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Please help me with the following questions about leasing & buying:
1) Any costs related to the Machine will be borne by the Buyer when we bought the machine BUT not in the case of Leasing because it is the responsibility of Lessor to pay for any maintenance & running costs of the Machine?
2) In case of Lease, we will get the tax saving only on lease rentals because lease payments being tax deductible; BUT in case of Buying, we will get Tax savings on both Maintenance & Service costs plus on the Capital Allowance?
I am also having problems with the timings of Taxation & Capital Allowance in Lease & Buying questions such as:
3) If the Lease rental payments are payable at the start of the year, then we have to put them at [Time 0]. Otherwise, they are usually occurred at the year-end of the financial year [Time 1] if they are not payable at the start of the year?
4) While, Taxation & Capital Allowance is usually occurred at the year-end of financial year [Time 1] BUT it would be put at [Time 2] if they are payable [one year after the end of financial year]?
5) Are these timings for the taxation & capital allowance same for the usual NPV questions (or it is only a special case for Leasing & Buying questions?)
6) Can you please also state what is financial lease & operating lease and what is the difference between them & whether these two leases will change the cash inflows & outflows for the lease calculation in the exam?
1. What you have written is normally the case (unless obviously the question says differently for the leasing).
2. Yes – what you have written is correct/
3. If lease payments are payable in advance (as is usually the case in the exam) then the first payment is a time 0. If they are payables at the ends of years, then the first payment is at time 0.
4 and 5. If tax is payable 1 with a 1 year delay, then if a flow occurs at the start of the year the tax effect is 2 years late. If a flow occurs at the end of the year, then the tax effect is 1 year later. That is the case for all flows whether or not they are lease and buy.
6 An operating lease is where an asset is effectively rented for a period but is always owned by the lessor (who takes the asset back at the end of the period). With a finance lease, at the end of the period the asset belongs to the lessee. The financial accounting treatment is different, but the cash flows are the same in Paper FM.
Have you watched my free lectures on lease and buy because I do explain all these points in the lectures?
Sorry Sir 🙁 I’m afraid I do not understand your points 2, 3, 4.
3) You said that if lease payments are payable in advance then the first payment is at time 0 [understood] BUT if they are payable at the end of the financial year then the first payment will be at time 1 (how can it be at time 0 as u said – confused here!)
4) Taxation & Capital Allowance usually occurs at the year-end of the financial year which is Year 1 [or Time 1] as u said in your lecture BUT it would be put at Year 2 [or Time 2] if they are payable [one year after the end of the financial year because the Year 1 or Time 1 would be a 1st financial year]? – This is the same rule that you applied in your lecture for Lease & Buy topic BUT I wanted to ask you here to be sure of this rule…
This is the point that I wanted to be clear that the timings for the taxation & capital allowance in the Lease & Buy questions are the same for any usual NPV questions which are not lease & buy questions?
I have already watched your lecture on this topic But I needed to ask you in case if I was wrong! 🙂
3. If the are payable in advance them the first payment is at the start of the first accounting period, which is time 0.
If they are payable at the ends of year then the first payment is at the end of the accounting period which is time 1.4. Time 1 is not a year, it is a point in time which is 1 year away from time 0. So if the first lease payment is at the start of the first accounting period then it is paid at time 0. Tax is calculated at the end of the accounting period (which is 1 year later than time 0) and the tax effect is one year after the end of the accounting period, which is time 2.
In most other NPV questions, we assume that cash flows occur at the ends of accounting periods and so the tax effect is 1 year later. If we are told that any flow occurs at the start of an accounting period then that tax effect of this flow is 2 years later (for the same reason as given in my really to point 4.)
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