...Lease Financing Brigham and Daves Ch. 19 Christopher B. Alt CFA PhD Topics in Chapter Types of leases Tax treatment of leases Effects on financial statements Lessee’s analysis Lessor’s analysis Other issues in lease analysis 2 Who Are the Two Parties to a Lease Transaction? The lessee, who uses the asset and makes the lease, or rental, payments The lessor, who owns the asset and receives the rental payments Note that the lease decision is: a financing decision for the lessee, but an investment decision for the lessor 3 Primary Lease Types Operating lease – Short-term (asset is not fully amortized) and normally cancelable – Maintenance usually included Financial lease – Long-term (asset is fully amortized) and normally noncancelable – Maintenance usually not included – Lessee usually pays property taxes and insurance (hence, a “net, net” lease to the lessor) Sale and leaseback – Similar to financial lease, except equipment is used, not new, and lessor buys equipment from user-lessee, not manufacturer/distributor 4 Primary Lease Types Combination lease – Hybrid lease which contains some features of both operating and financial leases (e.g. financial lease with a cancelation clause) "Synthetic" lease – Used by firms (Enron,Tyco) to acquire LT assets but keep debt off balance sheet Firm SPE leases asset to firm for 3-5 year term records transaction Firm SPE Special Financial Purpose...
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... 2011 Subject: FASB Lease Practices and Client Recommendation I have researched and analyzed the different Financial Accounting Standards Board (FASB) practices related to lease options, which our trucking client may want to consider in his or her new business opportunity. Leases are a way in which companies can finance a business project. According to the official FASB website, a lessor may record a lease transaction as a sales type lease, a direct financing lease, or an operating lease. A sales type lease and a direct financing lease are different ways to record a capital lease (Standards, 1976). One lease option the trucking client has is to record the leases as direct financing leases. Direct financing leases are recorded when the carrying value of the lease is equal to the fair value of the leased property at inception (Standards, 1976). This lease arrangement is a sales and financing transaction. When a direct financing lease is recorded, only the interest received is recognized on the lessors books as income. The cash outflow is equal to the carrying value of the asset, and the cash inflow is equal to the lease payments (CFA, 2011). Another lease option the trucking client has is to record the leases as sales type leases. A sales type lease is similar to a direct financing lease, except upon inception of the lease; profit on a sale is recognized. The profit recorded at the beginning of the lease term is the present value of the lease payments, less the cost...
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...Capital Leases | Overview According to FASB ASC 840 (n.d.) (IAS 17), a capital lease exists if one of four conditions is met: the transfer of title of the asset to the lessee, the lease includes a bargain purchase option, the lease period is equal to or greater than 75% of the estimated economic life of the asset, or the present value of the minimum lease payments is 90% or more of the fair value of the asset less investment tax credit held by the lessor. Capital Leases | Requirements of the Lessee The lessee should report the asset and liability on the balance sheet or in footnotes at the present value of the minimum lease payments at the beginning of the lease unless the fair value of the leased asset at lease inception is lower (FASB ASC 840, n.d.). Disclosure requirements in the balance sheet or footnotes include the gross amount of assets recorded under capital leases, future minimum lease payments, and total of minimum sublease rentals (FASB ASC 840, n.d.). The income statement presentation must include the total contingent rentals (FASB ASC 840, n.d.). Capital Leases | Requirements of the Lessor Lease agreements, in general, require systematic payments from the lessee to the lessor. Depending on the recognition of the lessor’s income, historically in relation to lease agreements, the lessor had an option to either follow the accounting matching principle and pair lease payments with the applicable operating cost in any given period or chose...
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...Sable sells and leases equipment to its customers. * Sable entered into a contract with Buildit Co. leasing a bulldozer for construction. * The lease term is 10 years and the economic and useful life of the bulldozer is 15 years. * Annual lease payments due at the end of every year will be $16,000. * Buildit is responsible for maintenance, insurance, and tax payments arising from the lease. * The residual value of the bulldozer at the end of the lease term is estimated at $24,000, although no guarantee of the residual value. * Lease does not transfer ownership of the asset at the end of the lease. * The bulldozer cost Sable $100,000 to manufacture and sells for $135,000. * Sable has recently been selling the bulldozer for $125,000 because of economic situations. * Implicit rate on $135,000 fair value is 5.45%. * Implicit rate on $125,000 fair value is 6.93%. * Payments are expected to be collected when due. Identification of Issues and Alternatives: The major question at hand in this case is whether or not the lease should be classified as a sales-type lease, a direct financing lease, a leveraged lease, or an operating lease. If the lease meets any of the criteria for being a capital lease and meets the extra required criteria for each classification then it is one of the first three, and if not then it is an operating lease. The determination of the type of lease will affect how the lease is classified on...
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...Benefits of a Capital Lease December 3, 2012 MEMORANDUM TO: Trucking Company, Inc. FROM: Accountant DATE: December 3rd, 2012 SUBJECT: Benefits of a Capital Lease CC: John Smith, Supervisor In response to your request for more information on the topic of leases, I will explain the different aspects of leases to help you get a better understanding of the topic so that you may make an informed decision on which type of lease is best for your company. Capital Leases A capital lease emulates an installment purchase of an asset. This type of lease transfers the benefits and risks associated with ownership of an asset to the lessee (Schroeder, Clark, & Cathey, 2011). According to ASC 840-10-25 (FASB, 2009) (IAS 17), a lease must meet at least one of the following four criteria to be considered a capital lease: a. Ownership is transferred by the end of the lease agreement. b. There is a chance to purchase at a bargain price. c. The length of the lease is 75% or more of the assets life. d. The sum of the minimum payments, calculated at present value, exceed 90% of the assets fair value. Criteria c and d do not apply if the term of the lease begins in the final 25% of the assets useful life. Two Types of Capital Leases There are two types of capital leases concerning the lessor; direct financing and sales-type leases. For a capital lease to be considered a direct financing or sales-type lease, according to ASC 840-10-25 (FASB, 2009), both of the following...
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...have researched the FASB website for information on leases and lease structure issues, in particular the current practices and thought related to direct financing, sales type, and operating leases. The following is a brief explanation of the results and also a recommendation of an approach that the client can use to evaluate and capitalize on the opportunity of adding the new customer. The FASB has outlined certain criteria for classifying leases as either capital leases or operating leases. In SFAS No. 13 the criteria for classifying a lease as a capital lease are; the lease transfers ownership, the lease contains a bargain purchase option, the lease term is equal to 75 percent or more of the estimated remaining economic life, and at the beginning of the lease term the present value of the minimum lease payments equals or exceeds 90 percent of the fair value of the leased property less any related investment tax credit retained by the lessor (Schroeder, Clark, & Cathey, 2011). The lease only has to meet one of those criteria to be a capital lease. If none of these criteria are met then the lease is classified as an operating lease. Leases can also be classified as a sales type lease or a direct financing lease. For a lease to be classified as a sales type or direct financing lease the lease would have to meet one of the criteria listed above plus two other criteria. The other two criteria are; collectability of the minimum lease payments is reasonably predictable and no important...
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...(“Tiger”) to lease a backhoe, which Eagle will use for a new project involving the construction of several apartment complexes in the Mobile area. The pertinent terms of the lease are as follows: • The lease term is for 10 years, while the economic life of the backhoe is estimated to be 15 years. The useful life of the backhoe is also estimated to be 15 years. • Annual lease payments of $16,000 are due at the end of each year. Eagle is also responsible for all maintenance, insurance, and taxes arising from the lease of the backhoe. • The residual value of the backhoe is estimated to be $24,000 at the end of the lease term. Tiger does not have a residual value guarantee. • The lease does not transfer ownership of the backhoe to Eagle by the end of the lease term or provide an option for Eagle to purchase the equipment. • The backhoe costs Tiger $100,000 to manufacture and this model is currently listed for sale at $135,000 should customers wish to purchase it outright. Tiger believes that the lease payments from Eagle will be collected when they are due. In addition, the equipment is fully constructed and no additional costs will be incurred to complete production of the backhoe before lease commencement. As a result of a recent economic downturn that has directly impacted the construction industry, a number of companies in the industry have modified their sales or lease terms to maintain profitability. Some of Tiger’s direct competitors have negotiated lower lease payments...
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...research results | | | As you requested, I have completed the research on the lease types and lease structure issues on the Financial Accounting Standards Board (FASB) website for the Lone Star Trucking Company. I did specific research on direct financing, sales type, and operating leases. After going over the information I have, I will provide you my recommendation for handling the client’s situation According to the FASB, both the client and the client’s potential new customer need to determine if their arrangement will meet one or more of these four criteria: 1. Transfer of ownership – the potential lease will transfer ownership of the property to the lessee at the end of the designated lease term (fasb.org). The client will have met this criterion if the lease agreement provides for the transfer of title at or shortly after the end of the lease term. Usually, there is a nominal fee that is required by statutory regulation to transfer title. 2. Bargain purchase option – the potential lease will contain a bargain purchase option, where the lessee will have the option to purchase the asset for a percentage less than the fair market value (fasb.org). 3. Lease term - the potential lease term is equal to 75 percent or more of the estimated economic life of the lease property (fasb.org). 4. Minimum lease payments - the present value at the beginning of the lease term of the minimum lease payments, excluding any portion of the payments representing miscellaneous costs...
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...To Lease or Purchase? May 2, 2011 ACC/400 Peter Ioveno To Lease or Purchase? It is important to know when it is a good time to purchase items or lease items, as an individual and in the business world. If you purchase an item at the wrong time, it could easily put a company as risk for financial hard times. The following will detail some important factors to review when purchasing or leasing is an option. The Differences between Leasing and Purchasing Both leasing and purchasing has its pros and it cons. The trick is to figure out which would be better for a company’s current financial status. Leasing allows a lessee to avoid large down payments, keep updated materials, lower lease payments due to shared tax advantages, and the property that is being leased does not show as an asset or liability. These are all positive factors if your company is a smaller company and does not have the cash to purchase the material or only needs the material for a limited time. Next are a few pros of purchasing through a capital lease. Leasing payments on an operational lease might be higher than those payments on a capital lease due to interest rates and since the company does not own the property, it must not be abused or used to harshly because it will be returned to the lessor. A capital lease gives you tax breaks such as deprecation, while operational leasing does not. As stated above, operational leases (rental agreements) and capital leases (purchasing leases) both have...
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...LEASE OR FINANCE?? In today’s competitive economy, a vehicle is no longer considered a luxury anymore, but rather a necessity. There are not very many cities in the U.S. where you can live without car. I live in Orlando, Florida and dependable transportation is a mandatory expense. If you want to buy a new car, the cheapest way to buy a car is to pay cash for it. By paying cash you will avoid any finance charges. However, there are not very many people have thirty to fifty thousand dollars to spend on the vehicle. Lease or finance are two main options if you don’t have a lot of cash available to spend on the car. I have chosen the BMW and Infinity dealership to do my analysis. I picked two similar cars form the both dealerships: X5 xDrive35i Sport Activity from BMW and Infiniti FX50 from Infinity dealership. After analyzing financing and leasing options, there is no clear answer on whether to finance or lease a vehicle. It basically all depends on how much money you have, how many miles you drive, how long you want to keep your car for and etc. BMW offers 0.9% APR for 24 month and 3.9% for 25-60 month with $0 down payment to finance the X5 xDrive35i Sport Activity. The price of the vehicle is $57,700. It’s approximately $1,700 per month for 36 months. The lease option is $699 per month for 36 months with $3,000 down payment, $725 acquisition fee, and $4,424 cash is due at signing. The total lease payment is $25,164. At the end of the lease, lessee will be liable for disposition...
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...Group In Re: Leases and Lease Structures A company wants information about leases and lease structures in the FASB codification required by the supervisor in response to the request of the client. The client is a regional trucking company. The company owns one hundred trailers 20 less than the requirement to take a new job proposal. The opportunity offers new growth, the doubt about the duration of the work is unclear and the client needs advice about whether to buy or lease the extra trailers needed to complete the job. The paper will give the outcome of the research completed on the lease and lease structures in the FASB codification required by the supervisor in response to the request of a client. The codifications of the Financial Accounting Standards Boards give substance to different lease structures and the terms and conditions for lease transactions. The statement of financial accounting standards (SFAS) speaks of different lease structures. SFAS Number 13 discusses the categorization of various principles about lease structures to capital leases and operating leases. The capital leases are leases in which the benefits and the risks pass to the lessee. “A lease is considered a sales type lease when the manufacturer or dealer’s profit or loss implies that the leased item is considered inventory and the seller or the lessor is earning a profit on the sale”. (Schroeder, Clark & Cathey, p.439, 2010) In an instance with a sales type lease, the fair value...
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...CAPITAL BUDGETING PROCESS HSM 340 3/30/12 Organizations that decide to issue bonds generally have six steps to go through. Let’s discuss them. The first step is for the issuer to select bond counsel and the underwriter or financial advisor. The issuer and the solicitor work with these participants to structure the financing. Some basic questions need to be answered: (1) what is the purpose of the issue -- to fund a capital project, to refund prior debt, or a combination of both (2) what are the legal parameters involved -- does the capital project serve a proper legal purpose, can the debt be refunded under the federal tax rules (3) how should the bonds be sold -- through negotiation with one underwriter or through a bidding procedure with multiple underwriters (4) does credit enhancement make economic sense (that is, is the cost of the insurance or letter of credit less than the resulting debt service savings to the issuer). (1) Once the structure is formulated, the issuer needs to select the paying agent or trustee and the credit enhancer, and all the participants begin to prepare the required documentation. The underwriter or financial advisor and the issuer prepare the disclosure document which is usually called the preliminary official statement. Bond counsel drafts the ordinance or resolution and other legal documents. When the preliminary official statement is in proper form, it is distributed to potential purchasers. The marketing period usually lasts about...
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...birth of Islamic banking in the mid-1970s. Its objective was to provide a financial alternative that was fair, transparent and above all, a source of economic upliftment for all those in need Islamic banking, enlightened with the guidance of Islamic Shari‘ah principles, emerged as an alternative financial system that neither gave nor took interest, thereby introducing a fair system of social justice and equality, while fulfilling the financial needs of people and maintaining high standards of ethics, transparency and a sense of responsibility According to Shari‘ah, interest free loans are meant for cooperative and charitable activities, and not normally for commercial transactions, except in a very limited range. So far as commercial financing is concerned, the Islamic Shari‘ah has a different...
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...MINI CASE #1 Issue Identified How to account for the expected loss resulted from redemption of the debt obligations in the period that it announces its intent to call the debt for redemption? ASC References ASC 470-50-40-2 states that “ a difference between the reacquisition price of debt and the net carrying amount of the extinguished debt shall be recognized currently in income of the period of extinguishment as losses or gains and identified as a separate item.Gains and losses shall not be amortized to future periods. “ ASC 405-20-40 states that “a debtor shall derecognize a liability if and only if it has been extinguished. A liability has been extinguished if either of the following conditions is met: The debtor pays the creditor and is relieved of its obligation for the liability. Paying the creditor includes the following: Delivery of cash Delivery of other financial assets Delivery of goods or services Reacquisition by the debtor of its outstanding debt securities whether the securities are cancelled or held as so-called treasury bonds. The debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor. ASC 470-50-55-9 specifies that “the following situations do not result in an extinguishment and would not result in gain or loss recognition under either paragraph 405-20-40-1 or this Subtopic: An announcement of intent by the debtor to call a debt instrument at the first call date In-substance defeasance ...
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...would change on financial statements in regards to these securities. It takes into account present effects as well as future years; in addition it also considers the conversion of bonds as well as how debt covenant restrictions effect these financials. The paper also documents how both capital and operating leases are accounted for in varying situations. It does not examine criteria for designation between the two, rather how they are handled in regards to common situations. The author adds his own thoughts and provides commentary on these topics and gives consideration to the methodology to which they are accounted for. Alternate Financing Decisions Companies take part in many activities that are recorded in their financial statements. They have sales, expenses, production costs, financing activities, assets & liabilities just to name a few. The inflows and outflows of cash needs to be monitored budgets need to be made and management needs to make important decisions regarding the direction the company is going and how they are going to get there financially. This could end up in the taking out lines of credit, selling assets or looking in to other alternate financing methods such as convertible bonds or the issuance of preferred stock. Baker Company a theoretical company in our text is one such company in need of one million dollars to expand its physical plant and are considering the idea of issuing convertible 10 year bonds or 10 year preferred stock in order to finance...
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