Muhammad

Zeeshan
Baloch
Muhammad
Sabir Hussain
Lease
A lease is a contractual agreement between a lessor and a lessee, that
gives the lessee the right to use specific property, owned by the lessor,
for a specified period of time.

Steps in leasing process
The entrepreneur choose the equipment and equipment supplier
The supplier provides a quotation
The lessee submits an application to the lessor
The lessor evaluates the application
The lessor and lessee sign a lease contract
The lessee pays the advance lease payment
The lessor orders the equipment from the supplier
The supplier delivers the equipment

Cont
The lessor registers and insures the equipment
The supplier provides after sale services as per contract
The lessee maintains the equipment(routine maintenance).
The lessor monitors the lease operation
The lessee pays installments as per contract
At the end of the lease period, the lessee either returns the equipment or
exercises the option of purchase
If the option is purchase, the lessee pays the agreed final sum and lessor
transfers the ownership of the equipment to the lessee.
Types Of Lease
Operating
lease
Capital
lease
Leveraged
lease
Sale and
lease
back
Direct
lease
One or more of four criteria must be met:
1. Transfers ownership to the lessee.
2. Contains a bargain purchase option.
3. Lease term is equal to or greater than 75 percent of the
estimated economic life of the leased property.
4. The present value of the minimum lease payments equals
or exceeds 90 percent of the fair value of the leased
property.

Capital Lease
Cnt
In capital lease following items will be created:
Asset
Liability
Expense (Interest & Depreciation)
Asset repairing responsibilities are transferred
to lease.


E21-1 (Capital Lease with Unguaranteed Residual Value) On January 1,
2007, Burke Corporation signed a 5-year non-cancelable lease for a machine.
The terms of the lease called for Burke to make annual payments of $8,668 at
the beginning of each year, starting January 1, 2007. The machine has an
estimated useful life of 6 years and a $5,000 unguaranteed residual value.
Burke uses the straight-line method of depreciation for all of its plant assets.
Burkes incremental borrowing rate is 10%, and the Lessors implicit rate is
unknown.
Instructions
(a) What type of lease is this? Explain.
(b) Compute the present value of the minimum lease payments.
(c) Prepare all journal entries for Burke through Jan. 1, 2008.

Example
E21-1 What type of lease is this? Explain.
Capitalization Criteria:
1. Transfer of ownership
2. Bargain purchase option
3. Lease term => 75% of
economic life of leased
property
4. Present value of minimum
lease payments => 90% of
FMV of property
NO
NO
Lease term 5 yrs.
Economic life 6 yrs.
YES 83.3%
FMV of leased property is
unknown.
Capital Lease, #3
E21-1 Compute present value of the minimum lease payments
Payment $ 8,668
Present value factor (i=10%,n=5) 4.16986
PV of minimum lease payments $36,144
Journal entry
1/1/07
Leased Machine Under Capital Lease 36,144
Leases liability 36,144
Leases liability 8,668
Cash 8,668
Operating Lease Capital Lease
Journal Entry:
Rent expense xxx
Cash xxx
Journal Entry:
Leased equipment xxx
Lease obligation xxx
A lease that transfers substantially all of the benefits and risks of property
ownership should be capitalized (only non-cancellable leases may be
capitalized).
The Leasing Environment
Operating Lease
Operating lease do not transfer the asset at the end
of the term.
Operating lease is written in income statement as
an operating expense.
Lessor is responsible for repairing of the object of
lease.

Transfer
Of Ownership
Bargain
Purchase
Lease Term
>= 75%
PV of
Payments
>= 90%
O
p
e
r
a
t
I
n
g
L
e
a
s
e
No No No
No
Yes
Capital Lease
Lease Agreement
Yes Yes Yes
Leases that DO NOT meet any
of the four criteria are
accounted for as Operating
Leases.
1. 100% Financing at Fixed Rates.
2. Protection Against Obsolescence.
3. Flexibility.
4. Less Costly Financing.
5. Tax Advantages.
6. Off-Balance-Sheet Financing.
Advantages of Leasing