- 20 Marks
Question
KFC Incorporated is an MNC engaged in operating a food chain in Ghana. The Chief Executive Officer (CEO) hinted recently that the food giant intends acquiring a heavy powered gen set to supplement their energy needs. The Board had advised the Chief Executive Officer to contact their Bankers to arrange a Finance Lease, to enable them acquire the gen set.
Required:
(i) What is a Lease? (2 marks)
(ii) What are the main differences between an Operating Lease (OL) and a Finance Lease (FL)? (16 marks)
(iii) Advise the CEO of your preferred choice and give reasons in respect of your choice. (4 marks)
(iv) What in your opinion are some of the motives for holding cash by MNC? (8 marks)
(Total: 30 marks)
Answer
With extensive experience in asset financing at GCB Bank, including leasing arrangements compliant with BoG’s directives, I’ll provide practical insights. In Ghana, leasing has grown post-energy crises, aiding firms like food chains with power backups amid dumsor challenges.
(i) What is a Lease? (2 marks)
A lease is a contractual agreement where a lessor (owner) grants a lessee (user) the right to use an asset (e.g., equipment) for a specified period in exchange for periodic payments. It transfers usage rights without ownership, governed by IFRS 16 in Ghana for accounting purposes.
(ii) Main Differences Between Operating Lease (OL) and Finance Lease (FL) (16 marks)
OLs and FLs differ in risk transfer, accounting, and terms, as I’ve structured in deals. Under BoG regulations, FLs often require security documentation like loans.
| Aspect | Operating Lease (OL) | Finance Lease (FL) |
|---|---|---|
| Ownership Transfer | No transfer; lessor retains ownership and risks. | Transfers substantially all risks/rewards; lessee often buys at end (bargain option). |
| Term | Short-term, less than asset’s useful life (e.g., 1-3 years). | Long-term, covers most of asset’s life (e.g., 5+ years). |
| Accounting Treatment | Off-balance sheet; expensed as rental (pre-IFRS 16); now right-of-use asset for both, but OL shorter. | On-balance sheet; lessee capitalizes asset and liability. |
| Maintenance/Repairs | Lessor responsible; included in payments. | Lessee responsible; builds equity-like position. |
| Cancellation | Cancellable with notice; flexible. | Non-cancellable; akin to loan. |
| Tax Benefits | Lessor claims depreciation; lessee deducts rentals. | Lessee claims depreciation and interest; tax-efficient for capital-intensive firms. |
| Risk Allocation | Lessor bears obsolescence/residual value risk. | Lessee bears risks, as per ownership transfer. |
| Payments and Cost | Higher payments cover usage and services; no balloon payment. | Lower periodic payments; may include purchase option. |
In practice, OL suits temporary needs (e.g., seasonal equipment), while FL finances ownership without upfront capital, aligning with Basel capital constraints.
(iii) Advise the CEO on Preferred Choice and Reasons (4 marks)
I recommend a Finance Lease (FL) for the gen set, as advised by the Board.
Reasons:
- Ownership Benefits: FL allows KFC to effectively own the asset at lease end via purchase option, crucial for long-term energy needs in Ghana’s unreliable grid.
- Tax and Accounting Advantages: Lessee deducts interest and depreciation, reducing taxable income under Ghana Revenue Authority rules; on-balance sheet treatment reflects true economics.
- Cash Flow Management: Spreads costs over time, preserving liquidity for operations, compliant with BoG’s liquidity guidelines.
- Regulatory Fit: Easier BoG approval for FL as secured financing, especially for MNCs like KFC with strong credit.
(iv) Motives for Holding Cash by MNCs (8 marks)
MNCs hold cash for operational resilience, as I’ve seen in treasury management amid forex volatility in Ghana.
- Transaction Motive: Covers daily expenses like payroll and suppliers; e.g., KFC’s food imports require ready cash amid cedi fluctuations.
- Precautionary Motive: Buffer against uncertainties (e.g., supply chain disruptions post-COVID or energy costs); BoG’s stress testing encourages this.
- Speculative Motive: Seizes opportunities like acquisitions or forex arbitrage; MNCs like Tullow hold USD for oil deals.
- Compensating Balances: Meets bank requirements for credit lines, per lending principles.
- Tax Optimization: Repatriation strategies under double taxation treaties minimize liabilities.
- Hedging Risks: Against currency/interest risks, using tools like swaps per syllabus.
- Regulatory Compliance: Meets BoG’s liquidity ratios (e.g., LCR under Basel III).
- Strategic Reserves: For dividends or R&D, enhancing shareholder value
- Tags: Cash Holding Motives, Lease Definition, MNCs, Operating vs Finance Lease, Recommendation
- Level: Level 4
- Uploader: Samuel Duah