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Chap15 - CHAPTER 15 QUESTIONS 1 The principal advantages to...

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673 CHAPTER 15 QUESTIONS 1. The principal advantages to a lessee in leasing rather than purchasing property are as follows: (a) Frequently, no down payment is re- quired to attain access to property when it is leased. This frees company capital to be used for purposes such as expanding production, reducing long- term debt, or providing for future pen- sion benefits. (b) A lease avoids the risks of ownership when a company has many uncertain- ties as to the length of benefit from various assets. If a company purchases assets, any obsolescence or reduction in usefulness of the asset would result in a loss. A lease leaves these risks of ownership with the lessor rather than shifting them to the lessee. (c) Leases give the lessee flexibility to get a different asset if market conditions or technological changes require it. 2. The principal advantages to a lessor in leasing property rather than selling it are as follows: (a) Lease contracts provide another alter- native to those businesses needing property for customers to acquire their services. This can increase the volume of sales and thus improve the operating position of the manufacturer. (b) Because a lease arrangement results in an ongoing business relationship, there may be other business dealings that could develop between the lessee and lessor. (c) The lease arrangement may be negoti- ated so that any residual value remains with the lessor. Although expected re- sidual values are usually considered in arriving at the financial terms of a lease, these estimates usually are con- servative. Thus, lessors may benefit from a higher residual value at the end of the lease term than expected when the lease was negotiated. 3. A capital lease is accounted for as if the lease agreement transfers ownership of the asset from the lessor to the lessee. Capital leases are generally long term, covering most of the economic life of the leased as- set, and the lease payments are large enough that they effectively pay for the as- set by the end of the lease term. An operat- ing lease , on the other hand, is accounted for as rental agreement, with no transfer of effective ownership associated with the lease. 4. Leases frequently give the lessee the op- tion to purchase the leased asset at some future date. If the price specified in the pur- chase option is so low that it is almost cer- tain that the lessee will end up buying the leased asset, the option is called a bargain purchase option . Because leases with bar- gain purchase options are likely to lead to transfer of ownership from the lessor to the lessee, they are accounted for as capital leases. 5. The lease term begins when leased prop- erty is transferred to the lessee and ex- tends to the end of the period for which the lessee is expected to use the property, in- cluding any periods covered by bargain re- newal options. If a bargain purchase option is included in the lease agreement, the term ends on the date this option is avail- able.
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