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Chapter 20

Chapter 20 Notes

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Financial Accounting
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Chapter 20 Leases NotesLeasing Basics y a lease is a contractual agreement between a lessor and lessee that gives the lessee for a specified period of time the right to use specific property owned by the lessor in return for specified and generally periodic cash payments rents y an essential element of the lease agreement is that the lessor transfers less than the total interest of the property y because of the financial operating and risk advantages that the lease arrangement provides many businesses and other types of organizations lease substantial amounts of property as an alternative to ownership Who are the Players y lessors are usually one of three types of companies 1 manufacturer finance 2 independent finance 3 traditional financial y manufacturer finance companies or captive leasing companies as they are also called are subsidiaries whose main business is to perform leasing operations for the parent company y independent finance acts as financial intermediary by providing financing for transactions for manufacturers vendors or distributors y subsidiaries of domestic and foreign banks are traditional financial institutions that provide leasing as another form of financing Advantages of Leasing y although leasing does have disadvantages the growth in its use suggests that it often has a genuine advantage over owning property y some of the advantages are as follows 1 100 financing at fixed rates 2 protection against obsolescence 3 flexibilityless agreements may contain less restrictive provisions than other debt agreements 4 less costly financing for lessee tax incentives for lessor 5 offbalance sheet financing Classification ApproachLessees Classification Criteria y benefits of ownership are the ability to use the asset to generate profits over its useful life to benefit from any appreciation in the assets value and to realize its residual value at the end of its economic life y the risks are the exposure to uncertain returns and to risk of loss from use or idle capacity and from technological obsolescence IFRS Criteria y under IFRS any one or a combination of the following situations normally indicates that the risks and rewards of ownership are transferred to the lessee and supports classification as a finance lease 1 There is reasonable assurance that the lessee will obtain ownership of the leased property by the end of the lease term If there is a bargain purchase option in the lease it is assumed that the lessee will
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