Strategic Financial Management · Leasing Decisions

Equated Annual Charge, Break-even Lease Rental and Cross-border Leasing

Updated 11 October 2026 · Fact-checked

Equated annual charge (EAC) converts the present value of an option's costs into a yearly figure by dividing by the annuity factor, so options with different lives can be compared. Break-even lease rental is the rental at which leasing and buying cost the same in present value. Solve it by discounting after-tax cash flows.

Understand Equated Annual Charge, Break-even Lease Rental and Cross-border Leasing

When you compare lease and buy, the usual tool is the present value of net cash outflows. That works well when both options cover the same period. It fails when two assets have different lives, because the longer-lived asset has more years of cost. The equated annual charge fixes this by turning each option's total present-value cost into an equal yearly cost. The option with the lower EAC is cheaper.

The break-even lease rental turns the question around. Instead of asking which option is cheaper at a given rental, you ask what rental makes you indifferent. You find the present value of the net cost of buying, then solve for the rental whose after-tax present value equals it. If the lessor offers a rental below this figure, leasing is better for the lessee. If the offer is above it, buying is better.

Cross-border leasing means the lessor and the lessee are in different countries. Reasons for it include cheaper funding in the lessor's country, tax benefits that differ between countries, and access to equipment that is not easily available locally. The extra risks are exchange rate movement, withholding tax on rentals, and legal and regulatory differences. In an exam, expect meaning, benefits and risks, not heavy computation.

Under Ind AS 116, a lessee uses a single model. At the start of the lease it recognises a right-of-use asset and a lease liability. The liability is the present value of the lease payments not yet paid, discounted at the rate implicit in the lease. If that rate cannot be readily determined, the lessee uses its incremental borrowing rate. Afterwards the lessee charges depreciation on the asset and interest on the liability. There are optional exemptions for short-term leases (12 months or less) and leases of low-value assets. For these, the lessee can simply expense the payments.

This is a different question from the lessee's lease-or-buy decision. Ind AS 116 is about how the lease is reported. EAC and break-even rental are about which option to choose.

Key rules to remember

Equated annual charge: EAC = PV of net cash outflows ÷ PVAF(r, n); Use the after-tax discount rate and the asset's own life n. Choose the option with the lower EAC when the options are costs only.
Break-even lease rental (annual, in arrears): L × (1 − t) × PVAF(r, n) = PV of net cost of buying; Solve for L. Use this form when rentals are fully tax-deductible and paid at year end. Adjust the timing if rentals are paid in advance.
Net cost of buying: Cost of asset − PV of depreciation tax shield − PV of after-tax salvage value + PV of after-tax costs borne only under purchase; Include running costs only if they differ between lease and buy.
Lease liability (Ind AS 116): Lease liability = Σ [Lease payment ÷ (1 + r)^t]; r is the rate implicit in the lease, or the incremental borrowing rate if that cannot be readily determined.
Lessee's subsequent charges: Interest = Opening lease liability × r; Depreciation = Right-of-use asset ÷ shorter of lease term and useful life; Depreciation applies to the right-of-use asset. Where ownership transfers at the end, use the asset's useful life.

How to solve Equated Annual Charge, Break-even Lease Rental and Cross-border Leasing questions

Use this order for any lease-or-buy, EAC or break-even question.

1Read the data and note the tax rate, discount rate, asset life, lease term, rental timing and salvage value.
2Choose the discount rate. If the lessee's cash flows are after-tax, use the after-tax cost of debt unless the question says otherwise.
3List the cash flows of buying: cost at time 0, depreciation tax shield each year, and after-tax salvage.
4List the cash flows of leasing: after-tax rental each year, which is rental × (1 − t). Add any deposit or other cost the question mentions.
5Discount both sets of flows and find the net present cost of each option.
6For an EAC question, divide each present cost by the annuity factor for that option's own life. For a break-even question, set the lease PV equal to the buy PV and solve for rental.
7For Ind AS 116, discount the payments to get the liability. Then compute interest, depreciation and the closing liability for each year.
8Write a clear recommendation in one line with the figures that support it.

Quickest way: Annuity-factor shortcut for EAC and break-even rental

When to use it: Use it when rentals are level, paid at year end, and the question gives or lets you read an annuity factor.

Compute the net present cost of buying once.
For EAC, divide it by the annuity factor. Do the same for the other option.
For break-even rental, divide the net present cost of buying by [(1 − t) × annuity factor]. This gives rental directly.
Check the answer: at the break-even rental, the lease PV must match the buy PV.
Compare the offered rental with the break-even figure and state the decision.

Common mistakes in Equated Annual Charge, Break-even Lease Rental and Cross-border Leasing

Comparing the NPV of costs of assets with unequal lives without adjusting for life.
Students are used to picking the lowest present cost.
Fix: Convert each present cost to EAC using its own life. Then compare the yearly figures.
Dividing by the annuity factor for the wrong number of years.
The question gives one table, and students use the same year for both assets.
Fix: Use each asset's own life and the same discount rate. Write n beside each division.
Using the pre-tax rental when solving for break-even rental.
Students forget that rentals are tax-deductible for the lessee.
Fix: Always write L × (1 − t) when rentals are deductible. Solve for L at the end.
Leaving out the depreciation tax shield when buying.
The shield is not a cash payment, so it feels like it does not belong.
Fix: Tax depreciation reduces tax paid, so include tax rate × depreciation as an inflow in the buy option.
Classifying a lease as operating or finance for the lessee under Ind AS 116.
Older Indian standards had that split for lessees, and the habit stays.
Fix: Under Ind AS 116 the lessee uses one model. It recognises a right-of-use asset and a lease liability, unless the short-term or low-value exemption is used.
Calculating interest on the lease liability using the rental, not the opening liability.
Students mix up the payment with the balance.
Fix: Interest = opening liability × rate. Then closing liability = opening + interest − payment.

Worked examples

Example 1

A firm must pick one machine. Machine X costs ₹5,00,000, lasts 4 years and has annual running cost of ₹1,00,000. Machine Y costs ₹7,00,000, lasts 6 years and has annual running cost of ₹80,000. Ignore tax and salvage value. The discount rate is 10%. PVAF at 10% is 3.1699 for 4 years and 4.3553 for 6 years. Which machine should the firm choose?

Show the solution

The lives differ, so compare equated annual charges, not total present costs.
Machine X: the equivalent annual cost of the purchase price is ₹5,00,000 ÷ 3.1699 = ₹1,57,734 (rounded).
Add the yearly running cost: EAC of X = ₹1,57,734 + ₹1,00,000 = ₹2,57,734.
Machine Y: ₹7,00,000 ÷ 4.3553 = ₹1,60,724 (rounded).
Add the yearly running cost: EAC of Y = ₹1,60,724 + ₹80,000 = ₹2,40,724.
Y has the lower EAC by about ₹17,010 a year.

Answer: Choose Machine Y. Its EAC is about ₹2,40,724, against about ₹2,57,734 for Machine X.

Example 2

A company can buy an asset for ₹10,00,000. It has a 4-year life and no salvage value. Tax depreciation is straight-line at ₹2,50,000 a year. The tax rate is 25% and the after-tax discount rate is 10%. A lessor offers it on lease with rentals paid at the end of each year. Find the break-even annual lease rental. Use PVAF(10%, 4) = 3.1699.

Show the solution

Annual tax shield on depreciation = 25% × ₹2,50,000 = ₹62,500.
PV of the tax shield = ₹62,500 × 3.1699 = ₹1,98,119 (rounded).
Net present cost of buying = ₹10,00,000 − ₹1,98,119 = ₹8,01,881.
After-tax rental = L × (1 − 0.25) = 0.75 L. Its PV = 0.75 L × 3.1699 = 2.3774 L (rounded to 4 places).
Set the two equal: 2.3774 L = ₹8,01,881.
L = ₹8,01,881 ÷ 2.3774 = about ₹3,37,290.
Check: 0.75 × ₹3,37,290 = ₹2,52,968. Multiply by 3.1699 gives about ₹8,01,900, which matches the buy cost within rounding.

Answer: The break-even rental is about ₹3,37,290 a year. A rental below this makes leasing cheaper for the company. A rental above it makes buying cheaper.

Exam tips

Show the buy and lease cash flows in a short table in your answer. It is easy to follow and earns method marks even if the arithmetic slips.
When the question gives two assets with different lives, say 'EAC is used because lives are unequal'. Examiners look for that reason.
State the discount rate you use and why. After-tax cost of debt is the usual choice for lease-versus-buy.
For Ind AS 116 questions, write the liability first, then the right-of-use asset, then the year-wise interest and depreciation.
For cross-border leasing theory, answer in three parts: meaning, benefits and risks. Link each benefit or risk to a business reason.

Practice questions from Leasing Decisions

Equated Annual Charge, Break-even Lease Rental and Cross-border Leasing in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Equated Annual Charge, Break-even Lease Rental and Cross-border Leasing: frequently asked questions

What is equated annual charge in lease versus buy?

It is the present value of an option's net costs divided by the annuity factor for its life. It gives an equal yearly cost. You use it to compare options with different lives.

How do I find the break-even lease rental?

Find the present value of the net cost of buying. Set it equal to the present value of after-tax rentals and solve for the rental. With level year-end rentals, it is the net buy cost divided by (1 − t) × annuity factor.

Is lessee accounting under Ind AS 116 still split into finance and operating leases?

No. A lessee generally recognises a right-of-use asset and a lease liability for every lease. The exemptions are for short-term leases of 12 months or less and leases of low-value assets, where the payments may be expensed.

What is cross-border leasing and why is it used?

It is a lease where the lessor and the lessee are in different countries. It is used for cheaper finance, tax differences between the countries and access to equipment. The risks include exchange rate changes, withholding tax and legal differences.