Purchase Option Definition
Purchase option, defined as the opportunity to purchase a piece of property which is being leased after the lease is completed, is part of the many options available in a lease agreement. A purchase option is often agreed upon by the two parties involved before the contract is made.
Purchase Option Explanation
Purchase option, explained by many business owners as an option to “try it before you buy it”, is available on almost any leased asset. The value of a lease purchase option agreement is evident. A party wants to lease a piece of equipment because they can not afford to buy it. However, to keep their options open they decide on a purchase option lease. This benefits the lessor by allowing her to choose, at the final moment, whether the item has created value and is worth keeping. Additionally, the lessor can account for changes in needs, expectations, or operations by leaving their options open and opting for a purchase option.
For the lessee, it allows them to make the income from leasing the item while also making the income from selling the item. In this way, a purchase option provides a benefit to both parties. It also allows access to and income from the asset almost instantaneously. A purchase option fee may be accrued while choosing to engage in such a contract.
Purchase Option Example
Asal is renting a piece of equipment for her graphic printing firm. Asal, because of her vast equipment needs, has to watch to make sure she has the cash flow necessary to operate her business based on the current needs it has. She currently can not afford to buy this piece of equipment. Still, she sees the value in having it available in her office. Asal balances these two needs by agreeing on a purchase option with the lessor.
Asal is creating a short-term agreement to lease the piece of equipment, a commercial quality printer. She will keep this printer in her office for one year, at which point she will buy the item. Asal and her lessor agree on a fair market value for the printer. So Asal completes the purchase option agreement and begins use of the item.
One year later, Asal is seeing a lot of growth in her business. So much growth, in fact, that she is going to outsource the printing for her customers to a better equipped company. She trusts this vendor and knows the quality of the products they produce, so she trusts the company.
This change of pace negates her need to purchase the printer she was leasing. Asal is nearing the end of her lease agreement, so she informs the lessor that she will not be accepting the purchase option at end of lease. She has more important expenditures to make at this point.