Leasing

Definition

Leasing is a financing option where a company obtains the right to use an asset, such as equipment or property, by making periodic payments to the asset's owner. It allows businesses to access and utilize assets without the full upfront cost of ownership.

5 Must Know Facts For Your Next Test

1. Leasing can provide businesses with access to assets without the need for large upfront capital investments, allowing them to preserve working capital.
2. Leases are typically structured as either operating leases or capital leases, with different accounting and tax implications for the lessee.
3. Leasing can offer flexibility in terms of asset upgrades, as the lessee can often return or exchange the asset at the end of the lease term.
4. Leasing can provide tax benefits, as lease payments are generally considered operating expenses and are deductible from taxable income.
5. The decision to lease or purchase an asset depends on factors such as the expected usage of the asset, the availability of capital, and the company's financial goals.

Review Questions

• Explain the key differences between operating leases and capital leases, and how they impact a company's financial statements.
  • Operating leases are treated as rental agreements, where the leased asset is not recorded on the company's balance sheet, and the lease payments are reported as operating expenses on the income statement. In contrast, capital leases are accounted for as a purchase, where the leased asset is recorded as an asset on the balance sheet, and the lease payments are split between interest expense and principal reduction. The choice between an operating lease or a capital lease can significantly impact a company's financial ratios and reported profitability.
• Describe the potential benefits and drawbacks of leasing assets compared to purchasing them outright.
  • The primary benefits of leasing include preserving working capital, gaining access to assets without large upfront investments, and potential tax advantages from deducting lease payments as operating expenses. However, leasing may result in higher overall costs over the life of the asset, as the lessee does not build equity in the asset. Additionally, leasing may limit the lessee's flexibility in terms of modifying or upgrading the asset. The decision to lease or purchase an asset should consider the company's financial goals, the expected usage of the asset, and the long-term cost implications.
• Analyze how a company's decision to lease or purchase assets might impact its capital structure and financing strategy.
  • A company's decision to lease or purchase assets can have a significant impact on its capital structure and financing strategy. Leasing, which is considered off-balance-sheet financing, can help a company maintain lower debt levels and improve its debt-to-equity ratio, as the leased asset and associated debt are not recorded on the balance sheet. This can improve the company's perceived creditworthiness and access to other sources of financing. However, the long-term financial obligations of leases must be carefully considered, as they can still impact the company's overall financial risk profile. The choice between leasing and purchasing assets should be aligned with the company's broader financing strategy and capital structure goals.

Related terms

Operating Lease: A type of lease where the leasing company retains ownership of the asset, and the lessee pays to use the asset for a specified period of time.

Capital Lease: A type of lease that is accounted for as a purchase, where the lessee assumes many of the risks and rewards of ownership.

Lease-to-Own: A leasing arrangement where the lessee has the option to purchase the asset at the end of the lease term, often for a nominal fee.