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Accounting Leases

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Accounting Leases A lease is a contractual agreement between a lessor and lessee that gives the lessee the right to use specific property for usually a monetary payment while the lessor still owns it. For instance, the new Petco (The lessee) in town probably leases the property they are using from the building owners (The lessor). The lease specifies the duration of the agreement and the lease payments. The obligations for taxes, insurance, and maintenance may be assumed by the lessor or the lessee, whichever is defined in the agreement. The advantages of a lease over just buying a property are that lease payments are often fixed, leases may be a less costly means of financing, leases may not require any money down, certain leases may not add to existing debt on the balance sheet, leases may contain less restrictive covenants than other types of lending agreements, and leases reduce the risk of obsolescence to the lease. So if we look back at the example of the new Petco in town, they came in already having competition in town. The risk of putting in the store is pretty high so they would want to lease the property to reduce their financial risk since the probability of them going out of business is a little higher due to the high number of competition already established in town.
There are two kinds of accounting methods for leases: operating and capital leases. A vast majority of leases are operating leases. An operating lease is treated like renting where payments are considered operational expenses and the assets that are being leased stay off the balance sheet. In contrast, a capital lease, or sometimes known as a finance lease, is more like a loan; the asset is treated as being owned by the lessee so it stays on the balance sheet. The accounting treatment for capital and operating leases is different, and can have a significant impact on taxes

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