Introduction

A lease is a payment to cover the rental and depreciation of an asset that is being used by the lessee. Leases are different than loans; a loan involves supplying money so that an asset can be purchased or for a number of other reasons. Ownership of the asset never changes hands, and at the end of the lease, the asset is returned to the lessor or possibly purchased by the lessee.

Calculation of Payments

Since lease payments are not interest and principal payments, they are calculated in a different way than loan payments. As an example, lets look at a lease on a $20,000 vehicle. We’ll assume that the interest rate is 3% and the residual value is 57%. So what would the monthly payments be on a three-year lease? 

The first step is to find out what the car will be worth three years from now. In other words, how much of the car’s value is going to be used during the lease term? In this example, multiply the sticker price of $20,000 by the residual value of 57%.

$$ {$20,000}\cdot{0.57} = $11,400 $$

The car will be worth $11,400 at the end of the 36-month lease. Since the car is worth $20,000 and it will be worth $11,400, you will be using $8600 of the car’s value.

$$ $20,000 - $11,400 = $8600 $$

Now we will divide $8600 by 36 (the number of months in the lease). That yields a base monthly payment of $238.89. Finding what the lease fee (or rental fee) should be is the second half of the calculation.

To find the lease fee, add the price of the car to the residual value and multiply this by the money factor.

$$ Money factor = \frac{\text{Interest Rate}}{2400} $$

So for our lease:

$$ \text{money factor} = \frac{3}{2400} $$

Which fraction simplifies to $$ 0.00125 $$

To calculate the lease fee portion, we will add the sticker price to the residual amount and multiply by the money factor.

$$ ($20,000 + $11,400) \cdot 0.00125 = $39.25 $$

Finally, these two figures are added together to give you the monthly lease payment excluding any taxes or fees. 

$$ $238.89 + $39.25 = $278.14 $$

Sales tax and fees may be added on top of this amount.

Accounting

Accounting for a lease is straightforward. When a lease payment is made, you will debit either cash or rent/lease expense receivable and credit rent/lease revenue for the lease fee portion of the payment. For the depreciation portion, debit depreciation expense and credit accumulated depreciation which should be a contra-asset account against either a specific item of inventory or your inventory as a whole.