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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: Leasing ready-to-use equipment can be more attractive if the asset requires lengthy preparation and set-up. 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. 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: Lease payments can be tailored to suit the lessee’s cash flows (up to 100% financing, instead of the 80% limit by banks). Properly structured leases may be “off-balance sheet”, avoiding debt-covenant restrictions. 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: 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 Seasonal leasing may affect equipment availability and pricing.
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