Whether to buy or lease farm equipment is a crucial question, though one with no definitive answer.
There is a rule of thumb that major equipment depreciates at about $400 per hour, or $3,200 in an eight-hour day, or $16,000 in a 40-hour week — though that city-time plan seldom works at planting and harvest time.
Depreciation is insidious in that it is a non-cash cost, but it is real. Newer equipment with higher price tags depreciates more slowly in physical terms, but faster when inflated currency is figured in. Let’s go through the numbers, courtesy of an example from management and accounting firm BDO on which, with a few simplifications, I’ve based this analysis.
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Let’s assume we’re considering acquiring a new front-end loader or other comparable equipment with a purchase price of $43,108. Tax-wise, the Canada Revenue Agency deems it a class 10 investment with a 30 per cent depreciation rate. The equipment will be used by a farming corporation.
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If the equipment is leased, it could require annual payments of $7,421 for years one, two and three and a buyout cost in year four of $25,524, for total costs under the lease of $47,787. Now take off tax savings of $5,813, and you’ve got a final cost of $41,974.
Compare that to ownership. If interest totals $4,538 over four years and capital cost allowance works out to $43,108, ownership would cost $47,646, with tax savings of $5,813. The net cash outflow would be $41,833. On a cash basis, costs of ownership and leasing are almost the same.
We’ve used a 4.99 per cent finance rate and a 5.49 per cent lease rate. Change those numbers and/or depreciation schedules and you get a different outcome. However, with the numbers in this BDO example, leasing and ownership work out about the same. The big difference is that after book-based depreciation, the owner has a saleable asset or a fixer-upper. The lease leaves no ownership other than the possibility of a buyout.
If a good used combine costs $500,000 and depreciates at 20 per cent per year, then the first-year capital cost is $100,000.
Ownership imposes a serious obligation to maintain equipment; leasing, a comparable level of obligation within the terms of the lease. The terms and costs are constant within the class definitions, but the bottom line is still dependent on crop prices.
It’s possible to adjust the outcome with variations in lease cost, maintenance costs and residual value. Depreciation is real, so it can be estimated in physical terms such as bushels of wheat. Then there is salvage value, which is a choice when all depreciation is gone or nearly gone. This is a market and individual case situation. So it’s back to the accountant again.
Now the reality. If you buy new equipment, you pay hefty depreciation in the first few years of use. If you buy used equipment, the calculation says you take less depreciation but you also get less useful life. Capital cost allowance rates are arbitrary, so you can exchange a pen for a toolbox and get more life with lower cost per bushel. The accounting equation may vary, so run it all by your accountant.
