Question

Leases are frequently used as an alternative to debt. Lessees include individuals, businesses, nonprofit organizations, and governments. Individuals regularly lease homes, automobiles, computers, and even furniture. Land, buildings, and equipment are leased by businesses, nonprofit organizations, and governments. Instead of signing a loan agreement calling for a fixed series of principal and interest payments, the company signs a lease agreement calling for a fixed series of lease payments over all or most of the asset’s life. Accountants recognize the similarity of leasing and borrowing by classifying those leases that are close substitutes for borrowing as financial leases, also called capital leases, and requiring the present values of the lease payments for those leases to appear as assets and long-term liabilities on the balance sheet. If a lease has the same economic consequences as debt, the present value of contractual lease payments should be treated as part of the long-term debt in cost of capital analysis as well. As a practical matter, the present value of lease payments appears on the balance sheet. As with debt, it is necessary to include the current portion of the lease obligation as well as the present value of payments on operating and capital leases that are due more than a year in the future. In the event of default, a lessor can often reclaim the leased asset faster and easier than would be the case for a secured lender. Therefore, lessors are often willing to provide assets through a lease when the company’s credit rating would not be strong enough to induce a creditor to make money available. The creditor compensates for risk by financing only part of the cost of the asset, while leases often provide close to 100 percent financing From an analysts' perspective, the fixed-charge coverage ratio includes lease payments and sinking fund payments with interest obligations to arrive at the ratio of earnings to all fixed cash obligations. Low or falling coverage ratios signal possible cash flow difficulties.

Is this a correct statement? Provide rationale.

Answer 1

A lease is a contract outlining the terms under which one party agrees to rent property,car, equipments etc owned by another party. It guarantees the lessee also known as the tenant, use of an asset and guarantees the lessor, the property owner or landlord, regular payments for a specified period in exchange. Both the lessee and the lessor face consequences if they fail to uphold the terms of the contract.

capitalized lease increases the total value of the assets on your balance sheet. That affects a number of ratios that creditors, potential investors and others use to evaluate your company's profitability and efficiency. It will reduce your company's return on assets (essentially, the profit it generates for each $1 worth of assets) and its asset turnover (the sales generated for every $1 worth of assets). And since the lease also appears as a liability, it affects measures of financial leverage, such as your liabilities-to-equity ratio. In short, a capitalized lease can make your company's performance look worse, so businesses often structure leases in such a way so they can report them as operating leases.

Breaking a Lease

Consequences for breaking leases range from mild to damaging, depending on the circumstances under which they are broken. A tenant who breaks a lease without prior negotiation with the landlord faces a civil lawsuit, a derogatory mark on their credit report or both. As a result of breaking a lease, a tenant may encounter problems renting a new residence, as well as other issues associated with having negative entries on a credit report. Tenants who need to break their leases must often negotiate with their landlords or seek legal counsel. In some cases, finding a new tenant for the property or forfeiting the security deposit inspires landlords to allow tenants to break their leases with no further consequences.