Chapter 19, Problem 1Q

a.

Summary Introduction

To explain: The terms lessee and lessor.

Explanation of Solution

Lessee is usually the person who makes the payment in order to use the asset taken on lease. Lesser can be explained as the title-holder of an asset given on lease to the lessee.

b.

Summary Introduction

To explain: The terms operating lease, financial lease, sale-and-leaseback and combination lease, synthetic lease and SPE

Explanation of Solution

Operating lease is defined as a lease that allows a lessee to use the asset acquired on lease but this does not expresses about the rights of possession of an asset. It is also known as service lease.

Financial lease is defined as a lease in which the lessee is typically a legal owner of an asset during the tenure of lease. It is also known as capital lease or sales lease.

Sale and leaseback can be referred to as leaseback. In this type of lease, a company sells the asset to another company during liquidity crisis and then acquires the same asset on lease to use it. It can be considered as a type of financial lease.

Combination lease is defined as a mixture of both operating and financial lease.

A synthetic lease is an arrangement among a company and a special purpose entity.

It produces to borrow money and purchase equipment. It doesn’t seem to be on the books of the company as an obligation though the amounts of “lease” to really borrowing money guaranteed by the lessee.

 A special purpose entity (SPE) is a company set up to simplify the creation of a synthetic lease.  It borrows money which is guaranteed by the lessee, purchases equipment, and leases it to the lessee.  Its determination is to keep the lessee from having to capitalize the lease and to carry the payments on the books as a liability.

c.

Summary Introduction

To explain: The terms off-balance sheet financing and capitalizing.

Explanation of Solution

Off-balance sheet financing is defined as a situation in which operating lease for the lessee and lesser never appeared on the balance sheets of both the parties to a lease agreement. To tackle this problem Accounting Standards Board (ASB) issued a statement named as FASB (Financial Accounting Standards Board) statement 13.

Capitalizing can be defined as incorporation of amounts of leased assets and leased liabilities in balance sheets to report as true and fair picture of balance sheet. It further included reporting of operating lease according to ASB update 2016-02.

d.

Summary Introduction

To explain: The terms FASB Statement 13.

Explanation of Solution

FASB Statement 13 is a statement issued by ASB that provides information regarding lease provisions and about the procedures to be followed while reporting the leased amounts in balance sheet.

e.

Summary Introduction

To explain: The term guideline lease.

Explanation of Solution

Guideline lease can be defined as a lease that fulfills all the conditions stated in Internal Revenue Service (IRS) required for a valid lease. It also recognized as tax-oriented lease. Fulfillment of IRS conditions can provide lesser with the benefits of ownership.

f.

Summary Introduction

To explain: The term residual value.

Explanation of Solution

Residual value can be defined as the market value of a lease asset at the end of its useful life.

g.

Summary Introduction

To explain: The terms lessee’s analysis and lessor’s analysis.

Explanation of Solution

Lessee’s analysis is explained as analysis done by a lessee before acquiring an asset on lease. Lessee determines whether buying an asset or leasing an asset which among the two options would be more cost effective.

Lessor’s analysis explained as analysis done by a lessor’s which involves determining rate of return on the proposed agreement by the lessee. If the cash inflows are much more than the opportunity cost than it is a cost effective investment.

h.

Summary Introduction

To explain: The term net advantage to leasing (NAL).

Explanation of Solution

Net advantage to leasing (NAL) can be defined as the difference between present value of after tax leasing cash flows and present value of after tax owning cash flows. It can also be stated as cost of leasing versus cost of owning.

i.

Summary Introduction

To explain: The Alternative minimum tax (AMT)

Explanation of Solution

AMT is figured at 20% of the profits which are reported to the stock holders. It is the provision of tax code which needs the profitable firms to pay at least some taxes when such taxes are more than the amount due under the standard tax accounting.

It provides a stimulus to leasing for firms which pays AMT as leasing lowers the profits which are reported to the stock holders.