Acct. 301B Final-Ch.21

• A contractual agreement between a lessor and a lessee
• lessee makes rental payments and has the right to use specific property for a specified amt of time, frm lessor

• 1) Banks
• 2) Captive leasing companies- subsidiaries...they perform the leasing operations for parent comp.
• 3) Independents- give innovative contracts for lessee

• 1) 100% financing at fixed rate- no $ down, don't deal with inflation costs.
• 2) Protection against obsolescence- trade in old equip for new.
• 3) Flexibility - % rate, payments (level or up and down)
• 4) Less Costly - both can take advantage of leasing tax benefits = less rental payments/$ back otherwise wouldn't be realized.
• 5) Tax Advantage -
• 6) Off-Balance-Sheet Financing -

can be short period of time to entire expected economic life of the asset

• Financial Report- do not report an asset/liability
• Tax Purposes- can capitalize n depreciate the leased asset
• = tax deductions early --> reduce taxes.

• Means to record the amt of an item in a balance sheet account as opposed to the income statement.
• Ex: Forklift truck should appear on the balance sheet as part of the company's equipment, and the amt of principal owed needs to be reported as a liability on the balance sheet.
• Balance Sheet- Equipment n liability (principle owed)

CERTAIN leases do not add to debt or affect financial ratios on Balance Sheet. It may add to borrowing capacity.

pg. 1118

• Capitalize when the lease is similar to an installment plan.
• Should capitalize a lease that transfers substantially all of the benefits and risks of property ownership, provided the lease is noncancelable.

cant cancel unless there is some remote contingency. or company wont cancel cuz provisions and penalties are too costly.

pg. 1120

• 1) Companies must identify the characteristics that indicate the transfer of substantially all of the benefits and risks of ownership
• 2) The same characteristics should apply consistently to the lessee and the lessor
• 3) Those leases that do NOT transfer substantially all the benefits and risks of ownership are operating leases. (Companies should NOT capitalize operating leases, they should account for them as rental payments and receipts.)

pg. 1120

Must be noncancelable & meet 1 or more of the 4 capitalization Criteria for lessee.

• 1) Lease transfers ownership of the property to the lessee
• 2) The lease contains a bargain-purchase option
• 3) The lease term is equal to 75% or more of the est. economic life of the leased property
• 4) The Present Value for the min lease payments (excluding executory costs) equals or exceeds 90% of the fair value of the leased property)

leases that do NOT transfer substantially all the benefits and risks of ownership

Operating Lease

Allows lessee to purchase the leased property for a price that is significantly lower than the property's expected fair value at the date the option becomes exercisable.


pg. 1121

Allows the lessee to renew the lease for a rental that is lower than the expected fair rental at the date the option becomes exercisable.

Cuz PV of min. lease payments is reasonably close to the mkt price --> basically it is effectively purchasing the asset.


pg. 1122

is the est. fair (mkt) value of the leased property at the end of the lease term

• - the certain or determinable amt lessee will pay lessor @ the end of the lease to purchase
• OR
• -Amt lessee or the 3rd party guarantees lessor will realize if the asset is returned

Leased assets that incur insurance, maintenance & tax expenses

• Captial- depreciate using the economic life of the asset
• Operating- depreciate it over the term of the lease

A series of equal amounts occurring at the beginning of each equal time interval.

Ownership-type costs, therefore it is not included in PV of min lease payments. Must exclude executory costs in computing costs (lessor) n making payments (lessee)

The depreciation method that results in the same equal amount of depreciation expense for each full year over the life of the asset.

Monthly payments - executory costs X PV of an annuity due @ rate %

• Expense & Liability
• Lessee assigns rent to the periods benefiting from the use of the asset and ignores, in the accounting , any commitments to make future payments

• B/S - Do not report equip / long term liab. for future rental payments
• I/S - Report Expense

• Same- Total charges to operations are the same over the lease term
• Dif - Capital charges are higher in earlier years n lower in later years.

• 1) increase amt of reported debt (debt to equity is high)
• 2) increase in the amt of total assets
• 3) Lower income at beg. of lease --> lower retained earnings

• less attractive to investors
• pr.1129

• 1) % Revenue
• 2) Tax Incentives- can lead to lower rental payments. Ex: boeing sold an airplane, wealthy investor bought only to use as a tax benefit, then sold to a foreign company at a cheaper price. (everyone wins!)
• 3) High residual Values- the return of the property at the end of the lease term can produce profits.

pg. 1130

An implicit interest rate is one that is not explicit; in other words, the rate is not stated. For example, if I lend you $5,000 and you agree to repay me $1,000 at the end of each year for six years you are obviously paying interest. However, our agreement did not specify any interest or interest rate. To find the interest rate that is “implicit” in this arrangement, you would do a present value calculation via a financial calculator, software, or present value tables.

• 1) Operating leases
• 2) Direct-financing Leases
• 3) Sales-type leases

pg. 1131

• 1) must meet 1 or more in Grp 1 (same as lessee list)
• 2) must meet both criteria in Grp 2

pg. 1131

• is the presence / absence of a manufacturer's or dealer's profit (loss)
• Profit (loss)- difference btwn the fair value of the leased property at the inception of the lease and the lessor's cost or carrying amt (book value)

pg. 1131

Operating

Operating Lease

pg. 1132

Operating Lease


pg. 1132

Sales-Type Lease


pg. 1132

Direct-financing Lease


pg. 1132

involves a profit (loss). it is the difference btwn the fair value at the time of lease inception & the lessor's cost (book value)

pg. 1131

the financing of an asset purchase by the lessee

pg. 1132

Lessor records a receivable while the lessee records a lease Asset. And a lease receivable is the PV of min lease payments.

• 1) Rental Payments (minus executory costs)
• 2) Bargain-purchase option (if any)
• 3) Guaranteed residual value (if any)
• 4) Penalty for failure to renew (if any)