Leasing leasing

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Capital Lease

Operating Lease

Ownership of the asset might be transferred to the Ownership
lessee at the end of the lease term.
is retained
Lease criteria by the lessor
Ownership
during and
after the
lease term.
Lease criteria Bargain Purchase
Option

The lease contains a bargain purchase option to
buy the equipment at less than fair market value.

The lease
cannot
contain a
bargain
purchase
option.

The lease term equals or exceeds 75% of the asset's The lease
estimated useful life
term is less
than 75
percent of
Lease criteria - Term
the
estimated
economic
life of the
equipment
The present value of the lease payments equals or
exceeds 90% of the total original cost of the
equipment.

The present
value of
lease
payments is
less than 90
percent of
the
equipment's
fair market
value

Transferred to lessee. Lessee pays maintenance,
insurance and taxes

Right to use
only. Risk
and benefits
remain with
lessor.
Lessee pays
maintenance
costs

Lease criteria Present Value

Risks and Benefits

Accounting Lease is considered as asset (leased asset) and

No risk of

Capital Lease

Operating Lease
liability (lease payments). Payments are shown in
Balance sheet

ownership.
Payments
are
considered
as operating
expenses
and shown
in Profit and
Loss
statement

Lessee is considered to be the owner of the
equipment and therefore claims depreciation
expense and interest expense

Lessee is
considered
to be renting
the
equipment
and
therefore the
lease
payment is
considered
to be a
rental
expense

Tax

Pros and Cons

Advantages of an operating lease




Operating leases provide much-needed flexibility to companies
that frequentlyupdate or replace their equipment.
The lessee is protected from the risk of obsolescence.
Accounting is simpler: the asset does not have to be included in the balance
sheet. The corresponding debt liability does not have to be calculated or included
either.




Lease payments are operational expenses, so they are fully tax deductible.
It provides improved Return On Asset (ROA) without capital budgeting
restraints.

Advantages of a capital lease


Capital leases recognize expenses sooner than equivalent operating leases.
The lessee is allowed to claim depreciation each year on the asset.



In addition to depreciation, the interest expense component of the lease
payment can also be deducted as an operational expense.
Aspects
of
Differenc
e

Operating Lease

Financial Lease

Definition

A lease in which all risks and rewards
related to asset ownership remain with
the lessor for the leased asset is called
operating lease. In this lease, the asset is
returned by the lessee after using it for
lease term agreed upon.

In financial lease (Also known
as capital lease), the risks
and rewards related to
ownership of asset leased are
transferred to the lessee.

Ownership

Ownership of the asset remains with the
lessor for the entire lease period.

Ownership transfer option at
the end of the lease period is
there with the lessee. Title
might or might not be
transferred eventually.

Accountin
g Effect

Operating lease is treated generally like
renting. That means, the lease payments
are treated as operating expenses and
the asset does not show on the balance
sheet.

Financial lease is treated like
loan generally. Here, the
asset ownership is
considered of the lessee and
so asset appears on the
balance sheet.

Purchase
Option

In operating lease, the lessee does not
have any option to buy the asset during
the lease period.

Financial lease allows the
lessee to have a purchase
option at less than the fair
market value of the asset.

Lease
Term

Lease term extends to less than 75% of
the projected useful life of the leased

Lease term is generally more
than or equal to estimated

Aspects
of
Differenc
e

Operating Lease

Financial Lease

asset.

economic life of the asset
leased.

Expenses
Borne

Lessee pays only the monthly lease
payment in operating lease.

In financial lease, lessee
bears insurance,
maintenance and taxes.

Tax
Benefit

Since operating lease is as good as
renting, lease payment is considered as
expense. No depreciation can be
claimed.

Lessee can claim interest and
depreciation both as financial
lease is treated like a loan.

Running
Cost

In operating lease, no running or
administration costs are to be borne for
example: registration, repairs etc. since it
gives only right to use the asset.

In a financial lease, running
cost and administration
expenses are higher.

Example

Normally, A Projector, Computers,
Laptops, Coffee Dispensers etc

Normally, Plant and
Machinery, Land, Office
Building etc

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