What is a lease?

A lease is an agreement conveying the right to use property, plant, and equipment (PP&E) usually for a stated period of time.Specifically excluded are lease agreements to explore or exploit resources such as oil, gas, minerals, and timber, and licensing agreements for items like motion picture films, plays, manuscripts, patents, and copyrights. A lease as an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.

Lease ContractA lease contract is an agreement under which the owner of the equipment (the lessor) conveys to the user (the lessee) the right to use the equipment in return for a number of specified payments over an agreed period of time. Typical examples in the technology industry for capital leases are leased photocopy machines (e.g. Xerox) or servers (e.g. Dell).

Financial (Capital) lease vs. Operating lease?AFinancial (capital) leaseis usually used to finance equipment for the major part of its useful life, and there is a reasonable assurance that the lessee will obtain ownership of the equipment by the end of the lease term.Anoperating leaseusually finances equipment for less than its useful life, and at the end of the lease term the lessee can return the equipment to the lessor without further obligation.

Advantages of leasingImmediate cash outlay is not requiredTypically, a purchase option exists, permitting the lessee to obtain the property at a bargain price at the expiration of the lease.Lessors expert service is made available.Generally fewer restrictions placed on the lessee by the lessor than are imposed when obtaining a loan to buy the asset.

Drawback of leasingA higher cost in long run than if the asset is purchased.The interest cost associated with leasing is typically higher than the interest cost on debt.If the property reverts to the lessor at termination of the lease, the lessee must sign a new lease or buy the property at higher current prices.The lessee may have to retain property no longer needed.The lessee cannot make improvement to the leased property without the permission of the lessor.

End of Lecture 11

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