lec16 - Accounting for Leases 15.511 Corporate Accounting...

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1 Accounting for Leases 15.511 Corporate Accounting Summer 2004 Professor SP Kothari Sloan School of Management Massachusetts Institute of Technology July 6, 2004
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Agenda ± Understand the rationale for leasing and the distinction between operating and capital leases. ± Understand the Income Statement and Balance Sheet differences between operating and capital leases from the lessee’s perspective. 2
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_____________________________________________________ The Nature of Leases A lease is an agreement conveying the right to use property, plant, or equipment, usually for a stated period of time, in exchange for periodic cash payments. The owner of the property is referred to as the lessor, and the renter is the lessee. Lease Rent Purchase ± What is the economic rationale for leasing rather than purchasing an asset? ± What is the economic rationale for capitalizing a lease? ± What are the accounting criteria for capitalizing a lease? ± How objectively can each lease criterion be applied? What judgment enters into each assessment? 3
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Economic Rationale for Leases ± Operational advantages to the lessee: ² Leasing ready-to-use equipment can be more attractive if the asset requires lengthy preparation and set-up. ² Leasing avoids having to own the asset that will be required only seasonally, temporarily or sporadically (leasing contract can be tailored). ± Lessor might be better positioned to lease the equipment again. ² Leasing for short periods protects against obsolescence. ± But lease payments are accordingly higher. 4
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Economic Rationale for Leases ± Financial advantages to the lessee: ² Lease payments can be tailored to suit the lessee’s cash flows (up to 100% financing, instead of the 80% limit by banks). ² Properly structured leases may be “off-balance sheet”, avoiding debt-covenant restrictions. ² Leasing can be tax advantageous when the lessee is unable to take the depreciation tax advantage of owning. 5
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Disadvantages to Leasing ± Disadvantages to the lessee: ² Leased ready-to-use equipment may be of lower quality than custom built (resulting in lower quality products and lower sales) ± High quality equip. might be unavailable for leasing ²
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lec16 - Accounting for Leases 15.511 Corporate Accounting...

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