Lease Financing MBA-IMK

8/12/2019 Lease Financing MBA-IMK

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Lease

A lease contract is an agreement where theowner conveys to the user the right to use an

asset in return for a number of specified

payments over an agreed period of time.

Lessor is the owner of the asset Lessee is the user of the asset


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Types of Lease

Operating Leases

Usually not fully amortied. !his means that the

payments re"uired under the terms of the lease

are not enough to recover the full cost of the

asset for the lessor.

Usually re"uire the lessor to maintain and insure

the asset. Lessee en#oys a cancellation option. !his option

gives the lessee the right to cancel the lease

contract before the e$piration date.


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Types of Leases

Financial Leases (capital or full payout leases)

!he e$act opposite of an operating lease.

Do not provide for maintenance or serviceby the lessor.

%inancial leases are fully amortied. !he lessee usually has a right to renew the

lease at e$piry.

&enerally' financial leases cannot becancelled' i.e.' the lessee must ma(e allpayments or face the ris( of ban(ruptcy.


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Types of Leases

)riteria for a )apital Lease *f one of the following criteria is met' then the

lease is considered a capital lease and must be

shown on the balance sheet Lease transfers ownership by the end of the leaseterm

Lessee can purchase asset at below mar(et price Lease term is for +, percent or more of the life of the

asset -resent value of lease payments is at least / percent

of the fair mar(et value at the start of the lease


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Types of Leases

Lessee Lessor Lessee Lessor

Asset 0ot on balancesheet 123456

disclose in

footnotes

Report on 234 Report on 234 0ot on 234

Lease payments 7$pense the

full amount as

rental e$pense

)laim as rental

income

Decompose

into interest

and principal

repayment' and

e$pense the

interest portion

)laim the

interest portion

of payments

received as

interest income

Depreciation

epense

(associate! "it#

lease! asset)

)annot claim )laim )laim )annot claim

Ta$le %&'% Operating ersus Financial Leases

OE*ATING FINANCIAL


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Types of Leases

Leerage! Leases A leveraged lease is another type of financial lease.

A three:sided arrangement between the lessee' the

lessor' and lenders. !he lessor owns the asset and for a fee allows the

lessee to use the asset.

!he lessor borrows to partially finance the asset. -opular in U.4. because lessor puts up only a portion of

the asset purchase price' but receives all of the ta$

benefits of ownership


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Ta Aspects of Leasing

Lessee can deduct lease payments for income ta$purposes ;ust be used for business purposes and not to avoid ta$es !erm of lease is less than


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Accounting for Lease

%inancial leases are essentially treated as

debt financing -resent value of lease payments must be

included on the balance sheet as a liability

4ame amount shown on the asset as the

=capitalied value of leased assets>

8perating leases are still =off:balance:sheet>and do not have any impact on the balance

sheet itself


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Accounting for LeasesFinancial Statement Effects of Lease Classification

)apital3%inancial3%ull -ayout Leases9*ncome 7ffects

?. 0et income will generally be lower for capital leases inthe early years and higher in the later years.

@. )%8 will be higher with capital leases. ))A may bededucted in measuring 0et *ncome after ta$' however'))A is added bac( when determing )%8. )apital3financial leases e$pense only the interest portion of thepayments in determining 72!.

2alance 4heet 7ffects

?. Lower current ratios' higher debt and leverage ratios'lower asset turnover and lower profitability ratios1especially in the early years of asset life5


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Accounting for LeasesFinancial Statement Effects of Lease Classification

8perating Leases9

*ncome 7ffects

?. 0et income will generally be higher for operatingleases in the early years and lower in the later years

because interest e$pense charged for the financiallease declines as the liability is amortied by thelease payments.

@. )%8 will be lower with operating leases since thefull lease payment is subtracted from )%8' unli(e

financial leases where only the interest portion ofthe payments is subtracted.

2alance 4heet 7ffects

?. igher current ratios' lower debt and leverage

ratios' higher asset turnover and higher profitabilityratios es eciall in the earl ears of asset life


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Ealuating t#e Lease DecisionLease -ersus +uy Ealuatie Frame"or,s

*RR of Leasing Analysis 7stimate incremental cash flows that result from

leasing

4olve for the discount rate 1*RR5 that e"uates theincremental cash flows with the initial value of theasset. 1!his is the after-tax IRRor cost of leasing5 *f *RR of leasing after:ta$ cost of borrowing 1borrow

and buy the asset5 *f *RR of leasing E after:ta$ cost of borrowing 1lease

the asset5


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Ealuating t#e Lease DecisionLease -ersus +uy Ealuatie Frame"or,s

0-V of Leasing Analysis

7stimate incremental cash flows that result from

leasing

)alculate 0-V using after:ta$ cost of borrowing

as the discount rate.

*f 0-V of leasing is : 1borrow and buy the asset5

*f 0-V of leasing Fafter:ta$ cost of borrowing 1leasethe asset5


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.otiation for Leasing

)heaper financing

Reduce the ris(s of asset ownership

*mplicit interest rates ;aintenance

)onvenience

%le$ibility )apital budgeting restrictions

%inancial statement effects

Documents

Lease Financing MBA-IMK