300934 Leasehold Improvement 3F Flashcards
On January 1, 20X1, Bay Co. acquired a land lease for a 21-year period with no option to renew. The lease required Bay to construct a building in lieu of rent. The building, completed on January 1, 20X2, at a cost of $840,000, will be depreciated using the straight-line method. At the end of the lease, the building’s estimated market value will be $420,000. What is the building’s carrying amount in Bay’s December 31, 20X2, balance sheet?
$819,000
$798,000
$820,000
$800,000
Question #300934
$798,000
This building is treated as a leasehold improvement. Although the land lease is for 21 years, the building will be in use for 20 years; thus, the depreciation period for the building is 20 years:
Cost ÷ Life = $840,000 ÷ 20 years = $42,000/year
Building cost − Depreciation = Carrying value of building
$840,000 − $42,000 = $798,000
Note: Leasehold improvements are depreciated fully without regard to salvage value if there is no option to renew (as is stated in this problem) and they are immovable (e.g., a building). In this case, because the land has a 21-year lease, any items permanently affixed to the land will revert to the owner at the end of the lease. Therefore, their market value at lease-end is irrelevant to Bay Co. because Bay Co. will no longer have the rights to the affixed property upon lease termination.
2362.04
Leasehold improvements: Considerable judgment should be applied when assessing how to account for leasehold improvements. In general, the lessee should:
- separately capitalize leasehold improvements (i.e., exclude leasehold improvement payments from the fixed lease payments if the lessee is not required to make such payments under the lease).
- include leasehold improvement payments in the fixed lease payment if the lessee is required to make such payments under the lease, provided the leasehold improvements are not specialized and could be used by a future tenant (i.e., would likely be considered an asset of the lessor).
- amortize the leasehold improvement depending upon the lease terms:
- If the asset is to be returned to the lessor, the lessee should amortize over the shorter of the useful life of the leasehold improvements or the remaining lease term.
- If the lessee is reasonably certain to exercise a purchase option, the lessee should amortize over the leasehold improvement useful life.
FASB ASC 842-20-35-12
Carrying Amount (Book Value)
The carrying amount or book value is the net amount at which an item is reported in the financial statements of the enterprise. For a receivable, the FASB ASC Glossary indicates the carrying amount is the “face amount increased or decreased by applicable accrued interest and applicable unamortized premium, discount, finance charges, or issues costs and also an allowance for uncollectible amounts and other valuation accounts.”
For a payable, the FASB ASC Glossary indicates the carrying amount is the “face amount increased or decreased by applicable accrued interest and applicable unamortized premium, discount, finance charges, or issue costs.”
Deferred
Deferred is delayed or postponed recognition of revenue or expense until a future period.
Depreciation
Depreciation is the process of systematic, rational allocation of the cost of operational assets to the accounting periods benefited. Depreciation is not a process of valuation (FASB ASC 360-10-35-4), does not represent a reserve to replace the asset, and does not mean that cash will be available to replace the asset. Depreciation allowed for tax purposes often differs from depreciation allowed for accounting.
Accounting depreciation attempts to match the cost of the asset to the revenues generated over the life of the asset. It represents accrual accounting and has no effect on cash flows (a noncash expense). Depreciation expense must be added back to accounting income when reconciling to cash from operations using the indirect method.
Computation of depreciation requires the following:
- Acquisition cost
- Estimated useful life
- Estimated residual (salvage) value
- Depreciation method (four GAAP alternatives):
- Straight-line
- Sum-of-the-years’-digits
- Double-declining balance
- Units of production—units of product and machine hours
Factors which cause the need for depreciation include the following:
- Physical factors:
- Wear and tear
- Effects of time and other elements
- Deterioration and decay
- Functional factors:
- Inadequacy of capacity
- Obsolescence
In the macroeconomic sense, depreciation is the part of business earnings/gross profit that is considered the replacement of capital stock used or worn out during the period. It is not included in net profit and is not a factor payment. (It is not a claim on the value of output by a factor of production.) Depreciation represents replacement investment, the amount that must be reinvested to maintain the existing level of capital stock, and the amount by which capital contributes to current production. It is a component of GNP (approximately 10%) and is computed by the income approach to national income accounting. Depreciation is the difference between gross and net investment.
In the foreign exchange sense, depreciation is the decline in the value of one currency against or in relation to another, in the sense that it now takes more of a particular currency to buy a unit of a foreign currency. Devaluation is the official change in the value of a country’s currency.
Example: Country A has an inflation rate of 5% and Country B has an inflation rate of 10%. The goods of Country A become relatively cheaper because the relative prices have changed, thus:
- increasing the demand in Country B for Country A’s goods,
- increasing the demand for Country A’s currency (to be able to import Country A’s goods), and
- decreasing the demand for (i.e., depreciating) Country B’s currency by approximately 5% (10%–5%).
Fair Market Value (FMV)
The fair value of an investment is the amount that the asset could reasonably expect to receive for it in a current sale between a willing buyer and a willing seller, that is, other than in a forced or liquidation sale. Fair value shall be measured by the market price if there is an active market for the investment. If there is no active market for the investment but there is a market for similar investments, selling prices in that market may be helpful in estimating fair value. If a market price is not available, a forecast of expected cash flows, discounted at a rate commensurate with the risk involved, may be used to estimate fair value. The fair value of an investment shall be reported net of the brokerage commissions and other costs normally incurred in a sale.
FASB ASC Glossary
For tax purposes, the fair market value is usually referred to as the sale price between a willing seller and a willing buyer when neither is compelled to buy or sell.
Gains
Gains are increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity except those that result from revenues or investments by owners. (SFAC 6.82–.89)
Gains are similar to revenues—the distinction depends on the nature of the entity, its operations, and its other activities. The primary purpose of distinguishing between revenues and gains is presentation and display.
Lease
A lease is a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.
FASB ASC Glossary
Lease Term
The lease term is the noncancelable period for which a lessee has the right to use an underlying asset, together with all of the following:
Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option
Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option
Periods covered by an option to extend (or not to terminate) the lease in which exercise of the option is controlled by the lessor
FASB ASC Glossary
Straight-Line Method
The straight-line method is a depreciation method based on an equal allocation of the cost of operational assets with the passage of time. It assumes that the useful life of the asset is used up evenly over time and charges a fixed amount per period to expense.
The computation for the straight-line (SL) method is:
- Straight-line depreciation expense per year = (Cost - Residual value) ÷ Useful life (years)
The advantage of the straight-line method is that it is simple to compute. The disadvantage is that the passage of time may not be representative of the use of the asset’s benefits and may not match cost to revenue.
- Straight-line rate = 1 ÷ Useful life (years)
The straight-line method is a method of allocation such that a constant dollar amount is recognized as revenue or expense each period. The straight-line method is commonly used for depreciation.
Example: An asset costing $100,000, with a salvage value of $5,000, to be depreciated over 10 years by the straight-line method of depreciation would be depreciated at $9,500 per year (($100,000 - $5,000) ÷ 10).
