In leasing, lessor usually take care of the maintenance

of property. The cost named executory cost. Usually in lease, maintanance, tax, insurance, depreciation, all covered by lessor and become operating expense. Various reasons offered for wanting to structure the sale and purchase of an asset as a lease:
Lessee wants to avoid large payable on balance sheet Lessee lacks the capital for buying Lessor by not transferring title to lessee, is able to earn

certain tax benefits, which it can pass to lessee.

 Basic financing lease: manufacturer finance the

acquisition of equipment by customer. Title may pass to customer at the end of finance term. In case the lease at last effect a purchase, lessee should record equipment leased at fair value and show lease payable in same amount. Lessor treat lease as sale. Sales-type lease: difference between the fair value of asset and cost recognized as normal profit. Direct financing lease: lessor show interest revenue on installment of sale. No profit recognized. At last, referred as capital lease.

 October 1949 in ARB 38, subsequently become

Chapter 14 of ARB 43, which is said: Where it is clearly evident that the transaction involved is in substance a purchase, the leased property should be included among the assets of the lessee with suitable accounting for the corresponding liabilities APB 5 and APB 7, issued in 1966, introduced operating and financing leases into general usage,

 FASB issued SFAS 13. criteria when lease sufficiently

treated like a purchase :

The property title will be transferred to the lessee by the

end of the lease term or under a bargain purchase option The term of the lease is at least 75% of the economic life of the property, unless the term begins within the last 25% percent of this life. At the inception of lease, PV of min.lease payments equals or exceed 90% of FV leased property.

 FASB criteria to determine lease as sales type or capital

lease:
The collection of min. lease payments should be

reasonably predictable. The unreimbursable costs to be incurred by lessor under the lease other than for insurance, maintenance, and taxes should be measurable and not be surrounded by important uncertainties.

 Complex, when there is potential conflict between

SFAS 13 and SFAS 66. SFAS 13 sales type lease, recognition of profit. SFAS 66 installment sale, no profit recognition. FASB decides real estate subject under provision of SFAS 66. Lease of land generally operating lease. If lease of land has bargain purchase option, than treated under rules of SFAS 66.

 Purchase assetsright to hold, use and dispose

property. lease assets not having the right of disposal. Lessee owning rights but not the assets. While leases and purchases share some characteristics, they do not share all:
The maintenance, tax, insurance covered by lessor. The residual equity is held by lessor.

Special tax benefits accrue to the lessor. Lessor may

transfers tax advantages to lessee.

 On legal level, if one default on installment payments,

one is still liable for the remaining payments. One default in lease, one is not liable for the remaining lease payment. Law treats leases as executory contracts. Basic criticismall criteria emphasize the similarities of lease to purchase, and fail to recognize that lease has characteristics of its own. Lease should be reported in a way that describes their nature and characteristics as completely as possible, rather than incorporate them as the traditional form of assets and liabilities.

 If goods/ services acquired on a year to year basis or

under contract that is cancelable rights and obligation are generally not material regarding their effect on balance sheet. No capitalization is necessary. If contract noncancelable by either party contract should be capitalized, discounted value of both rights and obligations should be disclosed.

 Contract to purchase given quantity of goods ><

an obligation to pay for goods already acquired about same amount, but differ in : 1st case,the firm has an obligation to pay goods when received. 2nd case, obligation to pay goods already received. Assets form long term commitment right to receive goods and services, and claim should be recorded on the basis of the discounted amounts of expected values. as with receivables the value of the claim depends on the expectations that they will materialize.

 In SFAS 13, leases confined to contracts for involving

land and depreciable asstes. But lease could be also in: intangible asstes, supply of heat and electricity, or take or pay agreements. Capitalization should be necessary only if the penalty is sufficient to act as a deterrent to unilateral default.

 Capitalization of commitment not as compelling as

capitalization of lease. Advantage of capitalization of long term commitment in general is that the valuation of the rights can be treated separately from valuation of obligation. Long term commitment exp. Purchase given quantity at pre determined price over long term period (take-or-pay contract) Capitalization of Long term commitment allows the valuation of the asset different from value of liability, in case goods price change materially. For record the losses, needs to set up partial liability / reverse (Ch.18)

 Application of the long term commitment principle

to lease extend the amount to be capitalized. Its included lessees payment for taxes, insurance, maintenance since its unconditional payment, regardless whether or not property is used.

 Argument against capitalization of long term

commitment other than long-term lease:

On long term lease, there is lack comparability. Firms

that own property show assets and obligation, those lease property failed show either asset & liab.at balance sheets financial ratios computed from statement of property owner cannot be compared. Payment under long term commitment more related o associated expense Reporting of current payments better discloses actual cash flow of the firm.