Please explain why chose what you choose. Which of the following statements is m
ID: 2754026 • Letter: P
Question
Please explain why chose what you choose.
Which of the following statements is most correct?
A. Some years ago leasing was called “off balance sheet financing” because the leased asset and the corresponding lease obligation did not appear directly on the balance sheet. Today, though, that situation has changed materially because all leases must be capitalized and reported on the balance sheet, along with the value of the leased asset.
B. In a lease-versus-purchase analysis, cash flows should generally be discounted at the weighted average cost of capital (WACC).
C. Each of the above statements is true.
D. Each of the above statements is false.
Explanation / Answer
C. Each of the above statements is true.
A. Operating lease ,was called off- balanace sheet financing as the lessee company need not include the liability on its balance sheet and hence the debt structure stands unaffected. Even then, the fact was diclosed as a foot-note and the lease rentals were part of Income statement as tax-deductible.
Now, the FASB has introduced new rules that all leases will be treated essentially the same as current capital leases-a revision to the standing FAS-13.Under this, the lease renewal payments need be capitalised.In essence, the classification as operating and capital leases is not there anymore.The capitalized asset and liability are amortized to depreciation and interest expense.
B. In a lease-versus-purchase analysis, cash flows should generally be discounted at the weighted average cost of capital (WACC).
Because WACC is the cost of funds that came into the company, by way of equity or debt or other type of borrowings. - with the help of which the lease or purchase is made. The capital is utilised in purchasing /leasing the desired asset. Hence it is only proper if the relevant cash flows are discounted to their present values , at the WACC of the lessee/purchasing company. As it is the blended cost, it is the minimum rate of return that should be earned to create value to the owners. Hence, it gains significance in lease/purchase decisions.