The Ethics of Leasing Arrangements Scenario: Greeley Golf and Country Club is co
ID: 2600762 • Letter: T
Question
The Ethics of Leasing Arrangements
Scenario: Greeley Golf and Country Club is considering leasing some equipment: 25 golf carts with GPS ball tracking - The fair value of each cart is $10,800. After three years, the company can purchase each cart for $8000. The fair value of the carts is expected to be $8,500 at that time. The useful life is expected to be 7 years. Specialized turf mower - the mower has a computerized function that automatically adjusts the height of the blade to account for minute variances in the topography of the putting greens. This prevents "scalping" of the very valuable turf grass. The mower has a useful life of 7 years. Current fair value is $75,000. The present value of the lease payments is $60,000, assuming that Greeley Golf would lease the mower for 5 years. Jane York, the company Controller, and Tony Hawkins are discussing possible leasing terms. Jane believes that the company should lease the carts for 3 years, and the mower for 5 years since the company needs this equipment to expand operations, and satisfy shareholder expectations. Tony Hawkins, the company President, would prefer to negotiate 1-year lease terms, with options to renew each year.
Please discuss the following questions for my initial post:
Do the leases qualify as short-term, regular operating or financing leases? Explain your reasoning.
Why would Mr. Hawkins prefer to have only one year terms for the leases?
Are there any ethical considerations at stake?
Explanation / Answer
CONDITIONS FOR A FINANCIAL LEASE
If any of these conditions are met , lease is classified as Financial Lease
Q1. The Golf Kart Lease is a financial lease as it provides an option to buy the equipment at a rate lower than fair value during the lease term
The mower is operational lease because the present value of lease is 0.8 of present fair value and the lease duration is 71% of the useful life with no bargain purchase option, thus it is classified as an operational lease
The duration of the lease in both cases is more than 6 months thus it is a long term lease
Q2. Mr.hawkins would prefer a 1 year term because it would convert the lease into operational lease , this leads to showing the rental as an expense and the asset need not be disclosed in the balance sheet nor it creates any liability against the asset
A financial Lease would result into showing rental expense as "investment" thus not deductible from profits and leading to a higher tax liability for the firm
Q3. Ethical concerns here are in regards with avoidance of tax and not disclosing the asset and liability in the balance sheet.
Because in operational lease , lease payments is classified as rental and tax deductible
And its not shown in the balance sheet.
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