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(^376) Financial Management
Lease Capitalisationís
Financial leases call for the lessee to make periodic payments to meet contractual
obligations. As such it is not conceptually different from a loan. Lease capitalisation
involves capitalising the lease payments at an appropriate capitalisation rate and showing
the capitalised amount as a liability. An entry equal to the capitalised lease obligations is
shown on the assets side of the balance sheet.
The capitalisation rate is generally equal to the lesseeís marginal cost of borrowing. For
example, a corporation leases a computer system for 6 years. Lease payments are to
be made in six annual payments of Rs 340,000 each. The first payment is made on the
day that the computer is installed. The second payment is due 2 years from today, and
so on. Payments three through six are capitalised at the firmís marginal borrowing rate
of 9 per cent. The capitalised value of payments 3 through 6 is Rs 340,000(0.84168 +
0.77218 +0.70843 + 0.64993) = Rs 1,010,555. The balance sheet entry for this leasing
transaction would be
Assets Liabilities
Net leased assets Rs 1,350,555 Current liabilities
Lease obligation Rs 340,000
Long-term liabilities
Lease capitalisation Rs 1,010,555
These entries would be adjusted each year as the firm makes its lease payment.4 keep
in mind that the net capitalised value of the lease of Rs 1,350,555 + Rs 340,000 = Rs
1,690,555.
Cost of Leasing
The typical situation in leasing involves a decision either to borrow and buy or to lease
the equipment. The best alternative of buying or leasing is the one with the highest net
present value. This situation is discussed in the last section of the chapter. Another
situation could be when the item available is for lease only and cannot be purchased.
Here the leasing analysis becomes intermingled with the capital budgeting decision
itself. All leases, however, involve, a rate of return to the lessor. One way to conceptualise
a before-tax cost of leasing is to view the lessorís cost of leasing. Consider the computer
system lease example given previously. Assume that the computer system costs the
lessor Rs 1.68 crore and that the investment tax credit is passed along to the lessee.
Maintenance and service costs are also borne by the lessee. From the lessorís viewpoint,
the lease involves an outflow of Rs 1.68 crore at t = 0 for the purchase, an inflow of Rs