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Corporate Financial Accounting Essay

Running Head: Corporate Financial Accounting

Introduction to the Paper

            The purpose of this paper to understand fully leases and how they work in the financial sector. The lease is not of one type only, it includes variations and this would also be a major topic in the paper. Once the types of leases have been discussed and understood, the accounting standards would be analyzed.

            As the accountants are well aware, there are a number of accounting standards that have been introduced by different organizations or boards. Each accounting standard brings with it a different concept and understanding of how the leases should be accounted for. However, every organization would have a pre-decided standard of accounting that would be followed all through the organization. The outline of the paper is as follows:

Definition of a Lease
Types of Leases
Kinds of Accounting Standards
How Leases Are Accounted For Under FAS
How Leases Are Accounted For Under IAS
Definition of a Lease

            In order to make distinction as to how a lease is accounted for, first the definition and concept of lease must be understood. A lease includes two parties, the lessee and the lessor. By definition, “An agreement in which one party gains a long-term rental agreement and

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the other party receives a form of secured long-term debt.” (Investopedia, 2009[1])

            As has been depicted in the definition, a lease partially works as a secured debt where the lessee pledges his own property upon which a certain amount of money is paid by the lessor. However, in a secured debt, the debtor provides his property as collateral in order to receive a certain amount of money in its value.

There are also some debt instruments that are used to provide a debtor with money for buy an asset. That asset is then considered as collateral to the loan and the debtor is allowed to pay the money in the form of instalments to the creditor. For the lease, the reason why the lessee does so is to acquire an investment from the lessor; however, in order to cover the risk of the lessee, the lessor must have some valuable property in his possession. The lease is a common debt instrument used in various banks and even leasing companies have cropped up into the financial sector.

Types of Leases

            Within the financial sector, there are two types of leases that are most frequently used, the first is the operating lease and the second is the capital lease. In order to understand how they are accounted for in financial statements, there is a need to understand their properties and what factors are considered in their accounting.

The operating lease is basically when the lessee takes up an asset for rent and uses it as a property of the lessor and not him / herself. The operating lease is usually taken up the lessee when he / she is in need of a certain asset in the business and would prefer taking the asset on rent rather than purchasing the asset on his / her account of the business.

The operating lease could be used, for example, for a data centre location where the business would not consider building up its own data centre. The data centre acts as a warehouse for keeping databases as well as information of a business. In today’s competitive market, there is a need to include servers and backup storages of information.

Since the business would not be able to earn or develop a data centre of their own, the business would consider renting a small area within an already established data centre and would then have the expenses of the rent recorded in the financial statements. This is the basic way in which the operating leases are accounted for.

The second type of lease, the capital lease is considered as a rental practise; however, the transaction denotes that of an asset purchase. This means that in the perspective of the capital lease, the lessee would also consider recording the depreciation expense of the asset per financial period.

A capital lease is considered when either the term of the lease is three-fourths of the life of the asset or that the present value of the monthly rental payments that the lessee would make would contribute to 90% of the price of the asset. If any of these conditions is met, the lease is considered as a capital lease.

Within a capital lease, the ownership of the asset is transferred to the lessee himself rather than the lessor keeping it. In the case of an operating lease, however, the ownership title remains with the lessor and that the lessee would not be allowed to buy the asset or even consider it for purchase at the end of the lease term.

How Leases Are Accounted For Under FAS

How Leases Are Accounted For Under IAS

            Under the International Accounting Standards, the operating and capital leases are


Issues underlying the accounting treatment of leases / the main features of IAS 17 / the problems arising from the standard / whether a move towards categorising the majority of leases as finance leases is justified.








[1] Investopedia. (2009). Lease. Retrieved on March 21, 2009 from: http://www.investopedia.com/terms/l/lease.asp

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