Motivations for Leasing Assets

When a company wishes to obtain the use of an asset, it can either purchase or lease it.

A lease is a contract between a lessor, the owner of an asset, and a lessee, the other party which is seeking to use the asset. Through a lease, the lessor grants the lessee the right to use the asset. In exchange for the right to use the asset, the lessee makes periodic lease payments to the lessor.

Leases vs. Purchases

Advantages of leasing an asset compared to purchasing it include:

• leases can provide less costly financing for the lessee than purchases. They usually require little, if any, down payment and often go at lower fixed interest rates than those that would otherwise be incurred if the asset was purchased;
• the lessor may be in a better position to take advantage of tax benefits of ownership, such as depreciation and interest;
• the lessor enhances their ability to value and bear the risks associated with ownership, such as obsolescence, residual value, and disposition of an asset;
• the lessor may enjoy economies of scale for servicing assets; and
• a negotiated lease contract may contain less restrictive provisions than other forms of borrowing.

Certain types of leases are also used because of perceived financial reporting and tax advantages. It is noteworthy that some leases are not shown as debt on the balance sheet. This means that no interest expense or deprivation expense is included in the income statement. In some countries, financial reporting rules may differ from tax regulations. This can result in a company owning an asset for tax purposes, while not reflecting the ownership in its financial statements.

Question 1

Which of the following is least likely an advantage of leasing an asset instead of purchasing it?

1. Leases can provide less costly financing.
2. A negotiated lease contract may contain more restrictive provisions than other forms of borrowing.
3. The lessor may be in a better position to take advantage of tax benefits of ownership than the lessee.

Solution

The correct answer is B.

A negotiated lease contract may contain less-restrictive, not more restrictive, provisions than other forms of borrowing. If the lease contract had more restrictive provisions, leasing an asset would be less attractive than purchasing it, especially in instances where money has to be borrowed in order to make the purchase.

Choices A and C give accurate statements.

Question 2

One of the benefits a company would enjoy when it leases an asset instead of buying it is:

A. Enhancing the company’s solvency ratios.

B. Enhancing the company’s liquidity ratios.

C. Enhancing the company’s productivity ratios.

Solution

The correct answer is C.

Productivity ratios are the sum of dividing the company’s productivity per input of capital/work/raw material. Leasing an asset – instead of purchasing it – would require no capital. Hence, the productivity ratios of a company leasing an asset would be better than a similar company owning the same asset.