What Is a Synthetic Lease?
A synthetic lease is an off-the-balance sheet operating lease whereby a special purpose entity, established by the operating or parent company, purchases an asset and then leases it back to the operating company. The synthetic lease is popular among publicly traded companies that seek to improve debt to equity ratios as the asset is shown on the balance sheet of the special purpose entity and expensed on the parent/operating company’s income statement.
How a Synthetic Lease Works
With a synthetic lease, the special purpose entity treats the lease as a capital lease for tax purposes and charges depreciation expense against its earnings. Essentially, the synthetic lease allows a company to lease an asset to itself. However, the asset does not show up on the balance sheet of the parent company. Instead, the parent company treats it as an operating lease for accounting purposes, recording it as an expense on the income statement.
KEY Points
- A synthetic lease is an operating lease in which a special purpose entity, owned by a parent company, purchases an asset and leases it to the operating company.
- The asset is owned by the lessor for accounting purposes but is owned by the lessee for tax purposes.
- For the parent company/lessee, the depreciation of the asset does not affect net income, as shown in the income statement.
- The lessee can, however, claim depreciation deductions for tax purposes.