MINI CASE

PART A.

1) Who are the two parties to a lease transaction? Lessor – The party who owns the asset
(Consolidated Leasing) Lessee – The party who uses the asset (Lewis Securities Inc.)
2) What are the five primary types of leases, and what are their characteristics? Operating
Leases: - Provides financing and maintenance - Maintenance costs are built into lease payments -
Leases are NOT fully amortized - Leases have cancelation clauses Capital (Financial) Lease: -
Do not provide maintenance - Leases do NOT have a cancelation clause - Leases are fully
amortized Sale-and-Leaseback Leases: - The lessor sells the asset - Makes an agreement with
new owner to lease the asset, becoming the lessee - Similar to Financial/Capital Leasing but with
used assets and equipment verses new assets Combination Leases: - A lease combining many
qualities of other leases - Typically Operating and Capital Leases - *Where the market is
currently focusing Synthetic Leases: - Lessee established a Special Purpose entity (SPE) - Uses
funds from SPE to lease asset - Leases have typical terms of 3-5 years - Leases are considered
Operating Leases - Have requirements at the end of term o Pay off the SPE (97% loan, 3%
equity) o Refinance the loan at current interest rate o Sell the asset and repay the difference
between the sale price and the remainder of the loan amount.
3) How are leases classified for tax purposes? Lease payments and depreciation of the asset
are tax deductible (genuine leases, not loans called a lease).
4) What effect does leasing have on a firm’s balance sheet? Originally, leasing did not appear
on a firm’s balance sheet, it was only mentioned in the footnotes that the company had leased an
asset. Once the Financial Accounting Standards Board issued Statement 13, all leases except
Operating Leases MUST be shown on the balance sheet. The value of the asset is recorded as a
fixed asset and the present value of future payments is recorded as a liability.
5) What effect does leasing heave on a firm’s capital structure? Off balance sheet capital
leases (Operating Leases) do not show any change in the capital structure of a firm. All other
leases increase fixed assets that, in turn, lower the debt/asset ratio,