A Beginner’s Guide To Accounting For Leases In Schools
Most schools have used leasing at some time but in recent years there have been reports that some schools that have found themselves on the wrong side of accounting rules. We’ve put together a beginner’s guide to understanding leases for schools, written for the teachers and school managers who aren’t accountants.
Don’t assume you need to pay for new equipment upfront
These days with tighter-than-ever budgets, few schools have the luxury of keeping a sufficient pot of money to allow them to pay cash for big investments in new equipment, such as IT, vehicles or gym equipment.
Often schools assume this means they must make do with what they have, replacing only a small amount each year. That can work in some situations, but it can also be inefficient if it means the school must manage a varied collection of equipment of different ages.
There are solutions. Local authorities or the Education and Skills Funding Agency may have funds they can provide for some investments, either interest-free or at a very low cost.
If there aren’t any grants or loans available through the official sources, schools can also use a particular type of leasing that’s defined in accounting rules. It’s called an operating lease.
Only consider operating, not finance, leases
State schools must follow various finance and accounting rules, and, although the details vary slightly, it’s safest to assume that a school can only use operating leases.
An operating lease is a hire, rather than a credit, arrangement. That means the school is paying to use the equipment and not to buy it.
If your school is sure it wants to use modern equipment, and have it replaced before it becomes obsolete, operating leases are suitable for many types of asset. If your view is that ‘if it isn’t broken, don’t fix it’ and you are perfectly happy with your Windows 7 PCs, you probably shouldn’t use operating leases!
There are a lot of detailed accounting rules to help determine whether a lease can be called an operating lease.
Fortunately, for the most part it’s clear, and our next two points will provide the answer in most cases.
If you want to read more about the difference between operating lease and finance lease – read our blog: Finance lease or operating lease? What is the difference?
Expect to return the equipment at end of the lease
Given this is a hire arrangement, you will either have to:
- Return the equipment to the leasing company at the end of the lease; or
- Pay to buy the equipment at its market value.
If there are any other options – for example you keep the equipment at no extra charge, or for a small amount (e.g. the equivalent of just one or two monthly rental payments) – it’s likely not to be an operating lease.
Expect the equipment to be saleable at the end
The only way operating leases can work is if the finance company can sell the equipment to another user after the end of the agreement. This means it must still have some value at that time (the leasing industry jargon is “residual value”).
It’s easiest to think about vehicles. For example, a minibus should still be saleable after six or more years. IT is trickier as generally it’s a problem to resell kit that’s over 4 or 5 years old (and perhaps even less time for tablets), however it can be done.
Don’t be blinded by (someone else’s) numbers
Finance companies and equipment salesman love numbers and will be keen to show you why the lease is an operating lease. There are various tests they can use, including whether the ‘present value’ (the value in today’s money) of the lease payments is higher or lower than the value of the equipment. It should be lower.
It’s fine if you have experts to check their work, but otherwise it’s probably safest to apply the common-sense checks detailed above. If those checks don’t tell you it’s an operating lease, it either isn’t, or you should take some independent advice to determine that it is!
Get advice if it’s unclear
If it’s not obvious that you have an operating lease, always check with an expert, such as a professional accountant, the local authority or the ESFA. Keep a record of their advice and the reasons for it.
We hope this beginner’s guide has been useful. There’s plenty more advice on making successful use of leasing on our website – see our resources library and other education related blog posts, as well as from from organisations including the Institute of School Business Leadership and the Finance and Leasing Association, together with the EFA and local authorities.