Net advantage to leasing (NAL)

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Net advantage to leasing (NAL)

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Define each of the following terms:
a. Lessee; lessor

Define each of the following terms:
b. Operating lease; financial lease; sale-and-leaseback; combination lease

Define each of the following terms:
c. Off-balance sheet financing; capitalizing

Define each of the following terms:
d. FASB Statement 13; ASU 2016-02

Define each of the following terms:
e. Guideline lease

Define each of the following terms:
f. Residual value

Define each of the following terms:
g. Lessee’s analysis; lessor’s analysis

Define each of the following terms:
h. Net advantage to leasing (NAL)

Explanation & AnswerSolution by a verified expert

Explanation

A lessee is the user of the asset who acquires it on lease or on rent from the owner binding in an agreement rather than purchasing it permanently. A lessee can use the asset only as per the terms defined in the agreement and is bound to pay  periodic payments for its use. The lessee is responsible to take reasonable care of the lessor's assets and to return them in the same condition as they were at the time of commencement of lease..
 
A lessor is the owner of the asset that is being dealt in a lease agreement. He transfers the asset to the lessee to use it in lieu of the fixed periodic payments as rent. The lessor is bound to deliver the asset to the lessee in good working conditions and owns the risks and rewards associated with the assets.

Explanation

An operating lease allows use of assets without the transfer of ownership rights of such assets. Under an operating lease, the administration and other maintenance charges for assets are borne by the lessor. The duration of an operating lease ends much before the estimated economic life of the asset and the lessor can lease the asset to another lessee for the remaining life of the asset.
 
A financial lease allows the use of assets for the specified period of lease term and then transfers ownership rights to the lessee at the end of the lease term. The depreciation and other  the administrative and maintenance expenses are borne by the lessee during the period of lease agreement. The financial lease generally has the lease term which covers almost the whole of the estimated economic life of the asset.
 
A sale-and-leaseback transaction includes selling of the asset by its owner to another party and then leasing it  back from its purchaser. The original owner ceases to own the asset but utilizes it under the lease agreement. The agreement is generally made for fixed assets, preferably real estates, as well as durable goods such as airplanes and trains.The selling of equipment under sale-and-leaseback transaction enhances the liquidity of the firm and fulfils its capital requirements without disturbing the profits earned from the concerned equipment.
 
A combined lease contains the mixed features of the operating as well as financial lease. The combined lease generally contains customized terms and conditions created to meet the different obligations of the parties which neither of the two types of leases fulfil.
For example, if a cancellation clause is provided in the financial lease which is one of the features of the operating leases, this makes this specified lease agreement a combination lease.

Verified Answer

An operating lease is an agreement that allows the lessee to use the lessor’s asset in lieu of rent for a period specified in the agreement without transferring the ownership of the asset.
 
A financial lease is an agreement where the lessee is allowed to use the asset during the lease term and is given the ownership of that asset by the end of the lease term.
 
A sale-and-leaseback is a financial transaction where the owner of the asset sells the asset to another party and takes it back on lease in order to use it without having the ownership rights.
 
A combination lease is a lease agreement that provides mixed features of the financial as well as the operating lease.

Explanation

Off-balance sheet financing is a way of reporting the company’s liability in such a way that it does not appear in the balance sheet of the company.
For example, under an operating lease, the lease liability was recorded as rent expense prior to the accounting standards amendment in 2019. Therefore, the lease liability was shown in the income statement as rent expense but not in the balance sheet of the company. However, the net income after deduction of rent expense was reported in the balance sheet.
Capitalising a lease records a lease whose term exceeds one year in the books of lessor and lessee. The lease is recorded as an asset in the books of the lessor and as a liability in the books of the lessee. Recording of these financial terms will give the actual financial statements representing actual assets and liabilities of the company to the end users. Therefore, the depreciation expense for the concerned assets and interest expense for the concerned liabilities are adjusted in the financial statements.

Verified Answer

The off-balance sheet financing is a practice of not reporting a liability directly on a company's balance sheet, the liabilities are reported in such a way that they do not appear in the balance sheet.
Capitalising a lease means to record any lease whose term is more than one year as the asset in the books of the lessor and as a liability in the books of the lessee.

Explanation

FASB statement 13 lays down the standards for the reporting of the lease agreements. FASB 13 regulates the classification of the lease agreements as financial and operating leases and their treatment in the books of lessee and lessor. It also explains the various calculations and valuation methods that are used to value the lease liability and the payments.
 
ASU 2016-02 is the accounting update issued by the fundamental accounting standards board (FASB) for capitalising a lease whose period exceeds one year. The capitalising of lease records the lease as an asset in the books of lessor and as a liability in the books of lessee and thus, helps in ensuring transparency and comparability among different organizations and depicts true accounts and financial position.

Verified Answer

The FASB statement 13 is the financial accounting standards board (FASB) statement that sets up the standards of financial accounting and financial reporting for leases by the parties to a lease agreement that is, lessor and lessee.
 
The accounting standards update (ASU) 2016-02 is the accounting update issued by the fundamental accounting standards board (FASB) for capitalising the leases that exceeds the time period of one year that is, reporting lease assets and lease liabilities on the balance sheet and disclosing the actual accounts to the users.

Explanation

All leases that fulfil the guidelines laid by the internal revenue service (IRS) to determine the availability of tax benefits to the lessor are called guideline lease. Once the lease fulfills these guidelines, the lessor and lessee becomes eligible to avail the tax benefits by claiming depreciation and recording lease payments respectively.

Verified Answer

A guideline lease, also known as a tax oriented lease is an arrangement that fulfils all the conditions specified in the guidelines issued by the internal revenue service (IRS) regarding lease agreements.

Explanation

The residual value is the remaining market value of the leased asset at the end of the lease term. Residual value is one of the primary elements used in performing lease analysis by the lessor. Lessor also uses the estimated residual value for determining what he should charge from the lessee as periodic lease payments as well as to  classify a lease into tax oriented or non tax oriented lease.

Verified Answer

The residual value is the remaining market value of the leased asset at the end of the lease term.

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