Accountants' Handbook Volume One: Financial Accounting and General Topics, Eleventh Edition

Chapter 23. LEASES

James R. Adler, CPA, CFE, PhD

Adler Consulting, Ltd.

INTRODUCTION AND BACKGROUND INFORMATION

A lease is an agreement conveying the right to use property, plant, or equipment, usually for a stated period of time. Since World War II, the leasing industry has become a major economic force, and leasing has become a method by which to finance acquisitions of property.

The rapid growth created by the demand to lease everything from equipment to automobiles, furniture, and even people has caused a highly price-competitive environment. Lessors earn their profits by buying equipment at lower prices than ordinary buyers, charging brokerage fees, and getting tax deductions for equipment write-offs. The 1986 Tax Reform Act has wiped out tax credits, removing some of the traditional cash flow advantages that lessors could gain upon initiating a leasing transaction.

Traditionally, lessees prefer to have operating leases rather than capital leases so that the future lease payment obligations do not appear on the balance sheet as a liability.

(a) FINANCING ADVANTAGES OF LEASING.

The financing advantages associated with leasing include the following:

• Leasing permits 100 percent financing, whereas a normal equipment loan may require a 20 percent to 40 percent initial down payment. Leasing can thereby conserve cash and working capital.

• Longer terms than are normally available with loans can be arranged for leasing many types of capital equipment.

• Financing of initial acquisition costs is ...