Question 1

If the lease payments of the $800,000 asset were $210,000, first payment occurring at the beginning of the first year when the lease is signed, how would the lessee treat these payments in his financial lease analysis? His tax rate is 40%.

Accepted Answer

The lessee would treat the lease payments as a cash outflow but would also get a tax benefit from these payments. Since the tax rate is 40%, the net cash outflow would be $210,000 * (1 - 0.40) = $126,000 per year, reflecting the tax savings from the lease payments.

Question 2

Which of the following is not a reason for leasing?

Accepted Answer

Leasing primarily benefits the lessee, not the lessor, in terms of insurance against obsolescence. The lessor is the owner of the asset, so the lessee avoids the risk of the asset becoming outdated.

Question 3

If a lessor paid $800,000 for an asset, how would the lessee treat this amount in his financial lease analysis?

Accepted Answer

The answer of If a lessor paid $800,000 for an...

Question 4

If in financial lease analysis an asset's undepreciated capital cost were $200,000 and its salvage or scrap value were zero, how would the lessor treat this situation if it were assumed the asset would be alone in its class if it were owned? The tax rate is 40%.

Accepted Answer

In financial lease analysis, the lessor would consider the lost tax shield (tax savings foregone due to leasing instead of owning) at the end of the lease life. In this situation, since the asset has no salvage or scrap value, it would not generate any tax shield at the end of the lease life. Therefore, the lessor would record this as an $80,000 lost tax shield (40% tax rate multiplied by the undepreciated capital cost of $200,000) at the end of the lease life.

Question 5

Even with lease capitalization, the financial positions of lessors and lessees differ.Which of the following statements does not support that assertion?

Accepted Answer

The asset choice influenced by the method of financing does not directly relate to how the financial positions of lessors and lessees differ due to lease capitalization. This statement is more about the decision-making process regarding asset acquisition rather than the financial impact of lease capitalization on lessors and lessees.

Question 6

Canada Customs and Revenue Agency is suspicious of financial leases that exhibit the following non-lease characteristic:

Accepted Answer

This non-lease characteristic indicates that the lease may be structured as a disguised sale rather than a true lease, and the lessee may be attempting to avoid paying taxes on the purchase of the asset. This raises red flags for Canada Customs and Revenue Agency. Choices A, B, and C are all legitimate lease characteristics and do not necessarily indicate a disguised sale.

Question 7

Equipment manufacturers lease out equipment because:

Accepted Answer

Leasing agreements help support and expand sales by allowing equipment manufacturers to provide their products to a larger customer base who may not have the capital to purchase the equipment outright. This can increase the manufacturer's revenue over time as they continue to lease out their equipment.

Question 8

A leveraged lease requires a situation where:

Accepted Answer

A leveraged lease involves the lessor (leasing company) borrowing a significant portion of the funds needed to purchase the leased asset, with the remaining amount being paid by the lessee (business). This allows the lessor to use the funds for other investments and projects, while the lessee benefits from lower lease payments. Option A, B, and D are not part of the definition of a leveraged lease.

Question 9

A financial lease is also called a full-payout lease because:

Accepted Answer

The answer of A financial lease is also called a...

Question 10

When deciding whether or not to lease an asset, the _____________ should be compared against the ______________, and if the first is lower then the company should proceed with the lease.

Accepted Answer

The internal rate of return (IRR) should be compared against the cost of debt. If the IRR is lower than the cost of debt, it indicates that the lease is a cheaper option for financing the asset.

Question 11

Off-balance sheet financing implies that:

Accepted Answer

Off-balance sheet financing refers to a situation where a company can obtain funding or incur liabilities without showing them on its balance sheet. Leases can be capitalized or not capitalized depending on the type of lease and the accounting rules applied. If leases are not capitalized, they are considered off-balance sheet financing because the lessee does not report the leased asset or the lease liability on its balance sheet. Instead, the lessee usually includes the lease payments in its income statement as an expense.

Question 12

Financial leasing is only justified by one of the following arguments.

Accepted Answer

Financial leasing allows the lessor to claim tax breaks, such as capital cost allowance (CCA) tax shields. The lessor can make better use of these tax benefits than a lessee, who may have different tax situations or may not be able to use the benefits as efficiently. This is often the primary justification for financial leasing. B, C, and D are incorrect because hiding capital expenditures, getting access to an asset with no money down, or not appearing on the balance sheet are not necessarily beneficial or justifiable reasons for financial leasing.

Question 13

Which one of the following is a valid statement about leasing in Canada?

Accepted Answer

In Canada, it is common for lessees to purchase the asset at the end of the lease rather than returning it to the lessor (option A is therefore incorrect). Lessors may prefer to retrieve the equipment after the end of a lease, but this is not a universal preference and not a characteristic of leasing in Canada (option B is incorrect). Operating leases are typically used for shorter-term, non-permanent use of an asset, so option D is also incorrect.

Question 14

If a financial lease analysis shows a positive result, which one of the following is true?

Accepted Answer

If a financial lease analysis shows a positive result, it means that leasing is financially beneficial compared to owning the asset outright. Therefore, given the asset choice, the lease terms favour leasing. This does not necessarily mean that the user should own the asset or the lessor should own the asset, or that leasing is preferable only if there is no salvage value.

Question 15

The lessee in a financial lease bears the most of the same risks and rewards as ownership except:

Accepted Answer

In a financial lease, the lessee bears most of the risks and rewards of ownership, but does not benefit from any extraordinary salvage value at the end of the lease term, as the asset typically returns to the lessor.

Question 16

A lessor finds a lease attractive from a tax viewpoint because he:

Accepted Answer

When a lessor leases out their assets, they can still claim capital cost allowance (CCA) on the asset while the lessee pays a lease payment. This means that the lessor can use the CCA tax shield from ownership to lower their taxable income. Therefore, choice D is the correct answer. A, B, and C are incorrect because they do not accurately represent the tax benefits for a lessor in a lease agreement.

Question 17

If the asset described in above Question had a CCA rate of 30%, with the usual half-year rule, and were leased for 5 years, how would the lessee treat the five years of CCA? The lessee tax rate is 40%.The asset class uses declining balance.

Accepted Answer

The lessee would calculate the CCA amounts for each of the five years, apply the tax rate against these amounts, and show these amounts as cash outflows. This is because the lessee is responsible for the tax implications of leasing the asset and would need to account for the CCA in their tax calculations. The half-year rule would also need to be applied to the CCA calculation, as it is the usual practice in Canada. The fact that the asset class uses declining balance is not relevant to how the lessee would treat the CCA in their cash flows.

Question 18

Which rate should you use to discount the leasing cash flows in an NPV analysis?

Accepted Answer

The answer of Which rate should you use to discount...

Question 19

Lease standardization helps justify leasing because:

Accepted Answer

Lease standardization helps lower costs through standardized leased asset and security evaluations, making it easier for both lessees and lessors to determine fair lease terms and conditions. This helps to justify leasing as a viable financing option for businesses. The other options are not directly related to lease standardization.

Question 20

Which of the following statements is not true of a financial lease?

Accepted Answer

A financial lease is a binding obligation for the lessee and is typically for most of the economic life of the leased asset. It is a source of financing, but it cannot be cancelled after the equipment is no longer needed. This is one of the key differences between a financial lease and an operating lease, where the latter can be cancelled before the end of the lease term.

Quiz 17: Leasing