Final Paper on Lease
Prof. Dan Yeomans
April 20, 2015
Lease is a rental agreement that extends for a year or more and involves a series of fixed payments. A lease agreement gives guarantees to the lessee (the renter) use of an asset and guarantees the lessor (the property owner) regular payments from the lessee for a specified number of months or years. Both the lessee and the lessor must uphold the terms of the contract for the lease to remain valid. (Lease Definition, 2003) Importance and Advantages of lease
The leasing process is faster, simpler, and often less costly than getting a loan for buying all these fixed assets. The lease helps to set expectations for the lessee and helps to keep understanding between lessee and lessor during the rental term. Monthly rent payment for lease finance will be operating expenses. It will allow deducting total income. Therefore, many companies try to get tax benefits in lease financing. Cancellation options are valuable.
One of the important points is that leasing is more convenient way of finance. You can fix your need of asset. (Importance of Lease Finance, 2011) Disadvantages of lease
Even though lessee is not the owner, lessee is responsible for repair and maintaining the asset as specified by the agreement The main disadvantage of leasing is that you never own the asset
Types of leases
There is list of leases. However, I would like to explain about finance lease and operating lease. Financial Lease: In a financial lease, the lessor transfers substantially all the risks and rewards related to the asset to the lessee. Generally, the ownership is transferred to the lessee at the end of the agreement. It is necessary to show the leased asset on the balance sheet as a capital item, or an item that has bought by the company. In finance lease, the lessor is only a financier. For example, a finance lease of big industrial equipment. Operating lease: In an operating lease, risk and rewards related to the assets are not transferred completely to the lessee. It is short-term lease. The lessor is dependent on many lessees for recovering his cost of the asset. In an operating lease, the lessor is not only a financier; he/she (lessor) has to provide additional services to the lessee in the period of using the asset. You do not have to show the asset on your balance sheet. For example, a lab equipment leased on rent with the scientist. Accounting for Leases
“The effects of leasing an asset on accounting statements will depend on how the lease is categorized by the Internal Revenue Service and by generally accepted accounting standards. Some of the issues the IRS considers in deciding whether lease payments are tax deductible or not include the following: Are the lease payments on the asset spread out over the lifetime of the asset? Can the lessee continue to use the asset after the life of the lease at preferential rates? Can the lessee buy the asset at the end of the life of the lease at a price well below market?” (Damodaran, A. (n.d.)) Effects of leasing on Financial Statements and Ratios
To have a concrete example for considering the impacts to the financial statements and ratios. Suppose that Ekon Infrastructure (the lessee) leases a machine with a fair market value of $100,000. They lease it for five years (after which they expect that the residual value will be $10,000), with annual (end-of-the-year) lease payments of $23,341; the interest rate in the lease is 8%. For an operating lease, the rent expense each year is the same as the (pretax) cash flow each year: Operating lease
For a finance lease, the expenses (interest plus depreciation) each year do not equal the (pretax) cash flows each year. However, the total expense over the...
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