How to Set Up a Capital Lease on a General Ledger

Factory equipment is a good example of a capital lease.

Capital leases are advantageous to business owners because they allow the lessee to build equity and work towards owning a piece of equipment or property without the risk of putting up collateral. What's more, the large payment on capital leases is generally at the end of the lease, rather than at the beginning as it is with a loan, so someone who is starting a business can free up seed capital by leasing, then use the money made from that lease to make the equivalent of a down payment at the lease's conclusion.

Instructions

1. Calculate the total cost of the lease--the principal value plus all the compounded interest.

2. Divide this cost by the amount of payments to figure out how much each payment will be.

3. Multiply the interest rate by the total amount owing on the lease.

4. Subtract the figure calculated in Step 3 from the fixed payment amount determined in Step 2.

5. Apply the value you found in Step 4 to the assets section of your ledger. This amount goes in the assets section because it is money you have spent on the principal portion of the lease balance--it is still capital even though it has changed from a liquid state (cash) to an illiquid state (the portion of the equipment you now own).

6. Apply the value found in Step 3 to the expenses portion of your ledger. This value is entered here because interest is the fee the owner charges you for the privilege of paying off the equipment value over time. The owner is providing you this, as a service, for a fee, just as a mechanic will charge you for his skills, a fee that, incidentally, will also go in your expense column.

7. Subtract the amount you put in the assets section of your ledger from the total amount owing and repeat the process for the next period, using the new amount. Repeat until the lease is paid off.

Tips & Warnings

• Be aware that while the amount you pay each pay period does not change, what it is made up of does--the first payment will mostly be interest, and the last payment will mostly be principal.

• Breaking capital lease agreements often comes with penalties. Make sure you know what they are in the event this happens.

References

• Investopedia: Capital Lease
• Investopedia: Capitalized Lease Method
• Businesstown.com: General Ledger