Leases

Question 1

In which way is a financial lease a form of lending?

Answer 1

Had the lessee borrowed funds to purchase the asset itself, the effect would have been much the same.

Question 2

What is an operating lease?

Answer 2

An operating lease is a lease which does not fit the description of a financial lease. With an operational lease, the rewards and risks of ownership do not transfer to the lessee.

Question 3

Name four reasons for why financial leasing has become a popular form of financing.

Answer 3

1. Ease of borrowing. In contrast with a lendor, a lessor may not require some type of security or a profitable track record (using the leased asset itself as a security)
2. Leaning agreements may be offered at a better cost.
3. Leaning provides flexibility where there are for example rapid changes in technology.
4. Leasing allows cashflows to be smoothed out over the leasing period.

Question 4

At the beginning of a lease, the lessee should recognize both an asset and a liability. What should the value be?

Answer 4

Whichever is lower of…

…the fair value of the leased asset
…the present value of the minimal lease payments

Question 5

At the beginning of a lease, the lessee should recognize both an asset and a liability. Sometimes, these number vill differ. Why?

Answer 5

Because initial costs incurred in negotiating and securing the lease agreement should be added to the asset figure.

Question 6

Why are financial leases subject to the same depreciation policies as an owned asset?

Answer 6

Because as asset held through financial lease is always reported in the financial statements in the same way as if it were owned.

Question 7

Lease payments are made up of two components. Which are they?

Answer 7

1. A capital element

2. A finance charge (treated as an expense by the lessee)

Question 8

How is the total lease financial charge calculated?

Answer 8

SUM(total lease payments) - (fair value of the asset) = total finance charge

Question 9

How is the lease finance charge for a given year calculated?

Answer 9

Assign digits for each year of istalment in reverse order. For four years it would be 4 the first year, then 3, then 2…

(digit for the relevant year) / (sum of digits) = finance charge

Question 10

How is the lease “capital” figure for a given year calculated?

Answer 10

(lease finance charge for the year) - total lease payment = capital (or “balancing figure”)

Question 11

How is the lease liability allocated?

Answer 11

Current liabilities = capital (or “balancing figure” for the year)
Non-current liability = fair value of asset - capital paid cumulatively

Question 12

How are operating leases recorded in the financial statements?

Answer 12

No asset or liability will appear in the financial statement. Operating lease payments are simple recognized as expenses.