Capital Leases and Operating Leases Essay

1493 Words Jan 30th, 2014 6 Pages
ACCT 3303 | CAPITAL LEASE vs. OPERATING LEASE | |

Dr. Serge Ryno
ACCT 3303
December 2, 2011
Capital Lease vs. Operating Lease Firms often choose to lease long-term assets rather than buy them for a variety of reasons including the tax benefits that are greater to the lessor than the lessees and leases offer more flexibility in terms of adjusting to changes in technology and capacity needs. Lease payments create the same kind of obligation that interest payments on debt create, and have to be viewed in a similar light. If a firm is allowed to lease a significant portion of its assets and keep it off its financial statements, an examination of the statements will give a very misleading view of the company's financial strength.
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The better the financials look, the easier it is to get needed financing in the future. Since there is no ownership involved, operating leases offer a great deal of flexibility. For example, a small business doesn't need to worry about equipment becoming obsolete. A company can simply lease newer equipment. The ability to directly expense leasing costs provides some accounting benefit. When a company owns an asset, accounting rules dictate that the property, plant or equipment must be depreciated and held on the balance sheet for the asset's useful life. In effect, this ties up the company's cash flow and leverages the company to financiers. Operating leases are not subject to these constraints. One disadvantage of entering an operating lease involves the higher level of expenses reported. Businesses who enter operating leases record a lease expense for each period throughout the duration of the lease. These expenses appear on the company's income statement. The income statement reports the revenues earned for the period, the expenses incurred and the net income for the period. Operating leases represent temporary arrangements between the lessor and the company. When the lease expires, the terms of that lease become void. The lessor and the company spend time renegotiating the terms or ending the relationship. The company needs to reconsider the lease and evaluate its options on a regular basis. This lack of continuity…

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