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Leasing Promulgations

Leasing Promulgations

There are two basic forms of leases: operating and capital leases. An operating lease involves only the right to use an asset for a period of time, where the asset is returned at the termination of the lease. With a capital lease, the lessee usually makes arrangements with the lessor with an option to acquire the asset at the end of the lease period. Because capital leases must be reflected on the balance sheet or statement of financial position, there has been a tendency for companies to simply classify all leases as operating, as this would allow them to defer expenses and report a lower debt amount. Such actions are often referred to as off-balance sheet reporting and can materially misrepresent the financial position of a company. The development of IAS 17 has created guidelines for determining how to classify and report a lease and reduce the amount of controversy involved. The intent is to stop off-balance sheet techniques for lease accounting to provide stakeholders with a more accurate representation of a company's financial position. Once published, these new leasing rules will have a major impact on many companies.

Write a guide for a 2- to 4-page paper comparing capital and operating leases (similarities and differences) and explain how each are classified on financial statements. Explain how their classification and the changes in how they were reported over time impacted accounting practice.

Solution Preview

Step 1
Capital leases are debts of the lessee and appear on the liabilities side of the balance sheet. These give the firm which is leasing, the benefits and problems of ownership. They are considered assets and they may be depreciated. Capital leases are used for long term leases and for those capital assets that do not become obsolete because of technology.

In case of operating lease the rental cost of the lease is an operating expense. The asset is used by the lessee but he does not take on the problems or benefits of ownership. Operating leases are typically used for short-terms leasing and are suitable for machinery and other assets that have a high degree of technology involved in it. Computers and office equipment are common examples of assets that are under operating leases.

Step 2
For equipment to quality for capital lease at least one of the following conditions must be satisfied. The present value of the lease payments should be more than 90% of the fair market value of the equipment. The term of lease should be more 75% of the ...

Solution Summary

This solution explains capital leases and operational leases. The sources used are also included in the solution.

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