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FAR 5 > Accounting for Leases > Flashcards

Accounting for Leases Flashcards

1
Q

Lease

A

Contractual agreement between a lessor, who conveys the right to use real or personal property (an asset), and a lessee, who agrees to pay periodic rents over a specified time

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2
Q

Operating lease

A

Includes a lessor, who collects rent, and a lessee, who uses the leased asset and pays periodic rent for such use

No transfer of ownership or any risk/benefit of ownership

Rental agreement

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3
Q

Lease rent expense (lessee accounting)

A

Lessee records rent expense over lease term, usually on straight line basis

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4
Q

J/E to record rent expense (lessee accounting)

A

Dr. Rent expense
Cr. Cash/rent payable

off b/s financing

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5
Q

Lease bonus (lessee accounting)

A

Prepayment for future expenses

Classified as an asset (deferred charge) and amortized using S-L method over life of lease (i.e. commission paid to real estate agent)

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6
Q

Leasehold improvements (lessee acct)

A

One that is permanently affixed to the property and reverts back to the lessor at the termination of the lease

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7
Q

How should leasehold improvements be accounted for under lessee acct?

A

Should be capitalized and added to PP&E section or intangible assets section of b/s

Depreciated (amortized) over the lesser of:

  • -Lease life
  • -Asset/improvement life
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8
Q

Rent kicker (lessee acct)

A

Premium rent payment required for specific event (period expense)

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9
Q

Refundable security deposit (lessee)

A

Reported as an asset until refunded by lessor

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10
Q

Free or reduced rent consideration (lessee)

A

Lessee must take total rent expense to be paid for entire lease term and divide it evenly over each period (matching principle)

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11
Q

Under an operating lease, how is the fixed asset accounted for in the lessor’s books?

A

The cost is included in the lessor’s PP&E

Depreciation is over the asset’s useful life

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12
Q

How is rental income reported in the lessor’s books?

A

Using the straight-line or other systematic method

Dr. Cash/rent receivable
Cr. Rental income

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13
Q

Nonrefundable security deposits (lessor accounting)

A

Deferred by the lessor (unearned rev) and capitalized by the lessee (prepaid rent expense) until the lessor considers the deposit earned

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14
Q

Refundable security deposits (lessor accounting)

A

Treat as a receivable by the lessee and a liability by the lessor until the deposit is refunded to lessee

Dr. Cash
Cr. Refundable deposit

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15
Q

Lease bonus (lessor)

A

Deferred (unearned income) and amortized (into income) over the life of the lease

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16
Q

Free or reduced rent consideration (lessor)

A

Lessor must take total rental income to be received over entire lease term and divide it evenly over each period (matching/rev recognition)

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17
Q

Capital lease / Finance lease

A

Transfers substantially all of the benefits and risks inherent in ownership of property to the lessee

Purchase/ownership

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18
Q

How does the lessee account for a capital/finance lease?

A

As the acquisition of both an asset and a related liability

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19
Q

How does the lessor account for a capital/finance lease?

A

As a sales-type or direct financing lease

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20
Q

Lessee capital lease criteria (US GAAP)

[OWNS]

A

Must meet just one condition to capitalize:

Ownership transfers at end of lease (upon final pymt or required buyout
Written option to bargain purchase
Ninety (90%) percent of leased property FV = PV of lease pymts
Seventy-five (75%) percent or more of asset economic life is being committed in lease term

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21
Q

J/E to capitalize leased property (US GAAP)

A

Dr. Fixed asset - leased property

Cr. Liability - obligation under capital lease

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22
Q

Lessee finance lease criteria (IFRS)

[OWES FACS - owes facts]

A

O - lease transfers Ownership
W - contains Written bargain
E - lease term for major part of Economic life
S - present value of min. lease payments is at least Substantially all of the fair value
F - gains/losses from Fluctuation in the fair value of residual accrue to lessee
A - lessee has Ability to continue the lease for secondary period at substantially lower than market rent
C - lessee can Cancel the lease and bears lessor’s losses
S - leased assets are of Specialized nature

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23
Q

Finance lease (IFRS)

A

A lease in which substantially all the risks and rewards inherent in ownership are transferred to the lessee

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24
Q

What criteria must be met for a lease to be classified as a sales-type or direct financing lease by the lessor?
(LUC)

A

All of the following:

  1. Lessee “owns” the leased property
  2. Uncertainties do not exist regarding any unreimbursable costs to be incurred by lessor
  3. Collectability of the lease payments is reasonably predictable
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25
Q

Sales-type lease

A

FV of the leased property at the inception of the lease differs from the cost or carrying amount to lessor

2 profits: gain on sale & interest income

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26
Q

Direct financing lease

A

FV of leased property at inception of lease is same as the cost or carrying amount

1 profit: interest income

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27
Q

Lessor finance lease criteria (IFRS)

A

Lessor classifies a lease as a finance lease if it transfers substantially all risks and rewards inherent in ownership to lessee

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28
Q

How does the lessee treat a capital/finance lease in their books?

A

As if they were purchasing the asset over time

Dr. Fixed asset - leased property
Cr. Liability - obligation under capital/finance lease

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29
Q

At what value does the lessee record a capital/finance lease?

A

The lesser of:

  1. FV of the asset at inception of lease
  2. Cost = PV of minimum lease payments
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30
Q

What is included/excluded in the “cost = pv of min. lease payments” for the capitalized amount of the lease?

A

Included: required pymts, bargain purchase option, guaranteed residual value

Excluded: executory costs, optional buyout

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31
Q

Guaranteed residual value

A

Amount guaranteed by the lessee to the lessor for the estimated residual value of the asset at the end of lease term

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32
Q

Executory costs

A

Insurance, maintenance, and taxes

Can be paid by the lessor or lessee

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33
Q

Under a finance lease (IFRS), why might the amount of the lease asset and lease obligation differ at lease inception?

A

Because initial direct costs of the lease paid by the lessee are added to amount recognized as a lease asset

34
Q

What interest rate is used when calculating PV of minimum lease payments?

A

The lesser of:

  1. Rate implicit in the lease
  2. Lessee’s incremental borrowing rate
35
Q

What is included in the capitalized cost for each criteria of OWNS?

A

Ownership = PV of pymts and required buyout (if any)
Written = PV of pymts and bargain buyout
Ninety % FV = PV of payments (no optional buyout)
Seventy-five % life = PV of pymts (no optional buyout)

36
Q

Depreciation of leased assets (formula)

A

Capitalized lease assets

= Depreciable base
/ Periods of benefit
= Depreciation expense (per period)

37
Q

What would be the depreciable life of a leased asset under US GAAP?

A

If ownership transferred or written bargain => estimated economic life of the asset

If 90% FV or 75% life => lease term

38
Q

What would be the depreciable life of a leased asset under IFRS?

A

The lesser of:

  1. the lease term
  2. the useful life of the asset
39
Q

How is the lease liability amortized?

A

Using the effective interest method

40
Q

Gross investment (Sales-type lease lessor)

A

Lease receivable

Minimum lease payments + any unguaranteed residual value (estimated FV at end) accruing to the benefit of the lessor

41
Q

Net investment calculation

A

PV of minimum lease pymts (including periodic lease pymts, bargain purchase option, or guaranteed residual value) + PV of any ungauranteed residual value accruing to benefit lessor

Gross investment x PV = Net investment (net principal)

42
Q

Unearned interest revenue (contra-lease receivable) calculation

A

Gross investment - Net investment = Unearned interest revenue (future interest)

43
Q

How is unearned interest revenue accounted for?

A

Recognized over the life of the lease using the effective interest method

Included in BS as a deduction from gross investment

44
Q

Cost of goods sold calculation

A

Cost of asset - PV unguaranteed residual value (what you get back) = COGS (net given up)

45
Q

Sales revenue

A

PV of the min. leasse pymts (does not include PV of unguaranteed residual value)

46
Q

Rule for sale-type lease:

Cost + Profit =

A

Present value = Selling price = FV (when sales price not given)

47
Q

What information is need to record / what is recorded for a sales-type lease?

A
  1. Gross Investment (lease receivable)
  2. Net Investment (principal)
  3. Unearned Interest Revenue (future interest)
  4. COGS
  5. Sales Revenue
48
Q

What information is need to record / what is recorded for a direct financing lease?

A
  1. Gross investment (lease receivable)
  2. Net investment (principal)
  3. Unearned interest revenue (future interest)
49
Q

Rule for direct financing lease

A

PV = Carrying amount of receivable = Cost of asset sold

50
Q

Sale-leaseback

A

Owner of property (seller-lessee) sells the property and simultaneously leases it back from purchaser-lessor

51
Q

Selling price (sale-leaseback)

A

Negotiated price in sale-leaseback agreement

52
Q

Profit/loss on sale (sale-leaseback)

A

Amount that would have been recognized by the seller-lessee assuming there was no leaseback (FV - BV)

53
Q

How is the operating lease excess profit on sale-leaseback calculated?

A

Sale price - Asset NBV = Tentative gain
Tentative gain - PV min. lease payment = Excess gain

Rent back

54
Q

How is the capital lease excess profit on sale-leaseback calculated?

A

Sale price - Asset NBV = Tentative gain
Tentative gain - Leaseback asset = Excess gain

Where leaseback asset is the lesser of:

  1. FV of leased property
  2. PV of min. lease payments

“OWNS”-back

55
Q

What is the general rule for sale-leasebacks?

A
  • Over 90% = Loan
  • 10-90% = Rules
  • 0-10% = Ignore
56
Q

Under US GAAP, how is the amount of deferred gain determined for sale-leasebacks?

A

Determined by the retained rights to remaining use of the “leaseback” property, which is determined by the PV of rent payments paid by the seller-lessee

57
Q

How may the seller-lessee’s rights be categorized?

A
  1. “Substantially All” rights retained (equal to or greater than 90%) ==> capital lease
  2. Rights retained are less than “substantially all” but greater than “minor” (between 90%-10%) ==> capital or operating lease
  3. Minor portion of rights retained by seller-lessee (less than or equal to 10%) ==> operating lease
58
Q

How is a gain treated if “substantially all” rights are retained?

A

Defer all gain and amortize with the leased asset

59
Q

How is a gain treated if less than “substantially all” but greater than “minor” rights are retained?

A

Defer gain up to the PV of minimum leaseback payments (operating lease) or capitalized asset (capital lease)

Gain in excess of this amount is recognized immediately

60
Q

How is a gain treated if “minor” rights are retained?

A

Recognize gain or loss at the time of the sale-leaseback transaction

Gains not deferred

61
Q

In sale-leasebacks, when would the seller/lessee need to recognize a loss immediately?

A

When the FV of the property at the time of the sale-leaseback is less than BV

62
Q

What is an artificial loss and how is it accounted for by the seller/lessee in a sale-leaseback?

A

It is when the sales price is below the FV

The loss is deferred and amortized over the leaseback period

63
Q

How are deferred gains/losses recognized/accounted for in capital leasebacks?

A

Amortized in proportion to the amortization of the leased asset

Deferred gain/loss recognized as “unearned profit/loss on sale-leaseback”

“Unearned profit/loss on sale-leaseback” treated as a valuation account of the leased (back) asset

64
Q

How would deferred gains/losses be recognized/accounted for in operating leasebacks?

A

Amortized in proportion to gross rental expense over life of lease

Deferred gain/loss recognized as “unearned profit/loss on sale-leaseback”

“Unearned profit/loss on sale-leaseback” reported as a deferred credit/debit in B/S

65
Q

Under IFRS, how is profit from a finance sale-leaseback transaction accounted for?

A

Deferred and amortized over the lease term

66
Q

Under IFRS, how is profit/loss from operating sale-leaseback transactions accounted for?

A

Recognized based on the leased asset’s carrying amount, FV, and selling price

  1. Sales price = FV (general rule) ==> Profit/loss recognized immediately
  2. Sales price > FV ==> Profit deferred/amortized over period that asset is expected to be used
  3. Sales price < FV ==> Profit/loss recognized immediately, except if loss is compensated for by future lease payments at below mkt price (then loss should be deferred/amortized over period of expected use
67
Q

If the sale-leaseback is a capital lease, how is the lease accounted for in the purchaser-lessor books?

A

As a direct financing lease

68
Q

For subleases, how is the newly created sublease classified if the original lease was a capital lease?

A

If it was capital due to OWNERSHIP transfer or WRITTEN bargain purchase option => capital

If it was capital due to NINETY percent fair value or SEVENTY-FIVE percent of life => operating

69
Q

Are executory costs included in the lease payment to calculate the present value of lease liability?

A

No (including taxes)

70
Q

For a sales-type (finance) lease, what is recorded as profit?

A

The excess of the PV of the selling price over its cost (PV of payments - Carrying cost = Profit on sale)

71
Q

When a lease is capitalized because of transfer of title or bargain purchase, what is depreciation based on?

A

The life of the asset, not the lease

72
Q

What life should leasehold improvements be amortized over?

A

The lesser of the remaining life of the lease and the life of the improvement

73
Q

Under a sale-leaseback under US GAAP, when the seller-lessee retains only a minor portion, how should the gain be accounted for?

A

Recognized immediately

74
Q

Under an operating lease, how are lease bonuses accounted for?

A

They recorded as rent expense but amortized over the life of the lease

75
Q

Reminder!!!

A

Always remember to subtract lease payments already made before calculating interest (especially in annuity due)

76
Q

Under a sales-type lease, what does the lessee record the lease as?

A

As an asset and a liability at the lesser of the FMV of the asset at inception of the lease of cost (PV of min. lease payments)

77
Q

Under sales-type lease, how should the lease be depreciated?

A

Over the lease term if the lessee does not take ownership of the asset by the end of the lease or if there is not a bargain purchase option

78
Q

Under a capital lease, what amount should be capitalized??

A

The PV of the min. lease payments

79
Q

In regards to the minimum lease payments, what is the difference between US GAAP and IFRS when determining whether to classify the lease as operating or capital?

A

IFRS: lease is classified as finance (capital) lease if the PV of the minimum payments amounts to at least substantially all of the FV of the leased asset

GAAP: 90%

80
Q

Under IFRS, a gain resulting from the sale of a sale-leaseback should be deferred and subsequently amortized when:

A

The seller-lessee accounts for the lease as a finance lease AND the seller-lessee accounts for the lease as an operating lease and the sales price is above FV

81
Q

In a sales type lease, what does COGS equal?

A

COGS = Historical cost of the asset sold - PV of the non-guaranteed residual value discounted over the life of the lease

82
Q

Under GAAP sale-leaseback transactions, what should be recognized when the FV of the property at the time is less than the book value?

A

A loss in the current year

FAR 5 (3 decks)

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