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Leasing
101 > Leasing
Wisdom > Impact on the Balance
Sheet > Electronic
Payment Convenience > Tax
Savings > What
is Leasing > Frequently
Asked Questions
Leasing is a flexible tool that lets businesses
keep equipment off the balance sheet, which may help them
meet financial objectives. For accounting purposes, balance
sheets for companies that lease equipment can show some of
their equipment all of the time, all of their equipment some
of the time, but they don't have to show all of the equipment
at any time.
Capital and Operating Leases
Whether or not a lease appears on the balance sheet
depends upon its classification--capital or operating--from
the perspective of the lessee. If the lease is a capital lease,
the lessee is treated as owner of the leased equipment. On
the balance sheet, the lease is shown as an asset with a corresponding
debt obligation. When the lease is classified as an operating
lease, it does not appear on the balance sheet, but rather
shows up as an operating expense on the income statement.
Only the balance sheet footnotes disclose the existence of
operating leases.
Benefits of off-balance-sheet financing
The most important benefit of operating leases is the effect
they have on financial ratios. Off-balance-sheet financing
lowers the debt to equity ratio, raises the current ratio
(liquidity), and raises return on assets (ROA). Improved ratios
may help an organization obtain additional traditional financing,
providing more capital for growth and profit-generating activities.
The performance of companies and their managers is measured
by their financial ratios for many different reasons, and
operating leases can help produce the desired results.
Classification criteria
The Financial Accounting Standards Board defines the criteria
for lease classification very clearly in FAS Statement No.
13. Any lease that has one or more of the following characteristics
must be classified as a capital lease.
1. The lease transfers ownership of the property
to the lessee by the end of the lease term.
2. The lease contains an option to purchase
the leased property at a bargain price.
3. The lease term is equal to or greater than
75 percent of the estimated economic life of the leased property.
4. The present value of the minimum lease payments
equals or exceeds 90 percent of the fair value of the leased
property.
Generally, equipment with shorter lease terms
and higher resale potential fit the first three requirements
more easily. Number four (the 90-percent test) is the one
that causes the most confusion.
To be classified an operating lease; the total
present value payment obligations of the lessee must be less
than 90 percent of the fair value of the equipment at the
beginning of the lease. If a lease fails the 90-percent test,
the lessor may provide an alternate lease structure. For example,
Signature has the structuring flexibility to offer an early
out or minimum lease term during which the total of all lessee
obligations is less than 90 percent. The lessee's total obligations
under the lease contract theoretically end at the minimum
lease term, and the contract spells out the conditions for
continuing the lease to the end of its regular term.
Tax Benefits
Tax deductions are granted depending upon the "ownership"
of the equipment determined by IRS guidelines. Although similar,
the criteria for determining ownership for tax purposes are
different than determining ownership for accounting purposes.
Equipment ownership for the same lease could very well be
assigned to one party for tax purposes and the other party
for accounting purposes. Signature Leasing recommends seeking
the advice of accounting and tax professionals when classifying
leases.
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