True Lease
Definition
A True Lease is a contractual arrangement where the lessor retains ownership rights and the associated risks and rewards while leasing the asset to the lessee for a specified period. The lessee gets the right to use the asset but does not hold the asset’s ownership or its residual value.
Examples
- Vehicle Leasing: A car dealership (lessor) leases a car to a customer (lessee) for two years. The dealership retains ownership and the residual value of the car at the end of the lease term.
- Equipment Rental: An equipment rental company leases construction machinery to a contractor for a project duration, where the rental company retains ownership and the machines’ residual value.
Frequently Asked Questions (FAQs)
Q1: What happens at the end of a True Lease?
A: At the end of a True Lease, the asset returns to the lessor unless a new lease agreement is made or the lessee decides to purchase the asset, if an option exists.
Q2: What are the advantages of a True Lease for the lessee?
A: A True Lease allows the lessee to use the asset without committing to the full cost of ownership, and often includes lower monthly payments and maintenance responsibilities covered by the lessor.
Q3: Can the lessee claim depreciation benefits for a True Lease?
A: No, since the lessee does not own the asset; the lessor is responsible for claiming depreciation expenses on their taxes.
Q4: How is a True Lease different from a Financial Lease?
A: In a Financial Lease (or Capital Lease), the lessee assumes the risks and rewards of ownership, often with an option to purchase the asset at the end of the lease term. In contrast, the lessor retains these risks and rewards in a True Lease.
Q5: What types of businesses commonly use True Leases?
A: Businesses requiring temporary or flexible use of high-value assets, such as vehicle fleets, office equipment, and industrial machinery, often utilize True Leases.
- Financial Lease: A type of lease where the lessee assumes both the risks and the benefits of ownership of the leased asset, and it is often considered a financial obligation.
- Synthetic Lease: A leasing arrangement that combines certain tax and accounting benefits of both True Leases and Financial Leases, with the lessee obtaining the operating lease treatment for accounting purposes, while gaining tax benefits of ownership.
Online References
- Investopedia: True Lease
- Wikipedia: Lease
Suggested Books for Further Studies
- “Equipment Leasing: Leveraged Leasing” by Peter K. Nevitt and Frank J. Fabozzi
- “The Handbook of Lease Financing” by Cleveland E. Cutler
- “Lease Accounting: A Practitioner’s Guide” by William H. Wiersema
Fundamentals of True Lease: Leasing Basics Quiz
### What distinguishes a True Lease from other types of leases?
- [ ] The lessee retains ownership of the asset.
- [ ] The lessee has the option to purchase the asset immediately.
- [x] The lessor retains the risks and rewards of ownership.
- [ ] The asset is leased permanently.
> **Explanation:** In a True Lease, the lessor retains ownership and the associated risks and rewards, while the lessee has the right to use the asset.
### Which party is responsible for claiming depreciation on a True Lease?
- [ ] The lessee
- [x] The lessor
- [ ] Neither party
- [ ] Both parties
> **Explanation:** The lessor retains ownership of the asset and consequently is responsible for claiming depreciation on a True Lease.
### What typically happens to the asset at the end of a True Lease?
- [x] It is returned to the lessor
- [ ] It automatically becomes the property of the lessee
- [ ] It is usually discarded
- [ ] It is destroyed
> **Explanation:** At the end of a True Lease, the asset generally returns to the lessor unless otherwise agreed upon.
### Which of the following assets is commonly leased under a True Lease?
- [ ] Real estate
- [x] Vehicles
- [ ] Intellectual Property
- [ ] Cash
> **Explanation:** Vehicles are commonly leased under True Leases where the lessor retains ownership and residual value.
### Under a True Lease, why do lessees typically experience lower payments?
- [ ] Because they own the asset
- [ ] Because of immediate depreciation benefits
- [x] Because the ownership risks are retained by the lessor
- [ ] Due to inflation rates
> **Explanation:** The lessee experiences lower payments in a True Lease as the lessor retains the ownership risks and rewards.
### Can a True Lease be considered a capital expense?
- [ ] Yes
- [x] No
- [ ] Sometimes
- [ ] Only for tax purposes
> **Explanation:** A True Lease is not considered a capital expense because the lessor retains ownership of the asset.
### Why might a business prefer a True Lease over purchasing equipment?
- [x] To avoid the high initial costs of ownership
- [ ] To gain immediate tax benefits
- [ ] To increase its liabilities
- [ ] Because it prefers asset depreciation
> **Explanation:** Businesses may prefer a True Lease to avoid the high initial costs and responsibilities associated with owning equipment.
### Which lease type offers the lessee an option to buy the asset at the end of the lease term?
- [x] Financial Lease
- [ ] True Lease
- [ ] Operating Lease
- [ ] Real Estate Lease
> **Explanation:** A Financial Lease often includes an option for the lessee to purchase the asset at the end of the lease term, unlike a True Lease.
### Who is responsible for maintenance costs in a True Lease?
- [x] The lessor
- [ ] The lessee
- [ ] Both parties
- [ ] A third party
> **Explanation:** Typically, the lessor is responsible for maintenance costs in a True Lease, alleviating this burden from the lessee.
### What is the primary focus of a Synthetic Lease?
- [ ] Unlimited usage of the asset
- [x] Combining benefits from both True and Financial Leases
- [ ] Immediate asset disposal after use
- [ ] Complete ownership transfer
> **Explanation:** A Synthetic Lease aims to combine the tax and accounting benefits of both True and Financial Leases.
Thank you for your journey through our detailed examination of True Leases, and for participating in our comprehensive quiz. Continue to enhance your leasing knowledge!
