In: Accounting
Explain the nature, economic substance, and advantages of lease transactions.
the lease is an arrangement by which the lessor gives the right to use an asset for given period of time to lessee on rent. lease involves the two parties, a lessor and a lesse. lessor is a person who owns the asset, aggrees to allow to the lessee to use it for a specified period of time in return for periodic rent payments.
the lease transistion derive its accounting complexity from number of alternatives available to the parties involved lease can be structured to take tax benefits. it can be used to transfer ownership of the leased asset, and it can be used to transfer the risk of ownership.
in any event substance of transistion dictates the accounting treatment, the transistion is probably the best example of the accounting professionals substance over legal form.
if the transistions effectively transfer ownership to lessee, then the substance of the transistions is that of a sale and should be recognised as such even through transistion take form of a lease.
for the purpose of accounting,the lease is classified into two catagories;-
a) finance lease
b) operating lease.
a) finance lease;- it is a lease which transfer substantially all the risks and rewards incidental to ownership of an asset to lessee by the lessor but not the legal ownership.
b). operating lease;- it is a lease which does not transfer substantially all the risks and rewards incidental to ownership of an asset to the lessee by the lessor.
classification of lease is made at the inception of lease.