Chapter 21 - Chapter 21: Accounting for Leases Lease a...

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Chapter 21: Accounting for Leases Lease – a contractual agreement between a lessor and a lessee which gives the lessee the right to use specific property, owned by the lessor, for a specified period of time In return for the use of the property, lessee makes rental payments over the lease term to lessor Three types of lessors: o Banks – largest players in the leasing business; have low-cost funds which give them the advantage of being able to purchase assets at less cost than their competitors o Captive Leasing Companies – subsidiaries whose primary business is to perform leasing operations for the parent company; facilitate sale of products to consumers which gives them the point-of-sale advantage in finding leasing customers o Independents – have lost market share as banks and captive leasing companies have become more aggressive in the lease-financing area but are good at developing innovative contracts for lessees Advantages of Leasing: o 100% Financing at Fixed Rates Leases are often signed without requiring any money down from the lessee which helps the lessee conserve scarce cash (especially desirable for new and developing companies) In addition, lease payments often remain fixed, which protects the lessee against inflation and increases the cost of money o Protection Against Obsolescence Leasing equipment reduces the risk of obsolescence to the lessee and in many cases passes the risk of residual value to the lessor Example: computers o Flexibility Lease agreements may contain less restrictive provisions than other debt agreements The duration of the lease – the lease term – may be anything from a short period of time to the entire expected economic life of the asset In most cases, the rent is set to enable the lessor to recover the cost of the asset plus a fair return over the life of the lease o Less Costly Financing o Tax Advantages o Off-Balance Sheet Financing Certain leases do not add debt on a balance sheet or affect financial ratios Capitalize a lease that transfers substantially all of the benefits and risks of property ownership , provided the lease is noncancelable
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o Noncancelable = a company can cancel a lease contract only upon the outcome of some remote contingency or the cancellation provisions and penalties of the contract are so costly that cancellation probably will not occur o Operating leases – do not transfer substantially all the benefits and risks of ownership Do not record asset or liability on balance sheet o Journal Entry for Capital Lease: Dr. Leased Equipment XXX Cr. Lease Liability XXX o Journal Entry for Operating Lease: Dr. Rent Expense XXX Cr. Cash XXX Accounting by the Lessee If the lessee capitalizes a lease, the lessee records an asset and a liability generally equal to the present value of the rental payments Having capitalized the asset, the company records depreciation on the leased asset Treats the lease payments as consisting of interest and principal
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Chapter 21 - Chapter 21: Accounting for Leases Lease a...

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