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ANSWERS TO END-OF-CHAPTER 19 QUESTIONS

19-1 a. The lessee is the party leasing the property. The party receiving the payments from the lease (that is, the owner of the property) is the lessor.

b. An operating lease, sometimes called a service lease, provides for both financing and maintenance. Generally, the operating lease contract is written for a period considerably shorter than the expected life of the leased equipment, and contains a cancellation clause. A financial lease does not provide for maintenance service, is not cancelable, and is fully amortized; that is, the lease covers the entire expected life of the equipment. In a sale and leaseback arrangement, the firm owning the property sells it to another firm, often a financial institution, while simultaneously entering into an agreement to lease the property back from the firm. A sale and leaseback can be thought of as a type of financial lease. A combination lease combines some aspects of both operating and financial leases. For example, a financial lease that contains a cancellation clause--normally associated with operating leases--is a combination lease. A synthetic lease is an arrangement between a company and a special purpose entity that it creates to borrow money and purchase equipment. Although the “lease” amounts to actually borrowing money guaranteed by the lessee, it doesn’t appear on the company’s books as an obligation. A special purpose entity (SPE) is a company set up to facilitate the creation of a synthetic lease. It borrows money that is guaranteed by the lessee, purchases equipment, and leases it to the lessee. Its purpose is keep the lessee from having to capitalize the lease and carry its payments on its books as a liability.

c. Off-balance sheet financing refers to the fact that for many years neither leased assets nor the liabilities under lease contracts appeared on the lessees’ balance sheets. To correct this problem, the Financial Accounting...