Chapter 5 - Lease Accounting

Question 1

who is lessor and lessee?

Answer 1

lessor owns the property. lessee use the item in exchange for periodic cash payments called rent

Question 2

what is advantages of leases?

Answer 2

1. conserves working capital because it requires little or no cash deposit
2. often involves less red tape than buying
3. allows more frequent equipment changes
4. allows the lessee to receive tax benefits
5. less negative impact on financial ratios
6. allow operation to obtain resources without following a capital budget

Question 3

what is disadvantages of leases?

Answer 3

1. any residual value of the leased property benefits the lessor unless the lessee has the opportunity to acquire the leased property at the end
2. cost of leasing in some cases is higher than purchasing
3. disposal of a financial lease before the end of the lease period often results in additional costs

Question 4

what are the two types of leases?

Answer 4

operating leases and capital leases

Question 5

what are the 4 criteria to meet for capital leases?

Answer 5

1. title transfer provision - the property is transferred to the lessee by the end of the lease term
2. bargain purchase provision - lease contains a bargain purchase option
3. economic life provision - the lease term is equal to 75% or more of the estimated economic life of the leased property
4. value recovery provision - the present value of minimum lease payments equals or exceeds 90 % of the excess of fair market value of the leased property over any investment tax credit retained by the lessor

Question 6

what is sale and leasebacks?

Answer 6

transactions whereby an owner of real estate agrees to sell the real estate to an investor and then lease it back. The major reason for sales and leaseback transactions is to raise capital that was preciously tied up in the property.