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4/7/2016 FinancialLease

FinancialLease
Accounting
MeaninganddefinitionofFinancialLease

Afinancialleaseisamethodusedbyabusinessforacquisitionofequipmentwithpayment
structuredovertime.Togiveproperdefinition,itcanbeexpressedasanagreementwhereinthe
lessorreceivesleasepaymentsforthecoveringofownershipcosts.Moreover,thelessorholds
theresponsibilityofmaintenance,taxes,andinsurance.

Afinancialleaseissimilartoanoutandoutpurchasetransactionwhichhasbeenfinanced
throughatermloan,inthatthepaymentsaremadeonamonthlybasis.However,unlikean
outandoutpurchasetransactioninthatthelesseedoesntpresenttheobligatedbalanceas
debt,showspaymentsasexpensed,andretainstheequipmenttitle.Duringtheleaseperiod,the
financecompanyisconsideredasthelegalowneroftheasset.

MainfeaturesofaFinancialLease

Acapital/financialleaseisacommercialarrangementwherein:

thelessee(borrowerorcustomer)selectsanasset(equipment,software,vehicle

thelessor(financecompany)purchasesthatasset

thelesseeusesthatassetduringthelease

thelesseepaysaseriesofinstallmentsorrentalsforusingthatasset

thelessorrecoversalargepartoralmostcompletecostoftheassetinadditiontoearning
interestfromtherentalspaidbythelessee

thelesseehastheoptionofacquiringownershipoftheasset(bargainoptionpurchaseprice
orpayingthelastrental)

ImpactofFinancialLeaseonAccounting

Afinancialleaseshowsthefollowingimpactsonaccounting:

Beingcapitalized,afinancialleaseleadstoanincreaseinassetsaswellasliabilitiespresent

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4/7/2016 FinancialLease

inthebalancesheet.Consequently,workingcapitalfalls,butanadditionalleverageis
createdbyanincreaseinthedebtequityratio.

Leaseobligationsarenotrecognizedunderoperatingleaseconditions,thus,resultingin
understatedleverageratiosandoverstatedratiosofreturn.

Inacashflowstatement,partofleasepaymentsarereportedunderoperatingcashflow
andpartunderfinancingcashflowbecauseoffinancialleaseexpensesbeingallocated
betweenprincipalexpenseandinterestexpenseakintoaloanorbond.

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