually paid at the time of signing the lease contract as part of the “due at lease signing” amount. It is mathematically expressed as below,

Sales Tax = (Depreciation fee + Finance fee) * Sales tax rate

Lease Payment Formula

The formula for Lease Payment is derived by adding the depreciation fee, finance fee and sales tax which is mathematically represented as,

Lease Payment = Depreciation Fee + Finance Fee + Sales Tax
Lease-Payment

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For eg:
Source: Lease Payment (wallstreetmojo.com)

Calculation of Lease Payment with Examples

Let’s see some simple examples of the lease payment to understand it better.

You can download this Lease Payment Excel Template here – Lease Payment Excel Template

Let us take the example of John, who is planning to buy a car on lease. The lease will be for a period of 36 months and charged an annual interest rate of 6%. John managed to negotiate the selling price to be $26,000 with a down payment of $4,000 and an outstanding loan balance of $5,000. The car is expected to have a residual value of $16,500 at the end of 36 months from now. The applicable sales tax rate is 5%. Determine the monthly lease payment for John.

Net Capitalized Cost

The net capitalized cost can be calculated using the below formula as,

Net Capitalized Cost = Negotiated Selling Price – Down Payment + Outstanding loan

lease payment example 1

= $26,000 – $4,000 + $5,000

Net Capitalized Cost = $27,000

Depreciation Fee

Depreciation fee = (Net capitalized cost – Residual value) / Term of lease

lease payment example 1.1jpg

= ($27,000 – $16,500) / 36

Depreciation Fee = $291.67

Money Factor

Money Factor = Interest rate / 24

lease payment example 1.2jpg

= 6% / 24

Money Factor = 0.0025

Financing Fee

Financing fee = (Net Capitalized Cost + Residual value) * Money factor

example 1.3pg

= ($27,000 + $16,500) * 0.0025

Financing Fee = $108.75

Sales Tax

Sales tax = (Depreciation fee + Finance fee) * Sales tax rate

example 1.4pg

= ($291.67 + $108.75) * 5%

Sales Tax  = $20.02

Monthly Lease Payment

Therefore, Calculation of Monthly lease payment can be done using below formula as,

Monthly lease payment Calculation = Depreciation fee + Finance fee + Sales tax

example 1.5pg

= $291.67 + $108.75 + $20.02

Monthly Lease Payment  = $420.44

Therefore, John has to pay a monthly lease payment of $420.44.

Advantages

Now, let us have a look at some of the advantages of Lease Payment:

Disadvantages

Now, let us have a look at some of the disadvantages of Lease Payment:

Conclusion

So, it can be concluded that lease financing is appropriate for business that doesn’t intend to fund their asset purchase through debt or term loan to reduce the burden of CAPEXCAPEXCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year.read more. Further, the lease payments work best for companies in industries that are susceptible to technology obsolescence. On the other hand, it is also beneficial for investors who want to invest their money efficiently without participating in the business and earn interest.

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