Leases

Leases Debate

For different reasons, companies usually make the decision to lease long-term assets instead of purchasing them. The tax benefits to the lessor are far greater than they are to the lessee. Leases give companies more flexibility. They allow companies to adjust to their needs and times as far as technological improvements and their capacity. The lease payments have the same responsibility that interest payments create on debt. If a firm can lease a large amount of its assets and keep them off of its financial statements, when someone analyzes the firms statements, they could easily be mislead in their opinion of the financial strength of the firm. This is the reason why accounting rules have been created in order to obligate firms to show the extent of their lease obligations in their financials.

When companies account for leases, they have two options. The first is an operating lease in which the lessor (owner) transfers only the right to use the property to the lessee. When the leasing period reaches its end, the lessee returns the property back to the lessor. Due to the fact that the lessee does not have the risk of owning the leased asset, the lease expense is booked as an operating expense on the firm’s income statement while the lease does not affect the firm’s balance sheet. A capital lease offers another situation. The lessee is the one responsible for some of the risks of ownership, but gets all of the benefits if the leased asset. Therefore, when the lease is signed, it is recognized as both an asset and as far as the lease payments, as a liability on the company’s balance sheet. The company is able to claim depreciation on the lease each year, and they can deduct the interest expense of paying for the lease each year. Basically, capital leases recognize expenses much sooner than operating expenses.

Companies tend to like maintaining leases off of their financials, and usually like deferring expenses. For this reason...