A lease is a contractual agreement between a lessor and lessee that allows the lessee to use specific property owned by the lessor for a specified period of time. There are several types of leases including operating leases, capital leases, leveraged leases, sale and leaseback, and direct leases. Capital leases meet certain criteria that require the lessee to record the leased asset and related liability on their balance sheet.

2. Muhammad
Muhammad
Zeeshan
Sabir Hussain
Baloch

3. Lease
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.

4. 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

5. 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

6. Types Of Lease
Sale and
Operating Capital Leveraged Direct
lease
lease lease lease lease
back

7. Capital Lease
One 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.

8. Cnt…
• In capital lease following items will be created:
» Asset
» Liability
» Expense (Interest & Depreciation)
• Asset repairing responsibilities are transferred
to lease.

9. Example
E21-1 (Capital Lease with Unguaranteed
Residual Value) On January 1, 2007, Burke
Corporation signed a 5-year non-cancelable
lease for a machine. The terms of the lease
called for Burke to make annual payments of
$8,668 at the beginning of each year, starting
January 1, 2007. The machine has an
estimated useful life of 6 years and a $5,000
Instructions
unguaranteed residual value. Burke uses the
(a) What type of lease is this? Explain. all of
straight-line method of depreciation for
(b)plant assets. Burke’s incremental borrowing
its Compute the present value of the minimum
lease payments. the Lessor’s implicit rate is
rate is 10%, and

10. 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

11. 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 $36,144
Journal entry
1/1/07 Leased Machine Under Capital Lease 36,144
Leases liability 36,144
Leases liability 8,668
Cash 8,668

12. The Leasing Environment
Operating Lease Capital Lease
Journal Entry: Journal Entry:
Rent expense xxx Leased equipment xxx
Cash xxx Lease obligation xxx
A lease that transfers substantially all of the benefits and risks of property
ownership should be capitalized (only non-cancellable leases may be
capitalized).

13. 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.

14. 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 t
Transfer Bargain Lease Term
PV of I
Of Ownership Purchase >= 75%
Payments No n
>= 90%
g
L
Yes Yes Yes Yes e
a
s
Capital Lease e

15. 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.