Question

In: Accounting

Mr. Kiran proposes to issue bonds and with the cash proceeds purchase the needed assets. What...

Mr. Kiran proposes to issue bonds and with the cash proceeds purchase the needed assets. What might be the advantages of leasing the assets instead of owning them? What might be the disadvantages of leasing the assets instead of owning them?

Expert Solution

Answer :

Concept :

Leases - Form of debt Financing where the Lessor ( Landlord ) gives the right to the Lessee ( tenant ) to use an Asset over a certain period of time in return for Periodic Lease Payment ( rentals ).

Types of Leases :

A. Operating Lease - Periodic lease payments accounted for as a Rent Expense; Lease in a "True Rental" Form.

B. Capital Lease ( Finance Lease ) - Lease in which the Lessee capitalizes the lease ( Debits Asset and Credits Liability) at the present Value of minimum lease payments.

Note: Lessee does not legally own the asset but still capitalizes the leasehold asset and claim depreciation using Concept "Substance over Form".

Substance Over Form is concept where Economic form of transactions are more important than its legal form.

Advantage of Leasing :

1. Entity can Lease the asset if it doesn't have funds to Procure the asset.

2. Lease provisions generally less Stringent than a Bond Indenture.

3. Negligible ( or Zero ) Initial Investment; may be no down payment requirement.

4. Creditor claims on Leased assets are restricted.

5. Lease can be structured in a manner to allow tax benefits to lessee.

Disadvantages of Leasing :

1. Overall Cost of Leasing generally more than the cost of purchasing the Asset.

2. Lease Liability needs to be recognized on the balance sheet.

ekkarill92 answered 2 years ago

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