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LeaseA lease is a contractual agreementbetween a lessor and a lessee, that givesthe lessee the right to use specificproperty, owned by the lessor, for aspecified period of time.
Steps in leasing process• The entrepreneur choose the equipment and equipment supplier• The supplier provides a quotation• The lessee submits an application to the lessor• The lessor evaluates the application• The lessor and lessee sign a lease contract• The lessee pays the advance lease payment• The lessor orders the equipment from the
Cont…• The lessor registers and insures the equipment• The supplier provides after sale services as per contract• The lessee maintains the equipment(routine maintenance).• The lessor monitors the lease operation• The lessee pays installments as per contract• At the end of the lease period, the lessee either returns the equipment or exercises the option of purchase
Types Of Lease Sale andOperating Capital Leveraged Direct lease lease lease lease lease back
Capital LeaseOne or more of four criteria must be met: 1. Transfers ownership to the lessee. 2. Contains a bargain purchase option. 3. Lease term is equal to or greater than 75 percent of the estimated economic life of the leased property. 4. The present value of the minimum lease payments equals or exceeds 90 percent of the fair value of the leased property.
Cnt…• In capital lease following items will be created: » Asset » Liability » Expense (Interest & Depreciation)• Asset repairing responsibilities are transferred to lease.
ExampleE21-1 (Capital Lease with UnguaranteedResidual Value) On January 1, 2007, BurkeCorporation signed a 5-year non-cancelablelease for a machine. The terms of the leasecalled for Burke to make annual payments of$8,668 at the beginning of each year, startingJanuary 1, 2007. The machine has anestimated useful life of 6 years and a $5,000Instructionsunguaranteed residual value. Burke uses the(a) What type of lease is this? Explain. all ofstraight-line method of depreciation for(b)plant assets. Burke’s incremental borrowingits Compute the present value of the minimumlease payments. the Lessor’s implicit rate israte is 10%, and
E21-1 What type of lease is this? Explain. Capitalization Criteria: Capital Lease, #3 1. Transfer of ownership NO 2. Bargain purchase option NO 3. Lease term => 75% of Lease term 5 yrs. economic life of leased Economic life 6 yrs. property YES 83.3% 4. Present value of minimum FMV of leased property is lease payments => 90% of unknown. FMV of property
E21-1 Compute present value of the minimum lease payments Payment $ 8,668 Present value factor (i=10%,n=5) 4.16986 PV of minimum lease payments $36,144Journal entry1/1/07 Leased Machine Under Capital Lease 36,144 Leases liability 36,144 Leases liability 8,668 Cash 8,668
The Leasing EnvironmentOperating Lease Capital LeaseJournal Entry: Journal Entry: Rent expense xxx Leased equipment xxx Cash xxx Lease obligation xxxA lease that transfers substantially all of the benefits and risks of propertyownership should be capitalized (only non-cancellable leases may becapitalized).
Operating Lease• Operating lease do not transfer the asset at the end of the term.• Operating lease is written in income statement as an operating expense.• Lessor is responsible for repairing of the object of lease.
Lease Agreement Leases that DO NOT meet any O of the four criteria are p accounted for as Operating e Leases. r a No No No tTransfer Bargain Lease Term PV of IOf Ownership Purchase >= 75% Payments No n >= 90% g L Yes Yes Yes Yes e a s Capital Lease e
Advantages of Leasing1. 100% Financing at Fixed Rates.2. Protection Against Obsolescence.3. Flexibility.4. Less Costly Financing.5. Tax Advantages.6. Off-Balance-Sheet Financing.