Buy or lease: the eternal question.

An auto leasing toolbox.

It's easy to understand the allure of auto leasing: Consumers make lower monthly payments; dealers gain volume, move expensive inventory--and keep customers. So it's not surprising to find that one of every three new cars on the road today is leased.

Although lease contracts have become more flexible and can be tailored to meet individual needs, many consumers still prefer to buy rather than lease. CPAs can help clients decide whether to lease or buy by advising them on the fairness of lease fees, dealer profit, the relevance and reliability of lease data and the overall desirability of leasing vs. buying. Financial managers in business and industry also may use such information in their capital budgeting decisions. CPAs and their clients should be aware that dealer profit is highly negotiable and often is a function of the dealership and leasing company selected as well as dealer add-ons such as rustproofing, extended warranty, custom detailing, lease options and financing alternatives.

As CPAs identify new assurance services and develop new competencies, a client-focused mind-set will enable them to offer independent professional services that improve the quality of available information. Although leasing assurance is not one of the original six services outlined by the AICPA assurance services committee, consultation on leasing vs. buying should be considered on a future list of expanded assurance services.

The evidence provided here indicates leasing generally saves money and gives consumers an opportunity to drive nicer, newer cars than they otherwise could afford. Buying, on the other hand, minimizes risk and retains equity. To help clients make the best choice, CPAs need tools that will help them understand the terms, preferences, calculations and cash flows of the auto lease vs. buy decision. The information outlined here provides the elements necessary for a complete `toolbox,' including background information on terminology, strategies from an auto dealer and other key factors. The dealership tips give CPAs valuable insight into auto industry trade issues affecting lease transactions. A spreadsheet framework for the lease-buy decision provides capital budgeting advice.

TRUTH IN LEASING

The truth is, dealers have profited more from leasing than from financing. An Atlanta-based leasing expert says, "On a sale, a dealer makes about $1,200 to $1,500 in profit. On a lease, it might be $2,500 to $3,000." That's fine, he notes, "unless it's done deceptively."

Complex lease contracts combined with hidden costs complicate the decision to lease or buy. Only recently have key lease terms such as the cost of the car been disclosed to consumers. Laws in a handful of states, as well as Federal Reserve Board Regulation M, which became effective in October 1997, and leasing data available on the Internet are prompting dealers to make increased disclosures. Unfortunately, some fees, including the interest rate the dealer uses to calculate the lease payment, known in the industry as the money factor, still remain unknown to the consumer.

Lease transactions generally are conducted in a language foreign to many consumers. A healthy familiarity with lease jargon, lease calculations and decision analysis is necessary to make a truly informed decision. Many of the critical terms (cap cost, charges included in the monthly payment and the lease-end residual value) now are disclosed in an easy-to-read format as a result of Regulation M. The glossary on page 27 explains the terms in a typical contract.

When a consumer signs an auto lease, the dealership sells the vehicle to a leasing company. The lease is a contract between the consumer and the car's new owner, the leasing company. The dealership acts as an agent. When the lease is signed, the car dealer profits in four possible ways:

* Seasonal rebates (dealer incentives) from the manufacturer, which average $500 to $1,000 per vehicle.

* "Holdbacks" or credits remitted on a quarterly basis from the manufacturer, which average $500 per vehicle.

* Selling the vehicle to the leasing company.

* Financial incentives from the leasing company, such as a reduction in consumer credit criteria to boost lease transactions or a waiver of leasing fees the dealer can retain.

Increased disclosure of lease components is becoming more prevalent, although details on the interest rate and its impact on the consumer usually are excluded. In the last year, five major leasing companies announced they would voluntarily report other lease charges, including title, registration, tag and security fees, first payment and local sales taxes. Auto industry representatives successfully lobbied against requiring disclosure of the money factor, but most dealers will provide the interest rate and other charges used in the contract if asked.

EFFECTIVE LEASE STRATEGIES

CPAs need to understand some general lease strategies and industry rules of thumb in order to provide proper assurance to clients in lease-or-buy transactions. The discussion below includes strategies CPAs--and their clients--can follow in negotiating auto leases and evaluating recommendations. To supplement this, the sidebar on page 28 includes strategies provided by Richard Llewellyn, the CEO of Palm Automotive Management, a group of 10 new car franchises in Florida.

Strategy 1: Consider soft issues up front. CPAs should get to know the client's needs. For some, the car buyer's attraction to leasing or buying is tied to his or her desire to avoid risk, to drive a new car or to own. In many cases, the client is predisposed to make a decision without really considering the dollars involved. CPAs should determine the strength of the client's conviction at the outset. A review of 24 consumer decisions revealed leasing and buying offered moderate differences in cash flow. For some consumers, soft issues--see exhibit 1, page 26--may outweigh the cash impact.

Exhibit 1: Leasing vs. Buying

                                                Advantages
Factors                                      Buying    Leasing

Minimized net cash outflows.                   (*)       (*)

Greater access to new and
high-priced autos.                                     [check]

Gain equity in vehicle and in                [check]
improvements such as window tinting or
upgraded hubcaps.

Greater warranty coverage                              [check]
for life of commitment.

Greater negotiability of excessive mileage   [check]
and wear and tear imposed by others;
no early termination fees.

Minimizes ambiguity of commitment              (*)       (*)
made. (Buyers bear the risk of asset
holding value and lessees bear the risk
of unknown lessor-imposed penalties
and undisclosed/inflated fees.)

(*) This factor can be an advantage in buying or leasing, depending on the circumstances.

Strategy 2: Save some money by leasing. Although lease payments generally are more affordable than loan payments, front- and back-end charges mean clients should look at total cash flows to determine whether leasing truly saves money. In 14 of 24 three-year leases, total cash savings ranged from $66 to $3,488 and averaged $1,272. The message is clear: Savings from leasing are moderate and may not be the deciding factor. Nonmonetary consider-actions may outweigh monetary ones; does the consumer want to drive a nicer, newer car than he or she could otherwise afford, or does the consumer want equity in the vehicle? Leasing does not make sense if the client intends to drive the car for 10 years.

Consumer leasing offers no tax advantages. If the client uses the car for business, however, CPAs should incorporate the tax consequences (for example, tax savings from the deductible portion of lease payments or depreciation if buying) into the cash flows.

Strategy 3: Lease cars that retain their value. Because lessees borrow a vehicle and pay for the portion of the car's value they use, it's wise to select one that retains its value. For example, consider Carl's choice of leasing a 1998 Mercedes vs. a 1998 Cadillac Seville for 36 months, at an interest rate of 9.12% and no down payment. The 1998 Mercedes E Class Sedan retailed for $48,140, with a lease residual of 61% (lease end value of $29,365). The 1998 Cadillac Seville SLS Sedan retailed for $44,000, with a lease residual of 50%. The Mercedes leases for less money. Why? It retains its value (an 11% higher residual). Leasing the Mercedes saves Carl $1,651 in total lease payments (36 months at $45.87 per month). Carl uses a smaller portion of the Mercedes's value and pays less for the lease.

Strategy 4: Resist the allure of lower lease payments. Payments to lease a car are almost always lower than payments to buy the same vehicle, because leases charge only for the portion used (cap cost minus residual). A lower lease payment does not necessarily mean a good deal. Lease payments should be lower than buy payments proportional to the lease residual. For example, Jordan wanted a 1998 Jeep Grand Cherokee Laredo, which costs $25,300, with zero down, 7.2% interest, payments due monthly over three years, and a lease-end residual of $15,600. Her projected monthly lease and purchase payments are

Purchase payment  $784 (due at end of month)
Lease payment     $392 (due at beginning of month)
Lease savings     $392 (50% of purchase payments)

Jordan's lease payments would be 50% lower than the purchase payments because the present value of the residual, $12,578 (50% of the purchase cost), is subtracted from the lease cost.

Strategy 5: Choose the right auto leasing company. A survey of 22 dealerships found them using from one to seven leasing companies. Dealers are apt to provide consumers with information on a select few companies, often the ones providing the best dealer incentives. They may or may not provide the best terms to the consumer. Reverse the scenario: Ask for the fees (security deposit, acquisition fee, money factor, residual, disposition charge) of all leasing companies the dealer works with, and base your choice on this information. The client also should be encouraged to ask about independent leasing companies, such as Curry Auto Leasing, Direct Leasing, Inc., or Superior Leasing, that minimize dealer contact. In such instances, the client typically provides the leasing company with information about the car desired and negotiates lease terms. The independent company then locates a dealership to provide the vehicle the consumer wants.

Strategy 6: Know the lease payment calculation used by the industry. The auto leasing industry uses a payment calculation that approximates, within a dollar, the familiar academic version used in textbooks and on financial calculators. Traditional time-value-of-money calculations are replaced with the industry version: average interest and straight-line principal amortization. To calculate the industry method, assume a vehicle cost, net of down payment, of $27,186.04, a residual of $17,976.75, an interest rate of 6.24% and a 36-month term. The industry method is illustrated in exhibit 2, below.

Exhibit 2: Auto Industry Lease Payment Calculation

The auto industry lease payment involves straight-line principal
and average interest calculations.

To illustrate, assume a $27,186.04 cap cost net of down payment,
$17,976.75 residual, .00260 money factor (6.24%), and 36-month
term.

Industry payment calculation:

1. Depreciation charge: (Cap cost - Residual)/Term =
   ($27,186.04 - $17,976.75)/36                            = $255,82

2. Lease charge: (Cap cost + Residual) x Money factor =
   ($27,186.04 + $17,976.75) .00260                        = $117.42

1 + 2 = Dealer's lease payment quote without tax           = $373.24

The 1 depreciation charge represents a straight-line monthly
principle payment. The 2 lease charge represents an average
monthly interest payment. The averaging of the lease charge
is illustrated in a two-step process:

Step 1: Convert money factor to average monthly interest rate

Money factor x 2,400 = annual interest
 rate % = .00260 x 2,400                                    = 6.24%

Money factor x 1,200 = 1/2 annual interest
 rate % = .00260 x 1,200                                    = 3.12%

Money factor x 100 = 1/2 monthly interest
 rate % = .00260 x 100                                      = 0.26%

Money factor = 1/2 monthly interest rate = .00260           = 0.0026

Step 2: Substitute average monthly interest rate for money
factor in lease charge

(Cap cost + Residual) x Money factor
 = ($27,186.04 + $17,976.75) x .002                        = $117.42

(Cap cost + Residual) x 1/2 monthly interest rate
 = ($27,186.04 + $17,976.75) x 1/2                         = $117.42

(Cap cost + Residual) 1/2 x monthly interest rate
 = ($27,186.04+$17,976.75)1/2 x .005                        =$117.42

(Average balance owed) x monthly interest rate
 = ($22,581.40) x .00520                                   = $117.42

The industry lease payment has two components similar to principal and interest. The $255.82 depreciation charge represents a straight-line monthly principal payment. The $117.24 lease charge represents an average monthly interest payment. The combined industry lease payment of $373.24 is within a dollar of the $372.71 payment a CPA might compute using the academic method.

Dealer lease quotes should agree with industry method calculations. Hidden components affecting monthly payments are avoided, for the most part, because Regulation M requires full disclosure of payment components (except the money factor).

Strategy 7: Negotiate the lease payment carefully. Four factors determine a lease payment: cost, residual value, interest and the lease term. The car's cost and residual value have the greatest impact; interest and term have the least. CPAs should be aware that when added to a lease component, dealer profit might appear small when it is divided into monthly payments. Pay attention to the cost and residual (especially the latter, since residuals vary widely among leasing companies) and avoid quibbling over interest rate and term. Exhibit 3, page 30, shows the sensitivity of lease payments to a change in lease terms.

Exhibit 3: Lease Payment Sensitivity

Lease Component                                   Lease Payment

This exhibit describes the changes                   Amount
in a $330 lease payment when the
cap cost, residual, money factor
or lease term increases ([arrow up]) by 1%, 5%,
and 25% while the other components
are held constant. In reality, the
residual, money factor and term are
interrelated and do not stay constant
(for example, the residual is lowered
when the term is extended).

Cap cost--down payment ($27,186)                    $330.00
1% [arrow up] ($27,458)                             $337.55
5% [arrow up] ($28,545)                             $367.76
25% [arrow up] ($33,983)                            $518.79

Residual ($20,819)                                  $330.00
1% [arrow up] ($21,027)                             $324.88
5% [arrow up] ($21,860)                             $304.40
25% [arrow up] ($26,024)                            $202.02

Money factor (.00319) = Interest rate (7.66%)       $330.00
1% [arrow up] (.00322) = interest (7.73%)           $331.53
5% [arrow up] (.00335) = interest (8.04%)           $337.65
25% [arrow up] (.00399) = interest (9.58%)          $368.28

Term of lease (36 months)                           $330.00
1% [arrow up] (36.4)                                $328.25
5% [arrow up] (37.8)                                $321.58
25% [arrow up] (45.0)                               $294.62

Lease Component

This exhibit describes the changes                  % [Delta]
in a $330 lease payment when the
cap cost, residual, money factor
or lease term increases ([arrow up]) by 1%, 5%,
and 25% while the other components
are held constant. In reality, the
residual, money factor and term are
interrelated and do not stay constant
(for example, the residual is lowered
when the term is extended).

Cap cost--down payment ($27,186)
1% [arrow up] ($27,458)                               2.29%
5% [arrow up] ($28,545)                                6.56
25% [arrow up] ($33,983)                              27.93

Residual ($20,819)
1% [arrow up] ($21,027)                               (1.55)
5% [arrow up] ($21,860)                               (4.80)
25% [arrow up] ($26,024)                             (27.54)

Money factor (.00319) = Interest rate (7.66%)
1% [arrow up] (.00322) = interest (7.73%)              0.46
5% [arrow up] (.00335) = interest (8.04%)              1.38
25% [arrow up] (.00399) = interest (9.58%)             6.65

Term of lease (36 months)
1% [arrow up] (36.4)                                  (0.53)
5% [arrow up] (37.8)                                  (1.52)
25% [arrow up] (45.0)                                 (6.15)

Strategy 8: Make sure the car costs the same for purchase or for lease. The negotiated price of the vehicle should be the same, whether the consumer is leasing or buying. Clients should negotiate the purchase price first to establish the value used in lease calculations. Avoid the financial bait-and-switch, or "flip," as it is known by sales personnel, in which the dealer imposes a higher lease price after negotiating the purchase price.

Dealers generally lose money on new cars and make up for it on used cars and in service centers. Because dealers make relatively little profit on purchase or lease transactions, one way for clients to gain leverage and perhaps a better lease deal is to capitalize on their loyalty to the dealership. Lease negotiations should include the offer of a few "carrots" of anticipated service work with the dealership and the prospect of repeat business.

Strategy 9: Take advantage of inflated residuals. Residuals quoted by leasing companies on 24 consumer lease-buy decisions surveyed in 1998 averaged 16% above lease--end residuals published in the industry-recognized Automotive Lease Guide--1998 Residual Percentage Guide. For example, a published residual for a given car at 44% is quoted by leasing companies, on average, at 51%. Inflated residuals lower the monthly payment and may raise the stated lease-end purchase value. Leasing companies often raise residuals as a marketing strategy to attract more customers. Clients are wise to consider a high residual, bank the savings in monthly payments and decline to buy at lease end if the leasing company will not renegotiate the purchase price to conform to current market value at lease end.

Strategy 10: Make sure the lease term matches the driver's needs. Encourage clients to avoid leases with terms longer than needed. Early termination costs money. Some leases require consumers to pay the difference between market value and lease balance, a termination fee (averaging $200 to $400) or the remaining lease in full. Regulation M mandates that consumers be warned that early termination costs "may be up to several thousand dollars."

Strategy 11: Monitor lease-signing fees. Consumers should request a full itemization of lease-signing fees. Regulation M requires disclosure of the down payment, security deposit and totals paid for taxes, insurance and lessor charges. A survey of 22 Florida dealers revealed the following range of fees due at signing:

* Florida license tag ($56 to $185).

* Lease acquisition fee (leasing company fee ranging from $300 to $600).

* Security deposit (first month's rent).

* Administrative fee (5 dealers imposed fees of $100 to $250).

* Florida rental fee ($60 required by Florida law).

* Tire-battery fee ($6.50 required by Florida law).

* Lemon law ($2 required by Florida law).

Excessive charges beyond these customary fees point to dealer profit that clients can sidestep. Avoid paying surcharges such as administrative fees. Dealers typically refund overcharges only at the consumer's request.

Strategy 12: Try to avoid lease-end penalties. Clients should be encouraged to avoid paying excess up-front mileage fees--the charges dealers impose for odometer readings greater than 12,000 or 15,000 miles annually--unless anticipated usage is heavy. At lease-end, clients can avoid having to pay excess mileage charges or penalties for excessive wear and tear by trading in the vehicle or buying it outright.

Strategy 13: Determine the lessee's equity. Clients should avoid returning the car to the original dealership without first doing some homework by obtaining three alternative trade quotes on the vehicle at lease-end to determine the extent of the lessee's equity. Equity is created when the consumer has the right to buy the car at a price lower than the current market or trade value. If the consumer trades the car, the trade equity (net of any sales taxes imposed) is applied against the purchase price of the new car to create a cash savings on the new car purchase.

WHERE DO I SIGN?

After negotiating both the lease and buy terms and assessing the reasonableness of dealer profit, CPAs and financial managers should advise their clients or employers on whether to lease or buy using capital budgeting techniques. This spreadsheet analysis uses a net-present-value method to evaluate the best option. Cash flows are discounted using the quoted lease-buy rate for payment calculations and the consumer's aftertax savings rate (assumed to be 5%) for all others. This is because dealer payment calculations use the dealer's discount rate while all other cash flows are affected by the consumer's discount rate. The money factor quoted by the dealership is converted to an annualized interest rate (see exhibit 2) for use as the lease rate. Comparing the net-present-value cash flows shows which alternative saves money.

Tax consequences are not included in the consumer lease-buy illustrations described below. If the auto is used for business purposes, CPAs and financial managers should incorporate additional tax issues into the decision framework.

Exhibit 4, page 33, illustrates the cash flows associated with purchasing or leasing a 1998 Chrysler Town & Country LXI minivan. The values come from an actual lease-buy negotiation with a dealer. In this case, the net-present-value analysis shows leasing saves $2,193.57 over buying. The analysis assumes the money saved in lower lease payments is invested at 5% interest (10% return less 5% opportunity cost of capital) over the life of the lease. However, if excess cash is unavailable, this element of the analysis should be ignored. As such, lease savings may be as low as $967.72. The cash savings and the less tangible soft issues described earlier should guide the decision to lease or buy.

Exhibit 4: Leasing vs. Buying Cash Flow Analysis

Costs or (Revenues)                                      Buy

Auto cost (1998 Chrysler Town & Country
 LXI, $32,685 MSRP)
1 Negotiated cost of car (purchase price
 or cap cost)                                        $30,400.00

Additional costs

2 Cash down payment or trade (negotiable)             $3,213.96
3 Fees paid in cash up front
  * Tag and "fees" (profit hidden here-amount
    should be < $170)                                   $225.29
  * Documentary stamps                                  $114.40
  * Lease acquisition fee
  * Security deposit
4 Present value of sales tax paid (varies
 by state--6% used here)                              $1,824.00
  Assessed on portion of vehicle paid
   for by consumer
  * Buy: [(1) x 6%]
  * Lease: [(2) x 6%] + [PVAD(1) of {(10) x 6%}]

Monthly costs

5 Residual value (dealership quote of 55% of MSRP)
6 Interest rate (convert the money
  factor to an interest rate)
  money factor quoted at .00260 x 2400 = 6.24%           9.00%
7 Cost of capital (after tax-saving rate)                5.00%
8 Term                                                 36 months
9 Loan payment:                                         $864.51
  payment x PVA = (purchase price - down payment)
     = [(1) - (2)]/PVA
10 Dealer's lease payment quote
 (excluding sales tax)
11 Industry calculation [used for
 reasonableness of (10)]
12 Present value of payments: [PVA of (9)]
 or [PVAD of (10)]                                   $27,186.04

Other costs (Revenues)

13 Present value of interest earned
   on savings in lease payment(2)
   [PVAD of {(9) - (10)}] - [{(9) - (10)} x (8)]
14 Present value of refunded
   security (that is, deducting
   forgone interest) PV of $425
15 Present value of lease disposition charge
   PV of $275
Cost after 36 months
 (2 + 3 + 4 + 12 + 13 + 14 + 15)                     $32,563.69
Less present value of trade-equity
 ($16,342.50) in 36 months(3)                        $14,070.50
Your total cost                                      $18,493.19
Lease savings

Costs or (Revenues)                                     Lease

Auto cost (1998 Chrysler Town & Country
 LXI, $32,685 MSRP)
1 Negotiated cost of car (purchase price
 or cap cost)                                        $30,400.00

Additional costs

2 Cash down payment or trade (negotiable)             $3,213.96
3 Fees paid in cash up front
  * Tag and "fees" (profit hidden here-amount
    should be < $170)                                  $288.89
  * Documentary stamps
  * Lease acquisition fee                              $495.00
  * Security deposit                                   $425.00
4 Present value of sales tax paid (varies
 by state--6% used here)                               $943.16
  Assessed on portion of vehicle paid
   for by consumer
  * Buy: [(1) x 6%]
  * Lease: [(2) x 6%] + [PVAD(1) of {(10) x 6%}]

Monthly costs

5 Residual value (dealership quote of 55% of MSRP)   $17,976.75
6 Interest rate (convert the money
  factor to an interest rate)
  money factor quoted at .00260 x 2400 = 6.24%           6.24%
7 Cost of capital (after tax-saving rate)                5.00%
8 Term                                                 36 months
9 Loan payment:
  payment x PVA = (purchase price - down payment)
     = [(1) - (2)]/PVA
10 Dealer's lease payment quote
 (excluding sales tax)                                 $373.24
11 Industry calculation [used for
 reasonableness of (10)]                               $373.24
12 Present value of payments: [PVA of (9)]
 or [PVAD of (10)]                                   $12,288.60

Other costs (Revenues)

13 Present value of interest earned
   on savings in lease payment(2)
   [PVAD of {(9) - (10)}] - [{(9) - (10)} x (8)]     ($1,225.85)
14 Present value of refunded
   security (that is, deducting
   forgone interest) PV of $425                       ($365.91)
15 Present value of lease disposition charge
   PV of $275                                          $236.77
Cost after 36 months
 (2 + 3 + 4 + 12 + 13 + 14 + 15)                     $16,299.62
Less present value of trade-equity
 ($16,342.50) in 36 months(3)
Your total cost                                      $16,299.62
Lease savings                                         $2,193.57

(1) PV denotes present value, A = annuity and D = due.

2 Cash flow differences between the buy-lease alternatives create opportunities for interest savings, The most significant difference is identified here; others (such as up-front fees) are ignored for simplification.

3 The trade-equity (residual) represents the industry recognized three-year residual published in the Automotive Leasing

Guide--1998 Residual Percentage Guide. The May 1998 residual for this auto was 50% of the MSRP. Avoid using the residual value quoted by the dealer.

SELLING THE SERVICE

Many clients compare a visit to an auto dealer to buy or lease a car with a trip to the dentist. Regular visits are necessary, but not eagerly anticipated. As a result, CPAs may find their offer of independent, objective and informed help with lease negotiations and purchase decisions an easy sale. Most of a CPA firm's existing clients will need such help at least every two or three years. In addition, the service can be marketed outside the firm's existing client base using traditional direct mail campaigns, ads in auto-related publications or on Internet Web sites or even by renting a booth at a local auto show.

NEW ASSURANCE SERVICE

Armed with the financial analysis skills needed to do the job, CPAs are uniquely qualified to provide clients with assurances on auto leasing vs. buying. Automobile consumers and the CPAs who advise them should consider both quantitative and qualitative measures and carefully negotiate all fees, just as when they purchase a home or sign any other contractual obligation. In the end, the ultimate choice to lease or buy involves an informed understanding of the financial and other factors of each alternative.

EXECUTIVE SUMMARY

* ONE OF EVERY THREE NEW CARS ON THE ROAD is leased, and consumers are confronted frequently with the decision of whether to buy or lease their vehicles. CPAs are in a good position to use their assurance skills to help consumers make this decision, offering advice on the reasonableness or fairness of lease fees, the resulting dealer profit, the relevance and reliability of data and the overall advisability of leasing or buying.

* LEASING TRANSACTIONS REMAIN COMPLICATED. Only recently have the meanings of key lease terms been disclosed to consumers, some as the result of Federal Reserve Board Regulation M, effective as of October 1997. Some fees, including the interest rate (money factor), generally remain unknown unless the consumer asks.

* CPAs AND THEIR CLIENTS CAN USE ANY OF A NUMBER of strategies to make negotiating the purchase or lease of a vehicle easier. While leasing generally saves money, it's important to consider other factors--some of them unrelated to cost--in deciding whether to buy or lease a car.

* TO HELP CONSUMERS MAKE THE BUY-OR-LEASE decision, CPAs can apply capital budgeting techniques. If appropriate, tax consequences should be considered as well.

Auto Leasing Resources on the Internet

Background and advice www.leasesource.com/

Long list of links, including international information www.autoguide.net/finance/leasing.html

Independent leasing www.autoflex.com/ autobytel.com/Se/Ly/autoleasing.html

Used car leasing www.advernet.com/aboutus/linc.html

Auto Leasing Glossary

                          Typically
Terms                     Disclosed?

Up-front lease issues
Lessor                    [check]
Lessee                    [check]

Lease payments issues
Cap cost                  [check]
Cap cost reduction        [check]
Residual                  [check]
Money factor
Term                      [check]
Depreciation charge       [check]
Lease charge              [check]
Sales tax charge          [check]

End-of-lease issues
Open-ended lease          [check]
Close-ended lease         [check]
Purchase option           [check]
Security deposit          [check]
Gap insurance             [check]
Excess mileage charges    [check]
Excess wear and tear      [check]
 charge
Early termination         [check]

Other terms
MSRP                      [check]
APR

Terms                     Meaning

Up-front lease issues
Lessor                    The leasing company to which the car
                          dealership assigns the rights to the
                          contract.
Lessee                    Consumer.

Lease payments issues
Cap cost                  The cost of the car to be leased. May
                          include the selling price and additional
                          fees capitalized; disclosure of the cap
                          cost may not be itemized.
Cap cost reduction        The cash paid up front to reduce
                          payments.
Residual                  The fixed future value of the car at
                          lease end.
Money factor              The interest factor -- quoted as a
                          decimal such as .0031. Easily converted to
                          an annual interest rate by multiplying by
                          2,400 (.0031 x 2400 = 7.44%). The money
                          factor is half the monthly interest rate.
Term                      The number of months covered under
                          the lease.
Depreciation charge       The portion of the payment reducing the
                          principal lease obligation.
Lease charge              The portion of the payment covering
                          interest.
Sales tax charge          The portion of the payment covering sales
                          tax.

End-of-lease issues
Open-ended lease          Lessee guarantees the value of the
                          car at lease end.
Close-ended lease         Lessee does not guarantee the residual
                          amount.
Purchase option           Option to buy at lease end.
Security deposit          Good-faith payment guaranteeing at lease
                          end the proper condition of a vehicle
                          that may (not) be returned. Averages one
                          month's lease payment.
Gap insurance             Coverage of the "gap" between the
                          insurance policy proceeds and the lease
                          balance owed if the car is stolen or
                          destroyed. Doesn't reimburse cash outlays
                          made. May be free or cost $200 to $400.
Excess mileage charges    Payment at lease end for decreased
                          residual value (usually around 10 cents
                          per mile).
Excess wear and tear      Same as above.
charge
Early termination         Terminating the lease contract before
                          its full term.

Other terms
MSRP                      Manufacturer's suggested retail price.
APR                       Annual percentage interest rate.

RELATED ARTICLE: Additional Strategies from an Auto Dealer

Here is more information on some of the topics discussed in the text provided by auto dealer Richard Llewellyn.

Strategy 1: Consider soft issues up front.

Leasing minimizes the risks associated with driving a car because leased cars often have "gap" insurance protecting against collision and theft losses. At lease end, the consumer walks away from the lease if the lease buyout is too high or receives equity back through trade or purchase if the lease buyout is low.

Strategy 5: Choose the right auto leasing company.

Leasing companies must provide the same quotes to all dealers within a region. For example, World Omni, a leasing company, must quote the same residual, money factor and acquisition fee to all dealers. Dealers have no contractual obligation to pass the same terms along to consumers. This permits undisclosed dealer add-ons, but market and competitive forces minimize abuses. Quotes among lease companies will vary due to different actuarial assumptions employed.

Strategy 8: Make sure auto cost is the same for purchase or lease.

On average, dealers lose money in the new car sales-leases department (due to high sales commission costs) but make up for the losses in other areas (used cars, body shop, parts and service).

Strategy 11: Monitor lease-signing fees.

Leasing companies may lower the lease security deposit or money factor as a dealer incentive. The dealership may or may not pass the savings along to the consumer. The disclosed security deposit may be paid to the leasing company or retained by the dealership as profit. As an example, dealers that advertise "autos at zero above cost" may fail to mention $875 in administrative fees (dealer profit) charged at lease signing. Scrutinize total costs carefully.

Strategy 12: Try to avoid lease-end penalties.

There are no penalties if the leasing company does not get the car back. Under this scenario, someone buys the car, either the dealership through a trade or the consumer through a purchase. The new owner bears the risk of excess mileage and wear and tear.

DEANNA OXENDER BURGESS, CPA, PhD, is assistant professor of accounting at Florida Gulf Coast University, Fort Myers. Her e-mail address is [e-mail].