FinancialLease
Accounting
MeaninganddefinitionofFinancialLease
Afinancialleaseisamethodusedbyabusinessforacquisitionofequipmentwithpayment
structuredovertime.Togiveproperdefinition,itcanbeexpressedasanagreementwhereinthe
lessorreceivesleasepaymentsforthecoveringofownershipcosts.Moreover,thelessorholds
theresponsibilityofmaintenance,taxes,andinsurance.
Afinancialleaseissimilartoanoutandoutpurchasetransactionwhichhasbeenfinanced
throughatermloan,inthatthepaymentsaremadeonamonthlybasis.However,unlikean
outandoutpurchasetransactioninthatthelesseedoesntpresenttheobligatedbalanceas
debt,showspaymentsasexpensed,andretainstheequipmenttitle.Duringtheleaseperiod,the
financecompanyisconsideredasthelegalowneroftheasset.
MainfeaturesofaFinancialLease
Acapital/financialleaseisacommercialarrangementwherein:
thelessee(borrowerorcustomer)selectsanasset(equipment,software,vehicle
thelessor(financecompany)purchasesthatasset
thelesseeusesthatassetduringthelease
thelesseepaysaseriesofinstallmentsorrentalsforusingthatasset
thelessorrecoversalargepartoralmostcompletecostoftheassetinadditiontoearning
interestfromtherentalspaidbythelessee
thelesseehastheoptionofacquiringownershipoftheasset(bargainoptionpurchaseprice
orpayingthelastrental)
ImpactofFinancialLeaseonAccounting
Afinancialleaseshowsthefollowingimpactsonaccounting:
Beingcapitalized,afinancialleaseleadstoanincreaseinassetsaswellasliabilitiespresent
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inthebalancesheet.Consequently,workingcapitalfalls,butanadditionalleverageis
createdbyanincreaseinthedebtequityratio.
Leaseobligationsarenotrecognizedunderoperatingleaseconditions,thus,resultingin
understatedleverageratiosandoverstatedratiosofreturn.
Inacashflowstatement,partofleasepaymentsarereportedunderoperatingcashflow
andpartunderfinancingcashflowbecauseoffinancialleaseexpensesbeingallocated
betweenprincipalexpenseandinterestexpenseakintoaloanorbond.
PageUrl: Date:7april,2016
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