NetLease - Handling Bargain Purchase Option

Overview

A lease with a bargain purchase option (BPO) allows the lessee to purchase the leased asset at the end of the lease term for a price significantly below its expected fair market value. The option must be accounted for if it is reasonably certain that the lessee will exercise it.

If it is assessed as reasonably certain at the lease commencement date, the bargain purchase option amount must be included in the lease payment of the period in which the option is expected to be exercised. This ensures the system accurately includes the BPO in both the Lease Liability and the Right-of-Use (ROU) Asset calculations.

The following article will walk through how to create a leases if it is reasonably certain the purchase option will be exercised. 

Creation of a Lease with BPO

Use Case: A user has determined that a bargain purchase option is reasonably certain to be exercised at the end of the lease term. The lease has the following details:

Asset: Building

Lease Term: 4 years (48 months)

Useful Life of Asset: 8 years (96 months)

Monthly Lease Payment: $1,500

Bargain Purchase Option (BPO): $2,000 (paid at the end of the lease)

Discount Rate: 5% annually

Lease Start Date: January 1, 2025

Creation Step by Step Process

1. When creating the lease record, enter the useful life of the asset (not the lease term) in the Lease Term (Months) field located in the Schedule Information section. 
   1. In the given use case, 96 months will be used. View full size
2. Proceed to the Amortization Schedules tab. Add the BPO amount as a lease payment in the period when the purchase option is expected to be exercised. 
   1. In the given use case, the BPO is added in month 48.
   2. If lease payments are made quarterly, adjust accordingly to reflect the correct month. This placement ensures the present value of the BPO is correctly calculated and included in the initial lease liability and ROU asset. View full size
3. After the BPO period, set the next lease payment to 0. This zeroes out the lease liability in the following period and allows the lease to continue amortizing for depreciation purposes over its useful life.
   1. The extended amortization reflects the depreciation of the now-owned asset. View full size
4. Proceed with the usual steps for lease creation and generation of the amortization schedule. The initial balances for Lease Liability and ROU Asset will now include the present value of the BPO. View full size

Handling BPO at the End of Lease Term

At the end of the lease term, there will be a value remaining in the ROU Asset account. To handle the continued depreciation of this newly acquired asset, there are two options as explained below. 

Retaining Amortization With NetLease

1. Once the lease reaches its end of term, the lease record will not be closed out along with the leases without BPO. Instead, the lease record will be retained in a “Commenced” status so that amortization (now depreciation) continues via NetLease.
   1. NetLease will still generate NetLease Amortization entries for this asset until it has been fully depreciated
   2. Once fully depreciated, the lease should stay in a “Commenced” status until the asset has been disposed, in which case it should be "Closed Out"
      1. To ensure the lease does not automatically close out once fully depreciated, ensure to have the "Automate Close out Journals" box in your NetLease system setup unchecked.

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Accounting For Depreciation Outside of  NetLease

1. Alternatively, the user may terminate the lease through the standard NetLease termination process.
2. The user will then need to manually adjust the termination journal entry to reclassify the net book value of the ROU Asset to the appropriate fixed asset account. 
   1. By default, the net book value is posted to the Gain/Loss on Lease Transactions Account, as defined in the asset type configuration. View full size
   2. To correctly allocate the net book value to a fixed asset account, the user must update the defaulted Gain/Loss on Lease Transactions Account to the appropriate target fixed asset account. View full size
   3. Once updated, future amortization (depreciation) will no longer be handled through NetLease and must be managed separately in NetAsset or another fixed asset management system