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Unformatted text preview: 21-121ACCOUNTING FOR LEASES CHAPTER OBJECTIVESAfter careful study of this chapter, students will be able to: 1. Explain the advantages of leasing. 2. Understand key terms related to leasing. 3. Explain how to classify leases. 4. Account for a lessee's operating and capital leases. 5. Understand disclosures by the lessee. 6. Account for a lessor's operating, direct financing, and sales-type leases. 7. Understand disclosures by the lessor. 8. Explain the conceptual issues regarding leases. 9. Understand lease issues related to real estate, sale-leaseback issues, leveraged leases, and changes in lease provisions (Appendix). 21-2SYNOPSISAdvantages of Leasing1. GAAP defines a leaseas an agreement conveying the right to use property, plant, or equipment (land or depreciable assets or both) usually for a stated period of time." A lesseeacquires the right to use the property, plant, or equipment. A lessorgives up that right. Other key terms about leases are listed in Exhibit 21-1 in the text. 2. Although leases are generally more expensive in the long run than purchases, the advantages of leases from the lessee's point of view include: (1) Financing benefits: An asset may be acquired with 100% financing, conserving cash for the lessee. A lease contract may be more flexible than other debt arrangements, and a lease creates a claim only against the leased equipment, rather than against all assets. (2) Risk benefit: The risks of obsolescence, so that the risk is borne by the lessor. (3) Tax benefit: Tax deductions, taken over the life of the lease, may be accelerated, and the full cost of the asset, including land, may be written off. (4) Financial reporting benefit: Some key financial ratios are improved when a leased asset is not recorded as an asset and a liability by the lessee. (5) Billing benefit: The interest element in lease payments may be charged to customers under some contracts, while debt interest may not. 3. The main advantages of leases from the lessor's point of view are that leasing provides (a) a way of indirectly making a sale; and (b) another means of obtaining a profit opportunity through the transfer of an asset by the lessor under the lease agreement. Classification of Leases 4. GAAP, based on the concept of economic substanceover legal form, concluded that a lease which transfers substantially all the risks and benefitsof ownership represents in substance a purchase by the lessee and a sale by the lessor of an asset. Exhibit 21-2 in the text summarizes the criteria for the classification of leases by both the lessee and the lessor. 5. A lesseemay have two types of lease: (a) capital lease, accounted for by the capital lease method; and (b) operating lease, accounted for by the operating method....
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- Spring '11