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UNIVERSITY OF TENNESSEE SYSTEM POLICY
FISCAL

POLICY NO: FI0440 SUBJECT:  PURCHASING - PURCHASING EQUIPMENT UNDER CAPITAL LEASE AGREEMENTS  
EFFECTIVE: 07/01/2005 REVISION NO: 14

TOPICS:
Purchasing Equipment Under Capital Lease Agreements Forms
Procedures Contacts

OBJECTIVE:

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To provide policies and procedures on purchasing equipment under capital lease agreements.


POLICY:

Purchasing Equipment Under Capital Lease Agreements[top]

  1. These regulations govern the acquisition of equipment by university departments through installment purchases or capital lease agreements. The Financial Accounting Standards Board and the federal government have issued guidelines to clearly define the accounting treatment for such transactions. Those guidelines are reflected in this policy.

  2. Lease Classification. A lease can be classified either as a capital lease or an operating lease. When a lease meets any of the following criteria, it should be classified as a capital lease (installment purchase), and a corresponding asset and liability must be recorded on university records:

    1. Property Ownership. The lease transfers ownership of the property to the university by the end of the lease term.

    2. Purchase Option. The lease contains an option to purchase the leased property at a bargain price (significantly lower than the property's fair value when the option is exercised).

    3. Lease Term. The lease term equals or exceeds 75 percent of the estimated economic life of the leased property.

    4. Rental Payments. The present value of rental payments equals or exceeds 90 percent of the value of the leased property.

    If none of these criteria are met, the lease is classified as an operating lease. Neither an asset nor a liability is recorded on university records.

  3. Required Accounting. Departments that purchase equipment on installment or capital lease agreements should be aware of the required accounting procedures so that the equipment may be capitalized (and tagged) and the corresponding liability recorded on official university records.

  4. Required Contracts. University purchase orders may not be issued to acquire equipment under an installment or capital lease. (Purchase orders can be issued for the current and subsequent year's obligation of funds.) Instead, separate installment or capital lease contracts must be completed. These contracts should reflect all pertinent facts and conditions, including provisions or outright purchase of the equipment during the lease term and amortization schedules for the equipment under contract. All contracts must go through the university's contract review process.

Departmental Procedures

The departmental responsibilities for installment and capital lease contracts are as follows:

  1. Purchasing Department.

    1. Terms. The purchasing department is responsible for securing the most favorable terms for the university, whether through an operating lease or a capital lease agreement.

    2. Quotations. The quotations received by purchasing should include an outright purchase quote as well as lease options. Equipment costing less than $50,000 may not be purchased under a capital lease arrangement without prior approval of the treasurer or chief financial officer (or designee).

    3. Review Process. The purchasing department will route all installment and capital lease contracts through the university's contract review process. These contracts should include amortization schedules and the rate of interest (implicit or stated). Purchase orders can be issued after the contracts are approved for the current year's obligation of university funds.

  2. Treasurer's Office. For approved installment or capital lease contracts, the Treasurer's Office will prepare journal vouchers scheduling the installments or leaseholds payable and capitalizing the purchased equipment. Each year end, the installments/leaseholds payable are reduced by the amount of the principal paid during the year under the installment purchase or capital lease contracts. This amount is determined by obtaining an expenditure summary for general ledger (G/L) code 461800 and can be verified from the amortization schedules on file. Only principal payments for these types of contracts should use G/L 461800.

  3. Acquiring Departments.

    1. Equipment Costing Less Than $50,000. Departments wishing to purchase equipment costing less than $50,000 under a capital lease agreement should check with campus/unit fiscal officers to determine if the equipment can be financed internally to avoid incurring interest charges to third parties.

    2. Invoice Processing. After equipment is purchased under a capital lease agreement, acquiring departments (using amortization schedules from the Treasurer's Office - see Appendix A) will submit an approved invoice for each installment or lease payment due. The invoice must show both principal and interest portions of each payment, using general ledger codes 416800 (for the principal) and 442200 (for the interest).

  4. Departmental Accounting Entries. The following is an example of departmental accounting entries for the purchase of an IBM 3031 computer with monthly payments of $12,615.59 for five years and an implicit interest rate of 8.85 percent:

    1. Installment Purchase Plan. If the computer is purchased under the installment purchase plan, the value of 60 monthly payments of $12,615.59 would be $609,872.00. The journal voucher prepared by Treasurer's Office to record the purchase would appear as follows:

      Account Number
      General Ledger Code Description Debit Credit
      M0140XXXXX -- Equipment $609,872.00 --
      M996X0001 -- Installments/Leaseholds Payable -- $609,872.00

    2. First Installment. When the first installment is due, the department prepares the invoice as follows:

      Account Number
      General Ledger Code Description Debit Credit
      E01XXXX 461800 Equipment Installment - Principal $8,117.78 --
      E01XXXX 442200 Equipment Installment - Interest $4,497.81 --
      A01020001 -- Cash -- $12,615.59

      (Note: The A01020001 credit is automatically performed.)

    3. Year-end Adjustment. At the end of the fiscal year, an adjustment in the installments/leaseholds payable account is necessary to record the principal reduction during the fiscal year. The journal voucher prepared by the Treasurer's Office would appear as follows:

      Account Number
      General Ledger Code Description Debit Credit
      M996X0001 -- Installments/Leaseholds Payable $101,463.50 --
      M99990001 -- Net Invested in Plant -- $101,463.50

PROCEDURES
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Knoxville:  http://web.utk.edu/~dfinance/fiscal-policy.shtml
Health Science Center:  http://www.uthsc.edu/policies/w932_document_list.php?app=FSC
Space Institute:   
Chattanooga:   
Martin:  http://www.utm.edu/departments/finadmin/procedures.php
FORMS
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FOR MORE INFORMATION
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  Samantha Johnson  (865) 974-3311  samantha@tennessee.edu