Chapter 21 Class Notes

Chapter 21 Class Notes - Chapter 21 ACCOUNTING FOR LEASES A...

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Chapter 21 ACCOUNTING FOR LEASES A lease is a contractual agreement between a lessor and a lessee that gives the lessee the right to use specific property owned by the lessor for a specified period of time. The largest group of leased equipment involves: * Information technology * Transportation (trucks, aircraft, rail) * Construction * Agricultural There are three general categories of lessors who own the property: Banks – Banks have low-cost funds, which give them the advantage of being able to purchase assets at less cost than their competitors Captive leasing companies – These are subsidiaries whose primary business is to perform leasing operations for the parent company, e.g., IBM Global Financing, Chrysler Financial, Caterpillar Financial Services, GMAC. Independents – These companies focus on developing innovative contracts for lessees and often act as captive finance companies for companies that do not have a leasing subsidiary. Advantages of leasing: 1. 100% Financing at Fixed Rates 2. Protection Against Obsolescence 3. Flexibility 4. Less Costly Financing 5. Tax Advantages 6. Off-Balance-Sheet Financing Accounting for Leases by the Lessee From the lessee’s standpoint, all leases are either a ‘ capital lease ’ or an ‘ operating lease .’ The issue of how to account for leases is a case of ‘substance over form.’ The FASB has determined that lesses should capitalize leases that transfer substantially all of the benefits and risks of property ownership ( capital leases ), provided the lease is noncancelable . Noncancelable means that the lessee can cancel the lease contract only upon the outcome of some remote contingency or that the cancellation provisions and penalties of the contract are so costly that cancellation probably will not occur . Leases 1
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that do not transfer substantially all the benefits and risks of ownership are operating leases . To determine if a lease is a capital lease, the FASB developed four criteria which are used to distinguish between a capital lease and an operating lease. To qualify as a capital lease, only one of the following four criteria must be met: Does the lease transfer ownership of the leased asset to the lessee? Does the lease contain a
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Chapter 21 Class Notes - Chapter 21 ACCOUNTING FOR LEASES A...

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