Chapter 19, Problem 1Q

Define each of the following terms:

1. a. Lessee; lessor
2. b. Operating lease; financial lease; sale-and-leaseback; combination lease; synthetic lease; SPE
3. c. Off–balance sheet financing; capitalizing
4. d. FASB Statement 13; ASU 2016-02
5. e. Guideline lease
6. f. Residual value
7. g. Lessee’s analysis; lessor’s analysis
8. h. Net advantage to leasing (NAL)
9. i. Alternative minimum tax (AMT)

Summary Introduction

To determine: The definition of lessor and lessee.

Explanation of Solution

Lessor is a party who lets the asset to the counterparty or the owner of the asset. Whereas the lessee is the person who has the lease of property or the occupant.

Summary Introduction

To determine: The definition of operating lease, financial lease, sale-and-leaseback, combination lease, synthetic lease, and SPE.

Explanation of Solution

Operating lease is type of lease in which the lessor allows lessee to holds the property for a specified period which is lesser than the economic life of the property without giving the ownership right. Finance lease is a type lease in which the lessee will get the ownership of the property before the lease periods completes and the overall risk and reward will be assigned to the lessee. Sale and leaseback is a deal in which the owner of an asset trades an asset, typically real estate, and then leases it back from the purchaser. In this way, the deal functions as a loan, with payments taking the kind of rent. The combination lease is a kind of lease deal in which it combines both the characteristics of financial and operating lease. A synthetic lease could be a financing course of action by which a company structures the control of a resource so that – for money related bookkeeping goals, the resource is possessed by a special-purpose substance and rented to the working company beneath an operating lease. A special-purpose entity may be a lawfully isolated commerce that assimilates risk for a organization. A special purpose entity can moreover be planned for the switch circumstance, where the resources it holds are secure indeed in the event that the related organization enters liquidation (which can be vital when resources are being securitized).

Summary Introduction

To determine: The definition of off-balance sheet financing and capitalizing.

Explanation of Solution

Off-balance sheet (OBS) financing is a strategy of accounting whereby a firm does not incorporate a liability on its balance sheet. It is utilized to affect a firm's level of debt and liability. The hone has been stigmatized by a few since it was uncovered as a key procedure of the ill-fated energy giant Enron. To capitalize is to enter a cost/expense on the balance sheet to delay complete identification of the expense.

Summary Introduction

To determine: The definition of FASB statement 13 and ASU 2016-02.

Explanation of Solution

FASB statement 13 is a standard of financial accounting Board state­ment (November 1976) that spells out in detail the conditions beneath which a rent must be capitalized, and the particular strategies to take after. ASU 2016-02 is the FASB overhaul that states that for all intents and purposes all leases longer than a year, counting operating leases, must be capitalized.

Summary Introduction

To determine: The definition of guideline lease.

Explanation of Solution

A guideline lease is a lease that satisfies every IRS necessities for a valid lease. A guideline lease is often called a tax-oriented lease. If a lease satisfies the IRS guidelines, the IRS provides the lessor to decrease the depreciation of assets and permits the lessee to decrease the lease payments.

Summary Introduction

To determine: The definition of residual value.

Explanation of Solution

The residual value is the evaluated value of a fixed asset at the conclusion of its rent or the conclusion of its valuable life. The lessor employments the residual value as one of its essential strategies for deciding how much the tenant pays in rent installments. As a common run the show, the longer the valuable life or rent period of a resource, the lower it's the residual value.

Summary Introduction

To determine: The definition of lessee’s analysis and lessor’s analysis.

Explanation of Solution

The lessee’s analysis includes deciding whether renting an asset is less exorbitant than buying the asset. The lessee will compare the present value cost of renting the asset with the present value taken cost of obtaining the asset (expecting the funds to buy the asset are gotten through a credit). If the present value of the cost of the lease is less than the present value cost of obtaining, the asset ought to be rented. The lessee can moreover analyze the lease utilizing the IRR approach. The IRR of the incremental cash streams of renting versus acquiring speaks to the after-tax taken a toll rate inferred within the lease contract. On the off chance that this rate is lower than the after-tax cost of debt, there's an advantage to renting. At long last, the lessee might assess the lease utilizing the comparable advance strategy, which includes comparing the net investment funds at Time in the event that the resource is rented with the show esteem of the incremental costs of renting over the term of the rent. On the off chance that the Time 0 savings are more prominent than the present value of the incremental costs, there's an advantage to leasing.

The lessor’s analysis includes deciding the rate of return on the proposed rent. In case the rate of return (or IRR) of the lease cash streams surpasses the lessor’s opportunity cost of capital, the lease may be a great investment. Usually proportionate to analyzing whether the NPV of the lease is positive.

Summary Introduction

To determine: The definition of net advantage of leasing (NAL).

Explanation of Solution

The net advantage to leasing (NAL) gives the dollar esteem of the rent to the tenant. It is, in a sense, the NPV of renting versus owning.

Summary Introduction

To determine: The definition of alternative minimum tax (AMT).

Explanation of Solution

The alternative minimum tax (AMT), which is figured at around 20 percent of the benefits detailed to stockholders, could be an arrangement of the tax code that requires productive firms to pay at slightest a few taxes on the off chance that such taxes are more prominent than the sum due beneath standard assess bookkeeping. The AMT has given a boost to renting for those firms paying the AMT since renting brings down benefits detailed to stockholders.