Ch 21 Ques & BE

Ch 21 Ques & BE - CHAPTER 21 Accounting for Leases...

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CHAPTER 21 Accounting for Leases ANSWERS TO QUESTIONS ** 1. The major lessor groups in the United States are banks, captives, and independents. Captives have the point of sale advantage in finding leasing customers; that is, as soon as a parent receives a possible order, a lease financing arrangement can be developed by its leasing subsidiary. Furthermore, the captive (lessor) has the product knowledge which gives it an advantage when financing the parents’ product. The current trend is for captives to focus on the company’s products rather than to do general lease financings. ** 2. (a) Possible advantages of leasing: (1) Leasing permits the write-off of the full cost of the assets (including any land and residual value), thus providing a possible tax advantage. (2) Leasing may be more flexible in that the lease agreement may contain less restrictive provisions than the bond indenture. (3) Leasing permits 100% financing of assets. (4) Leasing may permit more rapid changes in equipment, reduce the risk of obsolescence, and pass the risk in residual value to the lessor or a third party. (5) Leasing may have favorable tax advantages. (6) Potential of off-balance sheet financing with certain types of leases. Assuming that funds are readily available through debt financing, there may not be great advantages (in addition to the above-mentioned) to signing a noncancelable, long-term lease. One of the usual advantages of leasing is its availability when other debt financing is unavailable. (b) Possible disadvantages of leasing: (1) In an ever-increasing inflationary economy, retaining title to assets may be desirable as a hedge against inflation. (2) Interest rates for leasing often are higher and a profit factor may be included in addition. (3) In some cases, owning the asset provides unique tax advantages, such as when bonus depreciation is permitted. (c) Since a long-term noncancelable lease which is used as a financing device generally results in the capitalization of the leased assets and recognition of the lease commitment in the balance sheet, the comparative effect is not very different from purchase and ownership. Assets leased under such terms would be capitalized at the present value of the future lease payments; this value is probably somewhat equivalent to the purchase price of the assets. Bonds sold at par would be nearly equivalent to the present value of the future lease payments; in neither case would interest be capitalized. The amounts presented in the balance sheet would be quite comparable as would the general classifications; the specific labels (leased assets and lease obligation) would be different. ** 3. Lessees have available two lease accounting methods: (a) the operating method and (b) the capital-lease method. Under the operating method, the leased asset remains the property of the lessor with the payment of a lease rental recognized as rental expense. Generally the lessor pays the insurance, taxes, and maintenance costs related to the leased asset. Under the capital lease
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Ch 21 Ques & BE - CHAPTER 21 Accounting for Leases...

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