Different options in the market:
The distribution center has two options when it comes to replacing its forklifts – leasing or purchasing. With leasing, the center would use the forklifts for a specified period, usually a few years, and then return them to the leasing company. On the other hand, purchasing the forklifts will give the center permanent ownership of the forklifts.
Accounting treatment of the options:
Leasing forklifts is treated as an operating expense that is reflected in the income statement. The lease payments are recorded as expenses over the life of the lease. However, purchased forklifts are treated as a fixed asset that is depreciated over their useful life. The depreciation expense is recognized over several accounting periods on the income statement.
Tax implications of the options:
Leasing forklifts can provide significant tax savings for the business as the lease payments are fully tax-deductible expenses in the financial year they are made. In contrast, depreciation and interest expense for purchased forklifts are deductible over several years, so tax deductions are delayed.
Cost differentials and cash flow implications:
Leasing forklifts would result in lower upfront costs and lower monthly payments compared to purchasing, but the total cost of leasing is typically higher over the long term. In contrast, purchasing requires a substantial upfront payment or a loan, but the total cost is lower over the long term. Cash flow implications of purchasing include funding the entire upfront cost of the forklifts and paying for any maintenance and repairs needed over the lifetime of the forklifts, while cash flow implications of leasing include lower upfront costs but higher monthly payments, which will reduce available cash flow in the short term.
What would the correct decision be for the company:
The company should decide based on its financial situation, long-term business planning, and cash flow requirements. If the company has a limited budget, a short-term need for the forklifts, or requires the latest models frequently, leasing may be a better option. But if the company values ownership, anticipates long-term use or higher utilization, and has the cash resources or access to financing, purchasing may be the more cost-effective option. The decision should consider the financial implications, tax considerations, and cash flow requirements of either option.