Lease

Presented By

Muhammad ZeeshanBaloch

Muhammad Sabir Hussain

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.

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

supplier• The supplier delivers the equipment

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• If the option is purchase, the lessee pays the agreed

final sum and lessor transfers the ownership of the equipment to the lessee.

Types Of Lease

Operating lease

Capital lease

Leveraged lease

Sale and lease back

Direct 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.

Capital Lease

Cnt…

• In capital lease following items will be created:» Asset» Liability» Expense (Interest & Depreciation)

• Asset repairing responsibilities are transferred to lease.

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 unguaranteed residual value. Burke uses the straight-line method of depreciation for all of its plant assets. Burke’s incremental borrowing rate is 10%, and the Lessor’s implicit rate is unknown.

Instructions

(a) What type of lease is this? Explain.

(b) Compute the present value of the minimum lease payments.

(c) Prepare all journal entries for Burke through Jan. 1, 2008.

Example

E21-1 What type of lease is this? Explain.

Capitalization Criteria:

1. Transfer of ownership

2. Bargain purchase option

3. Lease term => 75% of economic life of leased property

4. Present value of minimum lease payments => 90% of FMV of property

NONO

Lease term

5 yrs.Economic life

6 yrs. YES

83.3%

FMV of leased property is unknown.

Capital Lease, #3

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

J ournal entry

1/ 1/ 07 Leased Machine Under Capital Lease 36,144 Leases liability 36,144

Leases liability 8,668 Cash 8,668

Operating Lease Capital LeaseJournal Entry: Rent expense xxx Cash xxx

Journal Entry: Leased equipment 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).

The Leasing EnvironmentThe Leasing Environment

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.

TransferOf Ownership

Bargain Purchase

Lease Term>= 75%

PV of Payments>= 90%

Operat Ing

Lease

No No No

No

Yes

Capital Lease

Lease Agreement

Yes Yes Yes

Leases that DO NOT meet any of the four criteria are accounted for as Operating Leases.

1. 100% Financing at Fixed Rates.

2. Protection Against Obsolescence.

3. Flexibility.

4. Less Costly Financing.

5. Tax Advantages.

6. Off-Balance-Sheet Financing.

Advantages of Leasing