Accounting 312- ch 17 - Accounting 312 Chapter 17...

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Accounting 312 Chapter 17- Accounting for Leases I. The Leasing Environment A. Who are the Players? 1. a lease is a contractual agreement between a lessor and a lessee 2. the arrangement gives the lessee the right to use specific property, owned by the lessor, for a specified period of time 3. in return for the property, the lessee makes rental payments over the lease term to the lessor 4. who are the lessors that own the prop a. banks i. largest players, have low cost funds which give them the advantage of being able to purchase assets at less cost than competitors, don’t have to be innovative in structuring lease arrangements b. captive leasing companies i. subsidiaries whose primary business is to perform leasing operations for the parent company ii. have the point of sale advantage in finding leasing customers iii. has product knowledge that gives it an advantage when financing the parents’ product c. independents i. market share dropped fairly dramatically as banks and captive leasing companies become more aggressive ii. do not have point of sale access or a low cost of funds iii. develop innovative contracts for lessees and act as captive finance co’s for some companies that do not have a leasing subsidiary B. Advantages of Leasing 1. 100% Financing at Fixed Rates a. no money down from the lessee b. lease pymts remain fixed 2. Protection against Obsolescence a. reduces risk of obsolescence and passes the risk of residual value to the lessor 3. Flexibility a. less restrictive provisions than other debt agreements b. duration of the lease (lease term) may by anything from a short period to the entire expected econ life of an asset, pymt may vary, etc 4. Less Costly Financing a. use tax benefits 5. Tax Advantages a. co do not report an asset or a liab in the lease agreement and for tax purposes co can capitalize and depreciate the leased asset so a co takes deduction earlier rather than later and it reduces taxes 1
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6. Off Balance Sheet Financing a. add to borrowing capacity C. various views on capitalization of leases 1. do not capitalize any leased assets a. views lease as an “executory” contract requiring continuing performance from both parties 2. capitalize leases that are similar to installment purchases a. this view holds that companies should report transactions in accordance with their econ substance 3. capitalize all long term leases 4. capitalize firm leases where the penalty for nonperformance is substantial a. capitalize only non-cancelable contractual rights and obligations- unlikely to avoid performance under the lease without a severe penalty *FASB agrees with the capitalization approach when the lease is similar to an installment purchase: capitalize a lease that transfers substantially all of the benefits and risks of property ownership, provided the lease is non-cancelable (meaning the co can cancel the lease contract only upon the outcome of some remote contingency or the cancellation provisions and penalties of the contract are
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Accounting 312- ch 17 - Accounting 312 Chapter 17...

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