Analytical Exercise and Questions Please read and make sure it is clear and you understand because this is a huge part of my grade.

Chapter 23 Notes

Owning versus Leasing Equipment

Overview

• Understand what purchasing equipment involves

• Understand what leasing equipment involves

• Recognize a for profit organization

• Recognize a not for profit organization

Purchasing equipment means taking title to or assuming ownership of the item. The asset representing the equipment is recorded as an asset on the organizations balance sheet. The purchase can take place by paying in cash from cash reserves or the organization can finance all or part of the asset. If financing occurs, the resulting liability is also recorded on the balance sheet.

Leasing Equipment

A lease is not considered a lease when it is a lease-purchase, also known as a financial lease.

Financial Lease

The lease-purchase is a formal agreement that may be called a lease, but is really a contract to purchase. This is also called a financial lease. The important difference is that the equipment must be recorded on the books as a purchase. This process is called “capitalizing”. The lease must be capitalized and be placed on the balance sheet as an asset with its corresponding liability, if the lease contract meets any of the following criteria:

1. The lessee can buy the asset at the end of the lease term for a bargain price.

2. The lease transfers ownership to the lessee before the lease expires.

3. The lease lasts for 75% or more of the estimated useful life.

4. The present value of the lease payments is 90% or more of the assets’ value.

Operating Lease

The cost of an operating lease is considered an operating expense. It does not have to be capitalized and placed on the balance sheet because it does not meet the criteria mentioned above.

An operating lease is treated as an expense of current operations. This is in contrast to the financial lease mentioned above which is treated as an asset and a liability, a payment on an operating lease becomes an operating expense within the time period when the payment is made.

Buy or Lease Management Decisions

Leasing is an alternative to other means of financing. When analyzing lease vs buying decisions, it is usually assumed that the money to purchase the equipment will be borrowed. In some cases, an organization will use their own funds to make the purchase.

Review Example on Page 264