What is hardware IT leasing and how does it work?
IT hardware leasing is a financial agreement where a business, (called the lessee), obtains the right to use certain IT hardware (such as a server or a laptop) for a predetermined period.
In exchange, the lessee makes recurring payments to the lessor, the financial company that retains legal ownership of the hardware throughout the lease.
At the end of the contractual period, the lessee has the option to buy the hardware at a preferential rate (even as low as 1 euro).
Leasing is very popular with more expensive assets, such as trucks or industrial machines, but since it helps spread out the costs and helps companies avoid big capital expenses.
Recently, IT hardware leasing has also become quite popular, especially for more high end devices.
We at INKI are a Device-as-a-Service provider, and not an IT hardware leasing company, however we have deep experience with the mechanics of leasing contracts.
For many companies, IT hardware leasing is a good way to acquire necessary computers, laptops and phones at a predictable monthly price.
However, leasing contracts have many subtle (and not so subtle) disadvantages that can make them much more expensive than initially planned.
Below are just some of these concerns that every company should take into account and properly analyze when deciding if leasing is a good choice.
Your company will be judged for credit worthiness
Before leasing IT hardware, a company must first submit a lease application. This requires providing key financial data so that the lessor can assess how creditworthy the lessee is.
For standard lease amounts, which can range from 10,000 to 100,000 euros, the approval process can be surprisingly fast, just 24 to 48 hours.
By comparison, traditional loan applications can take many more days or even weeks to get approved.
This means it is much quicker to faster to acquire new device through leasing, compared to taking out a loan to purchase them.
However, for more substantial leases exceeding certain thresholds, such as 100,000 euros or above, lessors will often require comprehensive financial documents.
This may include complete financial statements, detailed business plans, and projections to justify the larger financing request.
Another thing to consider is that most lessors often have minimum transaction values. It is uncommon to find lease agreements for total equipment purchases worth less than 3,000 euros, since the administrative costs are too high to be profitable.
Beware of hidden fees in hardware leasing contracts
A common and critical misconception is that the lessor, as the owner, bears all secondary costs associated with the device, such as property taxes or insurance costs.
Standard lease agreements almost universally transfer these responsibilities to the lessee.
The contract will stipulate that the lessee is responsible for maintaining adequate insurance coverage for the equipment against damage or loss and for paying any applicable taxes associated with the asset.
These costs are not typically included in the base monthly payment and represent a significant “hidden cost” that must be factored into any Total Cost of Ownership analysis.
When is the ownership transferred (and when it isn’t)
In almost all cases, the ownership of the leased device is transferred once the term of the lease is complete. However, this is typically done either through a finance lease or an operating lease:
The 1 euro Purchase Lease. In practice, this works like a “hidden” loan where the final purpose is to obtain ownership of the device.
This type of lease has higher monthly payments because they are calculated to cover nearly the entire cost of the equipment plus interest over the term.
Once the lease term is over, the lessee has the option to buy the device for a symbolic figure, often just 1 to 10 euros.
This lease is ideal for businesses that require an asset for its entire useful life but wish to spread the acquisition cost over time.
For accounting purposes, this structure is almost always classified as a finance lease and is considered a capital expense for accounting reasons.
The Fair Market Value (FMV) Lease. By comparison, the FMV lease is considered a “true lease,” functioning more like a long-term rental.
At the end of the term for a fair market value lease, the lessee is presented with three choices:
- return the equipment to the lessor,
- renew the lease for an additional period,
- or purchase the equipment at its then-current fair market value.
Typically, most lessees choose the third option and end up purchasing the device.
Because the lessor recovers a large part of the asset’s value through a resale, the monthly payments are typically lower than those of a $1 buyout lease.
This structure is typically classified as an operating lease, and the expenses are classified as operating expenses.
Other Variations: While less common for standard IT hardware, other structures exist.
A Purchase Upon Termination (PUT) lease, for example, obligates the lessee to purchase the equipment at the end of the term for a pre-agreed price, often set at 10% to 20% of the original cost.
This structure offers lower payments than a 1 euro purchase but still provides a path to ownership with a known final cost.
Early cancellations are very costly
An important aspect of a hardware lease is that an equipment lease is not a flexible, month-to-month rental. A lease is a legally binding, non-cancellable financial contract for a fixed term.
Leases are seen as flexible because lessees can choose what happens at the end of the lease (return, renew the lease or purchase the device). They also have the ability to add new equipment.
However, a lease does not give lessees the ability to modify or exit a contract prematurely. Trying to do so brings costly legal and financial consequences.
Financial Penalties: A lessee who terminates a lease early must typically pay the sum of all remaining payments due under the contract. In many cases, this amount is due immediately as a lump sum, often with little to no discount for early payment.
On top of this, the contract will likely contain early termination penalty fees, which can be as high as 10% of the remaining balance.
Legal Ramifications: From a legal perspective, an early termination by the lessee is a breach of contract. This entitles the lessor to sue for the recovery of the full expected value of the lease.
This can lead to costly litigation, court-ordered judgments for the full amount owed.
Credit and Reputational Damage: A default on a lease agreement is a negative event that is reported to business credit agencies. This can severely damage the company’s credit rating, making it more difficult and expensive to secure any form of loans and leases in the future.
The cost of complying with such requirements can be so prohibitive that it effectively forces the lessee to exercise an expensive purchase option at fair market value, even if they had no intention of keeping the outdated equipment.
For companies that value flexibility and want to be able to return devices at any time, a Device-as-a-Service (such as the one we at INKI offer) is generally a much better choice.
This is because Device-as-a-Service lets you cancel contracts at any time, without having to worry about long-term obligations.
A hardware lease is often considered a capital expense
From a tax and accounting perspective, the main benefit of a lease is that it should be easier to deduct from taxes compared to a direct purchase of the device.
This is because typically leases are classified as an operating expense, while purchases buying laptops, smartphones and other IT hardware are classified as a capital expense.
Operating expenses can be deducted in full in the fiscal period they were made, while capital expenses are typically deducted over the course of multiple years.
However, recent accounting changes are forcing a reclassification of some leases as capital expenses, except that they are incurred using loans.
This is the case for finance leases (also known as capital leases). A capital or financing lease is treated as a purchase of an asset.
This means the leased asset is recorded in the balance sheet as a fixed asset, alongside the debt associated with paying the lease.
From an accounting perspective, this means the expense is treated as both a capital expense (since the asset itself depreciates over time), and an operating expense since the lessee has to pay interest on the lease.
Therefore, a capital lease gives rise to expenses that are characteristic of a capital expenditure, not a simple operational one.
An operating lease is typically considered an operating expense. When a company enters into an operating lease, it must specify it has a right-of-use (ROU) asset and a corresponding lease liability on its balance sheet.
However, the expense recognition on the income statement is different from a finance lease. Instead of separate depreciation and interest expenses, the lease payments are recorded as a single lease expense.
This expense is classified as an operating expense, reflecting the nature of the lease as a cost of using an asset for a specific period, rather than acquiring ownership of it.
Leasing companies should offer lots of extra services
A modern leasing service shouldn’t just be a financing mechanism to acquire new devices. A leasing company should ideally offer a long list of services to justify their higher cost (compared to direct purchases) and strict contractual terms:
Ideally, a leasing agreement should be structured to bundle essential services alongside the hardware.
These essential services should include device maintenance and technical support.
This means that if a leased device malfunctions, the lessor is responsible for coordinating repairs or replacements.
This arrangement shields the lessee from the unpredictable costs and operational disruptions associated with hardware failures.
By integrating warranty management and repair logistics into the lease, the provider offloads a significant administrative and technical burden from the lessee’s internal IT department.
Leasing programs can include software and deployment services.
Leases can be structured to bundle necessary software licenses, such as operating systems and business applications, into a single monthly payment. This simplifies software asset management and consolidates billing.
Many providers also offer pre-configuration services. Before a single device is shipped, it can be pre-configured with the lessee’s specific corporate software, including all necessary applications, security policies, network settings, and user configurations.
Finally, many leasing companies should handle end of life disposal for the devices.
The end of an IT asset’s useful life marks the beginning of a complex and risk-laden process known as IT Asset Disposition (ITAD).
For companies that own their devices, this involves collecting aging hardware, finding secure storage, cleaning them of data and all while respecting environmental and data security regulations.
These are the minimum services that should be included in an IT hardware lease agreement in order for it to be cost effective.
This is because these services combined will significantly simplify the business processes associated with handling and managing devices.
These types of services are typically found in similar device ownership models, such as DaaS, so they shouldn’t be impossible to achieve by most lessors.
It’s difficult to upgrade the hardware
Most standard lease agreements explicitly forbid the lessee from making any alterations, additions, or upgrades to the equipment without the lessor’s prior written consent.
This means that upgrading existing hardware, or even just tinkering with it outside normal use can void the warranty and even cause contractual penalties.
This means that adding a new RAM module, replacing a screen, or replacing a component can only be done by the lessor, or at partners approved by the lessor.
This isn’t a major problem for typical IT hardware such as laptops and smartphones, but it can be for other devices such as desktop PC’s or servers where replacing different components is quite common and expected.
