Equipment is a type of long-term, physical asset and includes machinery and computers. When your small business obtains equipment, it is important to report it on the proper financial statement. The way you report equipment depends on whether you buy it or lease it and the type of lease arrangement you use. In general, equipment belongs on the balance sheet, but there are some related expenses, such as depreciation, that you must also report on the income statement.

Purchased Equipment Cost

A business reports the initial cost of purchased equipment under the “property, plant and equipment” classification in the assets section of the balance sheet. The total cost includes the purchase price, freight charges and any other costs necessary to install the equipment and prepare it for use. For example, if your small business buys machinery for $10,000 and pays $500 in delivery and installation fees, you would report $10,500 of equipment in the assets section of the balance sheet.

Purchased Equipment Depreciation

After the initial purchase, a business allocates a portion of the cost on the balance sheet to an expense on the income statement each period of the equipment’s life. This expense is called depreciation and accounts for wear and tear on the equipment. A business figures the depreciation expense using one of several methods, such as the straight-line method or the units-of-production method. For example, if you determine that your equipment’s depreciation is $2,000 per year, you would report a $2,000 depreciation expense on your annual income statement.

Leased Equipment

When a business leases equipment, it makes periodic payments to a finance company or other entity to use the equipment for a period of time. The method of accounting for leased equipment depends on whether the lease arrangement is a capital lease or an operating lease. To determine which type of lease a business has, it uses specific criteria that consider various factors, such as the length of the lease and the potential to transfer ownership.

Capital Lease

In general, a capital lease is one in which a business assumes some of the benefits and risks of owning the equipment and sometimes has the option to buy the equipment for a discount at the end of the lease. With this type of lease, a business reports the present value of all lease payments as the equipment’s cost in the assets section of the balance sheet and records the same amount as a lease obligation in the liabilities section. It also reports depreciation and the interest portion of the lease payments as expenses on the income statement each period.

Operating Lease

An operating lease is one in which a business has no ownership benefits and no discount buyout option. With this type of lease, a business reports the full lease payment as an expense on the income statement each period. There are no depreciation or interest expenses with an operating lease, and a business does not report the equipment on the balance sheet. For example, if your small business obtains equipment with an operating lease that requires $1,000 monthly payments, you would report a $12,000 lease expense on your annual income statement.