Accounting For Leases

Question 1

Operating Lease

Answer 1

Rental agreement
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 or benefit of ownership.

Question 2

Lease Rent Expense

Answer 2

Lessee records rent expense over the lease term, usually on a straight-line basis unless other methods warranted.
DR: Rent expense
CR: Cash/rent payable

Question 3

Lease Bonus (prepayment)

Answer 3

Lease bonus for future expenses should be classified as an asset (deferred charge) and amortized using the straight-line method over the life of the lease.
- commission paid to real estate agent

Question 4

Leasehold Improvements

Answer 4

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

• capitalized and added to PPE or intangible assets
• depreciation (amortized) over the lesser of: lease life or asset/improvement life

Question 5

Rent Kicker

Answer 5

Premium rent payment required for specific events–> periodic expense

Question 6

Refundable Security Deposit

Answer 6

Reported as an asset until refunded by the lessor.

Question 7

Free or Reduced Rent Consideration

Answer 7

If consideration (free rental months or reduced rental charge at beginning) is part of the package, lessee must take total rent expense to be paid for the entire lease term and divide it evenly over each period (matching principle).

Question 8

Fixed Asset - Lessor

Answer 8

The cost of the property is included in the lessor’s PPE.

- Depreciation: over the asset’s useful life

Question 9

Security Deposits

Answer 9

• Nonrefundable: deferred by the lessor (unearned rev) and capitalized by the lessee (prepaid rent expense) until the lessor considers the deposit earned.
• Refundable: Treat as a receivable by the lessee and a liability by the lessor until the deposit is refunded to the lessee.
  DR: Cash
  CR: Refundable Deposit

Question 10

Lessee (buyer) Capital Lease Criteria (GAAP)

Answer 10

Must meet one condition (OWNS) to capitalize:
O - Ownership transfers at end of lease
W - Written option for bargain purchase
N - Ninety (90%) percent of leased property FV = PV of lease payments
S - Seventy-five (75%) percent or more of asset economic life is being committed in lease term

Question 11

Lessee Finance Lease Criteria (IFRS)

Answer 11

Meet at least one condition (OWES FACS):
O - The lease transfers ownership
W - The lease contains a written bargain purchase option
E - The lease term is for the major part of the economic life of the asset even if title not passed
S - The present value…substantially all of the FV
F - G/L from the fluctuation in the FV of the residual accrue to the lessee
A - Lessee has the ability to continue the lease for a secondary period at a rent substantially lower than market rent.
C - Lessee can cancel the lease and the lessor’s losses associated w/the cancelation are borne by the lessee
S - Leased assets are of such a specialized nature that only the lessee can use them w/out modification.

Question 12

Lessor (Seller) - Sales-Type/Direct Financing Type Criteria (GAAP)

Answer 12

Must meet all three conditions (need all the LUC):
L - Lessee “owns” the leased property
U - Uncertainties do not exist regarding any unreimbursable costs to be incurred by the lessor
C - Collectability of the lease payments is reasonably predictable.

Question 13

Recording the Lease - Capitalized Amount

Answer 13

The lessee records the lease as an asset and a liability at the lower (lesser) of:

• Fair value of the asset at the inception of the lease
• Cost = present value of the minimum lease payments

Question 14

Interest Rate

Answer 14

When calculating the present value of the minimum lease payments, the lessee uses the lower (lesser) of the:

• Rate implicit in the lease (if known)
• Lessee’s incremental borrowing rate (not prime)

Question 15

Period of Benefit (Depreciable Life) - GAAP

Answer 15

• Under Ownership Transfer and Written Bargain: use estimated economic life of the asset.
• Under the 95% FV and 75% Life rules: use the lease term.

Question 16

Period of Benefit (Depreciable Life) - IFRS

Answer 16

The depreciation period is the shorter (lesser) of the lease term and the useful life of the asset.

Question 17

Gross Investment (Sales-Type/Finance Lease)

Answer 17

Lease Payment
+ Unguaranteed residual value (est. FV at end)
= Gross Investment

2 Profits: Gain on sale AND Interest Income
Recorded as Lease Payments Receivable

Question 18

Net Investment (Sales-Type/Finance Lease)

Answer 18

Gross Investment
x PV
= Net Investment/Principal

Question 19

Unearned Interest Revenue (Sales-Type/Finance Lease)

Answer 19

Gross Investment
- Net Investment
= Unearned interest revenue/future interest

Contra-lease receivable

Question 20

Cost of Goods Sold (Sales-Type/Finance Lease)

Answer 20

Cost of Asset (what it sold for)
- PV Unguaranteed residual value (what you get back)
= COGS/net given up

Question 21

Sales Revenue (Sales-Type/Finance Lease)

Answer 21

• Present value of the min. lease payments is recorded as sales revenue.

Question 22

Gross Investment (Direct Financing/Finance Lease)

Answer 22

Lease Payment
+ Unguaranteed residual value
= Gross Investment

1 Profit: Interest Income

Question 23

Net Investment (Direct Financing/Finance Lease)

Answer 23

Gross Investment
x PV
= Net Investment/Principal

Question 24

Unearned Interest Revenue (Direct Financing/Finance Lease)

Answer 24

Gross Investment
- Net Investment
= Unearned Interest Revenue/Future Interest

Question 25

Rule for Direct Financing Lease

Answer 25

PV = Carrying amt of receivable = Cost of asset sold

Question 26

Rule for Sales-Type Lease

Answer 26

Cost + Profit = PV = SP = FV * when sales price not given

Question 27

Sale-Leaseback

Answer 27

The owner of a property (seller-lessee) sells the property and simultaneously leases it back from the purchaser-lessor. General Rule: - Over 90% = Loan - 10-90% = Rules - <10% = Ignore

Question 28

Operating Lease Excess Profit (rent-back)

Answer 28

``` Sale Price - Asset NBV = Tentative Gain - PV min. lease payment = Excess gain ```

Question 29

Capital Lease Excess Profit (owns-back)

Answer 29

Recorded amt of the leaseback asset is the lesser of: - FV of the leased property, or - PV of the min lease payments ``` Sale Price - Asset NBV = Tentative gain - Leaseback asset = Excess Gain ```

Question 30

Amount of Deferred Gain (by seller/lessee)

Answer 30

Determined by the retained rights to remaining use of the "leaseback" property. The rights to the remaining use of the property are determined by the PV of rent payments paid by the seller-lessee.

Question 31

"Substantially All" Rights Retained

Answer 31

PV of the rent payments is equal to or greater than 90% of the FV of the property. Usually capital leases. Over 90% - major Defer all gain and amortize with the leased asset.

Question 32

Rights retained are < "Substantially All" but > "Minor"

Answer 32

Either capital or operating leases. 10-90% - middle Defer gain up to the PV of the min leaseback payments (operating) or capitalized asset (capital). Gain in excess of this amt is recognized immediately.

Question 33

Minor Portion of Rights Retained by Seller-Lessee

Answer 33

Operating Leases. 0-10% - minor Recognize gain or loss at the time of the sale-leaseback transaction. Gains are not deferred.

Question 34

Real Economic Loss

Answer 34

Recognized immediately. | FV of the property at the time of the sale-leaseback is less than BV.

Question 35

Artificial Loss

Answer 35

When the sales price is below the FV, the loss is deferred and amortized over the leaseback period.

Question 36

Capital Leaseback - Amortization of Deferred Gain

Answer 36

Deferred gain or loss is amortized in proportion to the amortization of the leased asset.

Question 37

Operating Leaseback - Amortization of Deferred Gain

Answer 37

Any deferred gain or loss is amortized in proportion to the gross rental expense over the life of the lease.

Question 38

Finance Lease (Sale-Leaseback) - IFRS

Answer 38

Profit from the sale-leaseback transaction is deferred and amortized over the lease term.

Question 39

Operating Lease (Sale-Leaseback) - IFRS

Answer 39

Profit or loss from the sale-leaseback transaction is recognized based on the leased asset's carrying amt, FV, and selling price.

Question 40

Subleases - Original Lease = Operating Lease

Answer 40

If the original lease was an operating lease, the sublease is also an operating lease.

Question 41

Subleases - Original Lease = Capital Lease

Answer 41

If the original lease was a capital lease due to: - Ownership Transfer (O) - Written bargain purchase option (W) Then the sublease is a capital lease. If the original lease was a capital lease due to: - 95% FV (N) - 75% of life (S) Then the sublease will be an operating lease unless it meets one of the capital lease requirements.