Burlington Northern Railroad Company: Equipment Leasing
To: Rob McKenney Vice President & Treasurer BNRR
From: Paul Weyandt Director of Equipment Finance BNRR
Date: July 15, 1990
Subject: Lease Vs Buy Option for Auto Racks Equipment
This memo is in regard to the recent proposal of leasing or buying the bi-level and tri-level Auto Rack equipment for Burlington Northern Railroad Company. As indicated before, this equipment is a great investment for our company as it exceeds our company’s 20% hurdle rate and therefore investing in them would be a great decision for the company. Hence this memo will seek to explain the optimal way to finance this investment; in other words, this memo will try and
…show more content…
Therefore in this agreement the equipment is going to be partially financed by the lessor (Northwest) through a third-party financial institution (Lender) and act as a leveraged lease, wherein the lending company holds the title to the leased asset, while the lessor creates the agreement with the lessee (BNRR) and collects the payment for the use of the equipment. Therefore the lease in this case will be regarded as a financial decision for BNRR
Looking at our company’s financial structure there are many advantages to such a setup:
• Since, such an agreement will be regarded as an Operating Lease and not a Capital Lease; this lease will not be reported on the company’s balance sheet. Keeping the lease off the balance sheet would make our financial ratios appear more attractive (lower debt/asset ratio) than otherwise. Hence, such a setup provides the advantage of financing the deal as an off-Balance Sheet item.
• Leasing business equipment and tools preserves capital and provides flexibility. Less Capital Investment will be required as part of this setup, as compared to owning the equipment.
• Also, the company would be able to take advantage of the tax benefits by paying lower tax’s in the long run, and operate within the covenants of the Alternative Minimum Tax (AMT) with such a setup. Lease payments will be deducted as business expenses on our tax return, reducing the net cost of our
“The recent economic downturn has shined a light on several weaknesses in equipment lease documentation. One of the most notable has been the lack of a lessor’s ability
The reason we want to capitalise the lease commitments is that reporting under operating assets leads to substantial amounts of off-balance-sheet assets and liabilities. Hence, it is difficult to compare financial statements between two similar companies but use different accounting methods for essentially the same transaction.
(c) The term of the lease is equal to 75% or more of the estimated economic life of the leased asset.
Research has been performed for your client to give informative information about leases and lease structures. Through this research there are three sub-types of leases from the standpoint of the lessor, which are direct financing leases, sales-type leases, and operating leases. The information found on the Financial Accounting Standards Board website pertaining to each type of lease will guide your client to making an appropriate decision regarding which type of lease will be beneficial to their company.
The determination of whether an arrangement is or contains a lease is based on the substance of the arrangement and requires an assessment of whether the fulfilment of the arrangement is dependent on the use of a specific asset or assets and whether the arrangement
While working on a consulting engagement, a supervisor in the team has given an assignment. The client is a regional trucking company. A new customer has approached the client with an opportunity that would require 120 trailers—20 more than the trucking company currently owns. The client is uncertain how long the relationship with the customer may last, but the deal has the potential for significant growth. The supervisor has asked a research to be conducted on leases and lease structure issues on the Financial Accounting Standards Board (FASB) website, in particular the current practice and thought related to direct financing, sales type, and operating leases. This paper is a memo addressed to the supervisor that summarizes
The investing activities showed a reduction in the cost of acquisition of equipment and favorable lease rights, but an increase in short-term investments. This reduction is the result of the leases providing a minimum annual rent that adjusts to set levels during the lease term. Approximately 52% of the leases provide additional rent based on percentage of sales to be paid when designated levels are achieved. The increase in short-term investments center around expansion and remodeling costs.
No, in accordance with ASC 740 the tax planning strategy to sell and not leaseback manufacturing equipment is not considered prudent and feasible.
Lease financing is a contractual relationship formed between a lessor, lessee and a supplier. The lessor buys goods from the supplier and rents the goods to a lessee who is given the right to possession of the good for a specified amount of time. This turns into a financing situation, since the lessee owes a debt to the lessor for purchasing the goods on behalf of the lessee . The lessor will usually benefit from an interest rate percentage that is collected from the lessee in exchange for financing the goods. Article 2A of the U.C.C is dedicated completely towards the true leasing of goods (Clarkson, 2015, p.383). Although the rules governing the leasing of goods is similar to the sale of goods covered in Article 2, Article 2A specific contract rules pertaining to leasing relationships. Under Aricle 2A-407, the lessee’s obligations to the finance contract are irrevocable and separate from the obligations of the financer. The lessee is obligated to make payments regardless if the equipment’s ends up defective and must refer to the supplier for relief of the defective product(Clarkson, 2015, p.). For example, a Bank purchases equipment and leases it to ABC Corp. The equipment later turns out to be defective and ABC Corp. stops making lease payments. The bank will be able to sue ABC Corp. because under Article 2A, payments are due regardless of the equipment condition.
The biggest notable difference is the handling of each on the financial statements. An operating lease is similar to a rental agreement so there is no long-term liability on the balance sheet. It allows the lessee to engage in off-balance sheet financing. This provides several benefits for the company to maintain a good financial position. When a company enters a capital lease the asset is reported on the balance sheet. This results in the debt to total equity increasing and the rate of return on total assets to decrease. The ratios can negatively affect financing opportunities, the corporate bond covenants, and management compensation incentives (Schroeder, Clark, & Cathey, 2011). In addition, the depreciation required on the asset in a capital lease will result in a deferred tax. The funds from operations on the cash flow statement will be higher by the deferred tax when a capital lease is used (Ingberman, Ronen, & Sorter, 1979). The cash from the operations section on the cash flow must be reconciled to remove noncash items during the period (Kieso, Weygandt, & Warfield, 2007). The company will receive benefits from both types of leases; the right option for the company will depend on their needs and strategy.
Lease is defined as an agreement where lessors promised to convey the right to use the asset for an agreed period of time to lessees in return for a sum of payment as in AASB 117 paragraph 4. Leases can be classified as either finance or operating lease based on the economic substance of the agreement.
Construction equipment undergoes wear, which means that its value depreciates over time. In other words, reselling it might not bring anywhere near the price that you paid for it. While you may be able to recoup some of the expense of owning via tax savings, you may still not be able to recover much of your investment. Another issue is that lending institutions typically regard purchased construction equipment as liabilities. As a result, buying can negatively impact your credit score and can make them less willing to lend to
Equipment leases are a part of a billion-dollar industry, which covers personal property, consumer leases, automobiles, aircrafts, industrial machinery, and equipment (Executive, 2011). The aforementioned types
According to FASB (1976), a lease is an agreement conveying the right to use property, plant, and equipment (PPE) usually for a stated period of time. Examples of assets that can be leased include land, buildings, and plant & equipment.
leased asset have been transferred from the lessor to the lessee. Under EAS, the leased asset is recognized in the lessor