© 2012 McGraw-Hill Ryerson Limited Chapter 17 -1

Operating Leases◦Need to compare the equivalent annual cost

of buying the asset versus the annual lease payment.

Financial Leases◦When you are considering a financial lease,

the decision amounts to lease versus borrow. Financial leases extend over most of the economic life of the lease equipment.

LO2, LO3

© 2012 McGraw-Hill Ryerson Limited Chapter 17 -2

Who really owns the leased asset?

The user is the real owner because in a financial lease, the user faces the risks and receives the rewards of ownership

Lessor gets the salvage value of the asset Once a secured loan is paid off, the user

owns the asset free and clear

LO3

© 2012 McGraw-Hill Ryerson Limited Chapter 17 -3

Leasing and the Canada Revenue Agency:◦ The lessee loses the CCA of the leased asset but can deduct

the lease payment in full. The lessor uses the CCA tax shield but must pay taxes on lease payments.

There is always a suspicion by CRA that the arrangement is genuine and not a disguised instalment purchase. Some examples of lease provisions that arouse suspicion:

1. Giving the lessee the option to acquire the asset, say, for $12. The lessee automatically acquires title after a specified

payment3. The lessee is required to buy the asset at the end of the

contract

LO3

© 2012 McGraw-Hill Ryerson Limited Chapter 17 -4

Financial Lease Evaluation A financial lease is superior to buying and

borrowing if the financing provided by the lease exceeds the financing generated by the equivalent loan

LO2, LO3

Net value of lease

= initial financing provided – value of equivalent loan

© 2012 McGraw-Hill Ryerson Limited Chapter 17 -5

NPV = Cost of leased asset – PV (after-tax lease payment- PV (CCA tax shield) – PV (salvage value)+ PV (saved Maintenance costs, if any)

LO2, LO3

© 2012 McGraw-Hill Ryerson Limited Chapter 17 -6

Taxes and the Lessor

◦ If both the lessor and lessee are in the same tax bracket, then the lessor’s position is merely the mirror image of the lessee’s position.

◦ If both the lessor and the lessee are in different tax brackets, the government suffers a net loss in the present value of the tax receipts as a result of the lease.

LO3, LO4

© 2012 McGraw-Hill Ryerson Limited Chapter 17 -7

Taxes and the Lessor◦ Other things being equal, the potential gains to

the lessor and lessee are highest when:

The lessor’s tax rate is substantially higher than the lessee’s

The CCA tax shield is received early in the lease period

The lease period is long and the lease payments are concentrated toward the end of the period

The interest rate (rD) is high

LO3, LO4