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Financial Accounting and Reporting > Accounting for leases > Flashcards

Accounting for leases Flashcards

1
Q

What is an operating lease?

A

a lease where the rights and risks of ownership don’t transfer, considered a true rental.

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2
Q

what types of leases can a lessor have?

A

operating
non-operating
**sales type
**direct financing

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3
Q

what types of leases can a lessee have?

A

Operating

Capital

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4
Q

what are the lessor’s responsible under a operating leases?

A
  • depreciates the asset
  • direct costs (commissions, legal fee’s) are amortized S/L over the lease term
  • executory cost (taxes, insurance and maintenance of the asset) are recognized as incurred as expenses
  • lease bonus is deferred (un-earned revenue) and amoritzed over the life of the lease
  • rent received in advance is considered unearned (deferred revenue)
  • security deposits
  • *nonrefundable-unrevenue until earned
  • *refundable-liability until returned
  • uneven rental payments are recognized uniformily (evenly) over the lease term (free rent for example)
  • termination cost should be measured and recognized at fair value at the date of the agreement is terminated.
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5
Q

what are the lessee’s responsibilities under an operating lease

A
  • rent expense is recognized uniformily (evenly even if it is free rent)
  • lease bonus is considered an asset and is amortized over straighline method
  • leasehold improvements are reported w/PPE and amortized over the shorter of the lease term or useful life
  • refundable security deposits are assets (receivable)
  • early termination costs must be recognized immediately at fair value by lessee
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6
Q

what disclosures are required for leases?

A
  • general description of the leasing arrangements

- minimum lease payments of each of the next 5 years and in the aggregate

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7
Q

what is a capital lease?

A

a lease where the rights and risks of ownership have transferred from the lessor to the lessee. In substance its a purchase although in form its a lease. the lessee recognizes both an asset and a liability at the present value of the minimum lease payments not to exceed fair market value while the lessor will account for such a lease as either an operating, sales-type or a direct financing lease.

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8
Q

what are the four criteria to account for a lease for as a capital lease?

A

ANY ONE of these makes it a capital lease….

  • transfer of ownership
  • written lease contains a bargain purchase option
  • the noncancellable lease term is equal to 75% or of the estimated useful/economic life of the property at inception
  • PV of the minimum lease payments is equal to 90% or more of the FMV of the property at inception

Note if the beginning of the lease term falls w/in the last 25% of the total estimated economic life of the leased property, criterion (75% of the economic life; minimum lease payments (mlp) 90% or more of the FMV) the lease should NOT be classifed as an capital lease

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9
Q

what is the minimum lease payments

A

the minimum amount that the lessee will pay or that the lessor will receive under the terms of the lease during the noncancellable lease term.

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10
Q

what is included in the minimum lease payments?

A

base rent-amount of the rent the lessee is required to pay to the lessor over the noncancellable term of the lease. it also includes the minimum lease payments during any renewal periods that are included in the noncancellable lease term.

Bargain purchase options are included in the minimum lease payment

penalties are part of the minimum lease payment because they are not severe so it is assumed the lease will not be renewed.

residual value is included in the minimum lease payment because it is assumed that the lessee will return the property at a certain value

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11
Q

how is a guaranteed residual value accounted for that is guaranteed by lessee?

A

lessee and lessor both include the amount of guaranteed residual value in the minimum lease payments

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12
Q

how is a guaranteed residual value accounted for that is guaranteed by third party?

A

only the lessor includes the amount in minimum lease payments

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13
Q

how are un-guaranteed residual values accounted for?

A

only the lessor includes the amount in minimum lease payments.

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14
Q

what is excluded out of minimum lease payments?

A

contingent rents (rents that are subject to the occurrence of some event in the future)

executory costs (taxes, insurance, or maintenance of the leased property these are expensed as incurred)

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15
Q

what methodology is used to record the lease from the lessee side

A

the lower of the FMV or the PV of the minimum lease payments

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16
Q

how do you PV the minimum lease payments

A

use the incremental borrowing rate that the lessee would pay in the lending market to purchase the leased asset.

UNLESS BOTH of these are known:
Lessee KNOWS the lessor’s implicit rate AND the implicit rate is LOWER than the incremental borrowing rate.

Note: the lessor ALWAYS uses the rate implicit in the lease.

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17
Q

if a payment is made on day 1 on a lease, how is it applied?

A

it is all applied to principal.

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18
Q

what is the journal entry for a lease payment made on day 1?

A

debit-lease liability

credit - cash

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19
Q

what is the journal entry for a lease payment that is due the following year

A

debit-lease liability for the current years amortized amount
debit-interest expense
credit- cash for the total amount due (it is the same amount each year)

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20
Q

Under the transfer of title or bargain purchase option; how does the lessee account for depreciation?

A

depreciate over the useful life and take out the salvage value.

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21
Q

if the lessee has an asset for more than or equal to 75% of its useful life or if the PV of the MLP is 90% or more of the FV of the asset; how is depreciation accounted for?

A

depreciate over the shorter of the useful life or the lease term. you ignore the salvage value

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22
Q

what are the criteria for the lessor to account for a lease as a sales type lease or a direct finance lease?

A

Both collectability of the lease payments is reasonable assured ANDn there are no significant uncertainties regarding unreimbursable costs to be incurred by the lessor (measurability)

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23
Q

what is a sales type lease

A

the seller is usually a manufacturer or dealer of the asset, and uses the lease as a way of selling the asset on an installment basis. the FV of the leased property differs from the cost which creates a dealer’s profit or loss which is recognized in the period of the sale & interest revenue earned over the lease term using the effective interest method.

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24
Q

what is the journal entry for a sales type lease?

A

debit-gross investment in lease (minimum lease payments+guaranteed/unguaranteed residual value)
credit-sales revenue (pv of min lease payments+pv of guaranteed residual value not PV of unguaranteed residual value)
credit-unearned interest revenue (contra account to gross investment, amortize using effective interest method

second J/E
debit-cost of goods sold (cost of asset+initial direct costs (exp this yr)-pv of unguranteed residual value)
credit-inventory for cost of asset

25
Q

what is the journal entry for the lessor to record the lease payment received?

A

debit-cash
credit-gross investment in lease

second JE
debit - Unearned interest revenue for the deferred revenue
credit-interest income

26
Q

what is a direct financing lease?

A

a lease where the lessor is financing the acquisition of an asset by the lessee but is not earning a manufacturer’s or dealers profit. the PV of the minimum lease payments will be equal to the FV of the property and the lessor will earn only interest income.

27
Q

what is the JE for a direct financing lease by the lessor?

A

debit-lease payment receivables
credit- equipment
credit-unearned interest revenue

28
Q

what disclosures are required for a direct financing type lease?

A
  • future minimum lease payments
  • unguaranteed residual value
  • earned income
  • future payments to be received over the next 5 years
29
Q

if a land lease does not contain a transfer of title or bargain purchase option; how is it accounted for?

A

an operating lease

30
Q

for land if a transfer of title is at the end of the lease how is it accounted for?

A

as a sales type lease if there is a manufacturers or dealer’s profit or loss.

it will reported as direct financing lease if there is no profit or loss

31
Q

If the BPO of a land lease is an option and assumed it will be taken by the lessee, how is the land accounted for by the lessor?

A

as an operating lease or direct financing lease as appropriate.

32
Q

what happens if leases involve building and land

A

if the agreement involves a TT or BPO; the lessee will capitalize the land and building separately.

33
Q

if it is neither a TT or BPO for a lease involving land and building, how is it handled?

A
  • lessee will determine if the land is significant.
  • if the FV of the land is less than or equal to 25% of the TOTAL FV, it is ignored and the lease is treated as a building only lease.
34
Q

if the FV of the land is greater than 25% how are the land and building treated.

A

they are treated as separate transactions.

35
Q

on a building and land lease if the building meets either of the 75% of estimated economic life or if the MLP is 90% of the FMV of the land and building how is it accounted for?

A

-the building will be capitalized and the land portion will be an operating lease.

NOTE: if neither of the latter two criteria are met, the entire lease will be accounted for as a single operating lease

36
Q

on a sales leaseback if the PV of rental payments is greater than or equal to 90% of the FV of the property at inception what does that imply?

A

that the seller-lessee retains substantially all the rights to the use of the property and the leaseback is accounted for as a capital lease. all gains are deferred and offset against depreciation expense.

37
Q

on a sales leaseback if the PV of rental payments is less than or equal to 10% of the FV of the property at inception what does that imply?

A

this implies that the seller only retains a minor portion of the rights to use the property, the sale and leaseback are considered separate transactions. the sale is recognized and the leaseback is considered an operating lease.

–recognize all gain immediately

38
Q

on a sales leaseback if the PV of rental payments is less than or equal to 10% of the FV of the property at inception what is the journal entry?

A

debit- cash
credit-equipment
credit-deferred gain

debit-leased asset
credit-obligation under capital lease

39
Q

how are capital leaseback’s accounted for?

A

gain/loss is deferred & amortized over the period used for depreciating the asset as a reduction of depreciation expense.

  • -deferred gain is reported as an asset valuation allowance to the leased asset account
  • -a loss is deferred and amortized as prepaid rent if the carrying amount (BV) of the asset sold is greater than the sale price, the FV exceeds the carrying value (BV)
  • -loss is recognized immediately if the carrying amount is greater than the FV.
40
Q

what is the journal entry for capital leaseback’s ?

A

debit-depreciation expense
credit-accumulated depreciation

debit-deferred gain
credit-depreciation expense

NOTE the net effect of depreciation expense is a reduction to the expense account.

41
Q

how are operating leasebacks accounted for?

A
  • gain/loss deferred and amortized over the term of the lease as a reduction of rent expense. the deferred gain is considered a deferred credit.
  • if a sales-leaseback occurs in the last 25% of an assets economic life, classify as an operating lease

NOTE: only REAL losses are recognized b/c an aritificial loss can happen between the FV and the Sales price paid but since the sales price is not what is recorded in the books then it makes it artificial. the difference btwn the BOOK value and FMV is what creates a real loss and that difference is recorded /recognized.

42
Q

what is the journal entry for an operating leaseback?

A

debit-RENT expense
credit-cash

debit-deferred gain
credit-RENT expense

43
Q

under IFRS what are the types of leases?

A

finance leases

operating leases

44
Q

under IFRS what is the criteria for a finance lease?

A

leases that transfer substantially all of the rights and risks of ownership to the lessee, regardless of whether title is actually transferred. all other leases are operating leases.

45
Q

under IFRS what does the rights of ownership include

A
  • benefit of profitable operation over the asset’s economic life
  • the benefit of appreciation in value or realization of a residual value
46
Q

under IFRS what does the rights of ownership include?

A
  • the possibility of losses due to idle capacity or obsolescence
  • reductions in returns due to changing economic conditions.
47
Q

under IFRS what circumstances individually or in combination will ordinarily be indicative of a finance lease?

A
  • title transfer by the end of lease term
  • the lease contains a purchase option that is sufficiently lower than expected market value to make it reasonably certain that it will be excercised
  • the lease term is for major part of the assets useful life
  • the PV of the minimum lease payments at the inception of the lease is substantially equal to the FV of the asset
  • the asset can only be used by the lesse w/o major modification.
48
Q

under IFRS what situations individually or in combination will ordinarily be indicative of a finance lease?

A
  • lessor losses associated w/the lessee’s cancellation of the lease are borne by the lessee
  • lessee incurs gains orlosses resulting from fluctuations in the FV of the residual asset
  • the lessee can renew the lease at rents that are substantially below market.
49
Q

under IFRS how does the lessee account for a finance type lease?

A

by recognizing a liability in an amount equal to the lower of the fair value of the leased asset or the PV of the minimum lease payments. an asset is recognized in the amount of the liability plus any initial direct costs incurred by the lessee.

50
Q

under IFRS how is the PV calculated?

A

-using the implicit rate (if the implicit rate is not determinable, then use the incremental borrowing rate)

51
Q

under IFRS how are the initial direct cost for a finance lease accounted for?

A

the lessee capitalizes the initial direct costs for a finance lease.

52
Q

sales type/direct financing lease

A

payments w/b allocated to interest 1st w/remainder allocated to reducing the principal balance of the receivable

since the principal balance is reduced each period the amount allocated to interest will decrease each period.

53
Q

leases containing bargain purchase options (BPO)’s

A

leased equipment containing BPO’s that w/b exercised will be depreciated over the ESTIMATED USEFUL life instead of the term of the lease. the amount to be depreciated is the capitalized amount including the BPO less the estimated fair value/salvage value at the end of the useful life.

54
Q

how are losses accounted for in a sales lease back transaction

A

losses are recognized immediately.

55
Q

how are gains accounted for in a sale-leaseback of a a lease classified as a capital lease

A

gains are recognized as a reduction to depreciation expense. the amount the gain will be divided by the term of the lease and offset against depreciation expense.

56
Q

if the present value of the lease payments is less than 10% of the sales price how is it accounted for?

A

it is a minor leaseback and the two transactions are are treated separately & NO PORTION of the gain on sale is deferred

57
Q

in a sales leaseback that is considered an operating lease how is a gain accounted for?

A

the gain will not be recognized on the income statement but will be reported as a deferred credit in the liability section of the balance sheet. it will be amortized over the term of the lease w/the amortization reported as a reduction of rent expense.

58
Q

Under IFRS how is a land and building accounted for?

A

it is separated into tow leases and the land protion is accounted for separately from the building portion.

Financial Accounting and Reporting (12 decks)

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