Leases

Hi Karen,

I’ve taken a brief look at the question you refer to.

I am not a tax expert but I would imagine you are correct in your assertion that a business can only claim the tax relief on WDA’s on assets which it legally owns – this is clearly a big advantage of debt finance (you get tax relief on the Interest on the loan and also tax relief on the WDA’s).

With Finance Leases, the company does not own the asset legally and so it can claim tax relief on the interest element of the annual rental payment only … and so it is more expensive than bank debt, especially after tax.

This BPP question is a good one, as it highlights the nature of these three very common methods of acquiring use of an asset.

As SOURCE of FINANCE, Finance Leasing is very significant these days – accounting for about 30% of the total Sources of Finance used by businesses to acquire non-current assets (excluding L&:).

I would certainly make sure that you can list the Definitions, Advs and Dis-adv’s of Operating Leases, Finance Leases and Debt Borrowing Before the end of this week.

Remember, Finance Leases are arrangements where a company needs to use a non-current asset (eg machinery) and instead of buying the asset itself , it arranges for the finance company (eg a bank anyway!) to buy the asset. The finance company then leases it to the business, probably for the entire economic life of the asset…. therefore like debt it is classified as LT source of finance.

Legally, it is the finance company who owns the asset , but from an accounting point of view the substance of the transaction is that the company has borrowed cash from the finance company (the bank) to buy the asset. Thus, the asset appears among the businesss’s non-financial assets and the financial obligation to the finance company is shown among the company’s long term borrowings.

Regards, Kevin