Chapter 25: Leasing

A lease is

a contract between two parties: the lessee and the lessor.

Non-tax lease:

although the legal ownership of the asset resides with the lessor, in a non-tax lease, the lessee receives the depreciation deductions.

If lease is deemed to be a security interest, the lessor is then treated as

any other secured creditor and must await the firm's reorganization or ultimate liquidation.

True tax lease: the lessee can

deduct the full amount of the lease payments as an operating expense, and these lease payments are treated as revenue for the lessor.

Non-tax lease: The lessee can also

deduct the interest portion of the lease payments as an interest expense.

FMV cap lease: lessee has the same option in a fixed price lease, although the option in this case is

easier to exercise because the lessee does not have to find a similar asset elsewhere to buy when the fixed price exceeds the market value.

A lease therefore allows the lessee to commit to

give the lessor superior treatment in default compared to ordinary creditors.

Fair market value (FMV) lease:

gives the lessee the option to purchase the asset at its fair market value at the termination of the lease.

Operating leases are disclosed in

he footnotes of the lessee's financial statements.

A sale and lease-back:

if a firm already owns an asset it would prefer to lease, they can arrange a sale and leaseback transaction.

Special-purpose entity (SPE):

in some circumstances the lessor is not an independent company but rather a separate business partnership called SPE which is created by the lessee for the sole purpose of obtaining the lease.

Non-tax lease: the interest portion of the lease payment is

interest income for the lessor.

Capital lease: (also called a finance lease)

is viewed as an acquisition for accounting purposes.

Capital lease: the PV of the future lease payment is

listed as a liability, and the interest portion of the lease payment is deducted as an interest expense.

Capital lease: the asset acquired is

listed on the lessee's balance sheet, and the lessee incurs depreciation expenses for the asset.

Within 120 days of filing Chapter 11, the bankrupt firm

must choose to assume or reject the lease.

If firm assumes the lease,

must settle all pending claims and continue to make all promised lease payments.

The lessor, who is the _______ is entitled to

owner of the asset, is entitled to the lease payments in exchange for lending the asset.

$1 out lease: (aka a finance lease)

ownership of the asset transfers to the lessee at the end of the lease for a nominal cost of $1. thus, the lessee will continue to have use of the asset for its entire economic life.

The lessee is liable for

periodic payments in exchange for the right to use the asset.

$1 out lease: The lessee has effectively

purchased the asset by making the lease payments.

A sale and lease-back: In this type of lease, the lessee

receives cash from the sale of the asset and then makes lease payments to retain the use of the asset.

If lease is classified as a true lease, then the lessor

retains ownership rights over the asset.

If the firm rejects the lease,

the asset must be returned to the lessor (with any pending claims of the lessor becoming unsecured claims against the bankrupt firm)

Operating lease: The lessee reports

the entire lease payment as an operating expense. The lessee does not deduct a depreciation expense for the asset and does not report the asset, or the lease payment liability on its balance sheet.

Classification of a true lease or security interest depends on

the facts of the case, but distinction is similar to accounting and tax distinctions made earlier

If lease is deemed to be a security interest,

the firm is assumed to have effective ownership of the asset and the asset is protected against seizure.

Fixed price lease: At the end of the lease, if the MV of the asset exceeds the fixed price,

the lessee can buy the asset at below its MV

FMV cap lease:

the lessee can purchase the asset at the minimum of its fair market value and a fixed price (the "cap").

Fixed price lease: At the end of the lease, if the MV of the asset DOES NOT exceed the fixed price,

the lessee can walk away from the lease and purchase the asset for less money elsewhere.

Fixed price lease:

the lessee has the option to purchase the asset at the end of the lease for a fixed price that is set upfront in the lease contract.

Leveraged lease:

the lessor borrows from a bank or other lender to obtain the initial capital for the purchase, using the lease payments to pay interest and principal on the loan.

Direct lease:

the lessor is an independent company that specializes in purchasing assets and leasing them to customers.

Thus, if a lease contract is characterized as a true lease in bankruptcy,

the lessor is in a superior position than a lender if the firm defaults.

Sales-type lease:

the lessor is the manufacturer or primary dealer of the asset.

True tax lease:

the lessor receives the depreciation deductions associated with the ownership of the asset.

By retaining ownership of the asset, the lessor has

the right to repossess it if the lease payments aren't made, even if firm seeks bankruptcy protection.

Because capital leases increase the apparent leverage on the firm's balance sheet, firms sometimes prefer

to have a lease categorized as an operating lease to keep it off the balance sheet.

Operating lease:

viewed as a rental for accounting purposes.

The treatment of leased property in bankruptcy will depend on

whether the lease is classified as a security interest or a true lease by the bankruptcy judge.