What are the different types of leases?
An operating lease is implemented for short-term leases of assets with a limited lifespan. The asset under this type of agreement stays as the lessor’s property, while rent payments are paid by the lessee for its use throughout the term specified in the said contract (Li & Xu, 2022). The finance lease is a long-term lease that typically encompasses assets with an extensive lifespan. The responsibility for maintenance, insurance coverage, and taxes during this contractual arrangement falls under the purview of the lessee as they have been assigned these obligations. Upon termination of said contract, there exists within it an option to buy said asset at residual value dictated by certain conditions outlined in prior agreements. Sale and leaseback involve vending an asset to a leasing corporation, which is then leased again for a specific duration (Lee & McDonough, 2022). This leasing mode effectively generates finances while still retaining ownership over the property.
How can a lease be better than buying the item with capital?
In certain situations, leasing can prove superior to purchasing an item with available capital. Utilizing business access to the use of assets without requiring full payment upfront conserves cash flow. Additionally, such arrangements could offer tax benefits since lease payments are usually deductible as expenses under favorable conditions.
Suppose an organization needs new machinery that costs $100,000. They have two options: lease the machinery for five years or purchase it outright using a loan with an interest rate of 8% per year.
Option 1: Lease
Lease the machinery for a monthly payment of $2,000 for five years, with no residual value.
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Total Lease Payments = $2,000 x 12 months x 5 years = $120,000
Option 2: Purchase
The monthly payment for the loan would be $2,057.05,
Total Loan Payments = $2,057.05 x 12 months x 5 years = $123,423
Comparing the two options, leasing would be more cost effective than buying the machinery outright.
What factors do you consider when evaluating a lease?
To choose between lease and buy, one must consider various factors. One factor examines the present value of payments due under a lease compared to those associated with purchasing an asset via capital infusion. While conducting this analysis, several variables should be considered, such as interest rates attached to financing costs, anticipated duration of productive usage for said item, and any relevant tax implications that may accrue over time (Gonzalez-Prida et al., 2022). As one scrutinizes a lease, certain elements worth considering entail the lease term, the monthly payment, how much its resale value can fetch in the future, and any repercussions from an untimely dissolution. Other variables to examine are whether or not the lessor’s credit standing is substantial enough and what regulations pertain to the said leasing agreement.
A company’s financial records can be impacted in diverse forms by leasing. The payments made for leases are characterized as operational costs and deducted from the earnings, which may result in a diminished tax burden. Nonetheless, incorporating lease liabilities into the balance sheet can influence an enterprise’s debt-equity ratio and other
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financial ratios (Gonzalez-Prida et al., 2022). Therefore, one must scrutinize how renting will affect their financial reports and overall fiscal stability.
References
González-Prida, V., Parra, C., Kristjanpoller, F., Viveros, P., Guillén, A., & Crespo, A. (2022). Overview for Leasing or Buying Decisions in Industrial Asset Management. In 15th WCEAM Proceedings (pp. 115-125). Cham: Springer International Publishing.
https://link.springer.com/chapter/10.1007/978-3-03…
Lee, C. F., & McDonough, R. (2022). The economics of and accounting for lease transactions. Springer Books, 2019-2040.
https://ideas.repec.org/h/spr/sprchp/978-3-030-912…
Li, K., & Xu, Y. (2022). Leasing as Capital Reallocation. Available at SSRN 4226239.
https://papers.ssrn.com/sol3/papers.cfm?abstract_i…
this was qoustion
Leasing Decisions
Businesses generally own fixed (capital) assets. However, it the ability to use buildings and equipment that is important to the business, not their ownership. One way to obtain the use of capital assets is to lease them.
Address the following requirements:
What are the different types of leases?
How can a lease be better than buying the item with capital?
What factors do you consider when evaluating a lease?