Leasing Canadian

Leases and accounting

to overcome the effects of leasing on companies balance sheets, the CICA provides guidelines on distinguishing between operating and financial leases and how to treat financial leases
Reasons For Leasing
Other reasons for leasing include: 1. ready availability


companies with poor credit ratings can sometimes obtain 100 percent financing through a lease compared to only partial loan financing on the same asset If payments on a loan are variable while lease payments are fixed, the borrowing option contains an additional element of risk, giving incentive to lease
direct lease – lessee gets the use of an asset not previously owned sales and leaseback – lessee sells an asset to a financial institution which than leases the asset back to the lessee

Framework for discounted cash flow analysis


both NPV and IRR can be used to analyse leases if IRR > than after-tax borrowing cost, borrowing is preferred and vice versa if NPV of the leasing cost is > than the asset value, borrowing is preferred and vice versa
Summary
3. Financial (or capital leases) call for a contractual arrangement of sufficient length to allow the lessor to recover the full costs of the asset plus a return. From the viewpoint of the lessee, reliance on a financial lease is very similar to raising funds through debt. Financial leases may take the form of direct leases or sale-and-leaseback arrangements, and they may be two-party leases or thirdparty, tax-leveraged leases.
Introduction

Financial leases


also called “full payout” leases a long-term contract that allows the lessor to recover the full cost of the asset plus a return during the period of the lease financial leases can take two forms:

Leasing as a form of debt financing

Evaluation of Financial Leases
lease and debt financing affects a firm’s financial position in the way they are committed to fixed payments before any earning are accrued to shareholders
Summary
1. The lessor retains title to the asset and makes it available to a lessee in return for periodic lease payments. The lessor takes capital cost allowance (CCA) and any residual value on the asset at the end of the lease agreement. 2. Operating leases provide for a contractual commitment that is short relative to the life of the asset. The risk of obsolescence rests with the lessor.
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residual values are often difficult to estimate because a judgmental risk-adjusted discount rate needs to be applied
1. direct cash outflows associated with the lease contract periodic lease payments minus taxes 2. opportunity costs associated with not owning the asset tax shields from CCA

Leasing has become a popular alternative to buying assets
Introduction
Introduction

Operating leases


contract covers a period that is shorter than the life of the asset usually longer than a year operating leases are advantageous for lessee when: the assessment of risk of obsolescence for an asset is higher than that of the lessor managers want the flexibility to exchange assets on short notice without penalties
Evaluation of Financial Leases


Relevant cash flow must be estimated to determine the economic desirability of leasing versus purchasing an asset The lessee avoids the initial outlay of capital required in purchasing the asset but subsequent costs are incurred including:
Evaluation of Financial Leases

Residual value


when evaluating whether to lease or purchase an asset, we have to charge a lease with the loss of any residual value The present value of net benefit from salvage is equal to:
2. payment provisions

Reasons For Leasing



Organizational considerations some leases are written simply to circumvent organizational restrictions on capital expenditures Lease financing through manufacturers terms under a manufacturers lease may be more attractive than those that a customer could get under a comparable loan Flexibility and obsolescence leases provide the lessee with flexibility and insurance against obsolescence
Introduction

Most leases fall into the class of intermediate-term financing Under a lease two parties are involved:
1. lessor – owns the asset 2. lessee – has full use of the asset and makes periodic lease payments to the lessor