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Rental Equipment Onerous Lease

Last year we sold our rental equipment to the bank in a sale and lease back arrangement. We then rent these lease these machines back off of the bank and rent them out to various businesses and receive an income. This year these businesses have handed the keys back, so we have a lease obligation and no income, hence the leases are onerous from a NPV standpoint.

In year 2 we have a huge component rebuilt which is required to maintain the machines, but management are arguing that these costs are improvements/upgrades and want to capitalise the costs. Therefore they have stripped the maintenance out of the NPV calc to improve the results arguing that the costs will be capitalised.

How does this work from an accounting standpoint? can the banks capitalise the costs and therefore residual value of machines increases which means that at the end of the lease they will be more expensive to buyback?

Any help would be much appreciated.

Answers

Steve Sheridan
Title: Associate
Company: Dean Lewis Associates
(Associate, Dean Lewis Associates) |

I'm curious as to what others will say. I don't think the bank can capitalize the improvements, but I haven't researched it. I'm thinking that if you lease a car and make improvements, the bank can't capitalize those improvements unless you give back the car at the end of the lease. When the lease runs out, your balloon payment will be less than the worth of the car.

Topic Expert
Wayne Spivak
Title: President & CFO
Company: SBAConsulting.com
LinkedIn Profile
(President & CFO, SBAConsulting.com) |

Isn't this done all the time with Leasehold Improvements (the silliest capital asset there is... you're capitalizing an item that has no value; belongs to the landlord and that you can use as collateral, but I digress)?

EMERSON GALFO
Title: CFO
Company: C-Suite Services
LinkedIn Profile
(CFO, C-Suite Services) |

Here is a thought........What does your LEASE AGREEMENT say?

If it is anywhere close to a cookie cutter agreement, of course with some special clauses to your deal, it SHOULD mention something about repairs and most importantly, revaluation/renegotiation.

But from what I gleam.... it is up to the bank if they will agree or not (chances are, they will not). You should have asked the bank before you made major "repairs/maintenance" or at least consulted the agreement.

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