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Leasing can be a way for an organization to hide a liability

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Leasing has become a way that many organizations attempt to hide liability. How is this possible?
From an accounting standpoint, what must a company recognize in most basic leasing transactions?
Describe the accounting literature around leasing and the many benefits.

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Solution Summary

the 514 word, cited solution carefully explains the difference between leasing and buying including the two types of leases: capital and operating. The history of leases, the definitions and the reporting in financial statements is included, plus the practical applications to business for the use of leases.

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It is relatively easy to hide debt because of the structure of leases. There are two types of leases: capital and operating. A capital lease is essentially a financing transaction which means a company is purchasing an asset and signing up for debt. If it is construed as a lease, then neither the asset nor the corresponding debt will be recorded.

Think through the transaction for a true lease: each month when the payment is made, the transaction that is recorded is:

Debit expense
Credit cash

The result is no asset and no debt. It is actually rent expense.

As with everything else in our innovative economy, the structure of leases was designed to follow the 'debit expense' scenario above. Companies liked it because their debt ratios were not ...

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