capital leases

Question 1

executory costs

Answer 1

property taxes
insurance and maintenance
these are expensed by lessee in a capital lease and lessor in a operating lease

Question 2

if total lease payments are 1600 and 300 are executory costs, then what do i Capitalize?

Answer 2

1300

the 300 would be expensed at inception of lease

Question 3

minimum lease payments are

Answer 3

annual lease payments
rental payments under bargain newel options
bpo
guaranteed residual value.

these are used to determine if pv payments are greater than 90% cash price of leased asset

Question 4

lessor implicit interest rate

Answer 4

the rate earned by the lesser on the lease

Question 5

lessee’s incremental borrowing rate

Answer 5

rate on similar debt

Question 6

what rate do i use?

Answer 6

use the smaller of lessors implicit rate and lessees incremental rate. LOOK AT RATES! not pvoa. this would be used for criterion #4. 90% fv

Question 7

capital lease criteria for lessee

Answer 7

1. title transfer-installment purchase implied
2. bpo-allows lessee to purchase asset at end of lease term for less than fv

3.lease term is >= 75% of the assets remaining useful life at inception. EX
useful life is 10 years
after 3 years asset is leased for 6 years
6/7=75%

4.pv of min lease payments is >=90% of the fv of the asset at inception.

Question 8

the criteria is the same for lessee and lessor but lessor must meet an extra two criteria to be classified as a capital lease.

Answer 8

lease payments are collectible

no material cost uncertainties for the lessor(guarantee against obsolescence)

Question 9

if fv does not equal bv then what type of lease is it for the lessor?

Answer 9

sales type lease

Question 10

there are two types of capital leases

Answer 10

sales type lease and direct financing lease

Question 11

lessee journal entries for sales type lease

Answer 11

1/1/x1 (annuity due lease)

leased asset (pv of payments)     17
             Lease Lia                                 17

Lease lia 5
Cash 5
(lease payments)

12/31/x1
interest expense (17-5*.1) 1.2
lease lia 1.2

Depn Exp (S/l) (17/4 years)      4.25
         AD                                             4.25

1/1/x2

Lease Lia 5
Cash 5

12/31/x2
Interest expense can be multiplied by lease lia balance 17-5-1.2-5=5.8*.1=.58

Int exp .58
Lease Lia .58

Question 12

Lessor Journal Entries for Sales type lease

Answer 12

1/1/x1
Lease Receivable (gross) (4*5) 20
cogs(cost) 12
unearned interest(20-17) 3
asset(take off at cost) 12
sales (fv) 17

cash 5
lease receivable 5
(1st payment received by lessee)

*gm 17-12=5

12/31/x1
interest revenue 1.2
unearned interest 1.2
(20-3-5*.1)

1/1/x2
cash 5
lease rec 5

12/31/x1
interest revenue               .82 
        unearned interest                .82
net reachable *.1
20-5-5-3+1.2=8.2*.1=.82
0r net receivable*.1

Question 13

criteria 1 and 2 is only used for

Answer 13

land leases

Question 14

if land and building are leased when do you separate them?

Answer 14

if fv of land is >25% of fv then separate lease and land lease is operating lease and building is capital lease.

Question 15

contingent rental

Answer 15

changes in lease payments that result from some future event other than passage of time. recognize as revenue or expense as they occur. not used in rent expense/revenue for operating leases and not included in min lease payments.

Question 16

depreciation is always calculated using the

Answer 16

initial capitalized amount at inception

Question 17

abe co leased machinery
economic useful life is 10 yrs
for tax purposes depreciable life is 7 yrs
the lease is for 8 yrs
abe can purchase the equipment for fav at the end of the lease term

what is the depreciable life for financial reporting?

what if there was a bargain purchase option?

Answer 17

1. 8 years
   because criteria 3 is met for it to be a capital lease
   8/10=80% and 80>75
2. 10 years
   the assumption is the lessee will take advantage of that option and hold the asset for its expected economic life

Question 18

on 12/30/x1 the parties sign a 4 year lease with the following data.
4 annual lease payments of 20,985 due at the end of the year.
end of lease term 12/31/x5
interest rate 10%
pvoa 3.486
pv .683
fv of asset at inception 80k
useful life 6 yrs (s/l depn and 5k residual)
at end of lease lessee can purchase asset for 10k. fv is estimated to be 25k.

Answer 18

20,9853.486 + 10k.683=80k
criteria 4 is met 80pv/80fv=100%

12/31/x1- Lessee
leased asset 80
lease lia 80

lease lia 20,985
cash 20,985

12/31/x2
depn exp (80-5/6) 12.5
AD 12.5
*because this lease met the bpo criteria we are using the useful life of the asset and not 4 yrs

12/31/x1-lessor
lease receivable (4*20,985+10k) 93,940
unearned interest(plug) 13,940
asset 80k

Question 19

unguaranteed residual question
1/1/x1 sign lease
annual lease payments due at 12/31 of 23,083
12/31/x1 end of lease term
lessee incremental rate 10%
pvoa 3.17
pv      .6830
lessor implicit rate 12%
pvoa   3.037
pv        .6355

fv of asset at inception 80k(cost)
useful life at inception 6 yrs (s/l 5k residual value.
at end of term asset reverts to lessor and is set 10k value.

Answer 19

lessor
230833.17=73183
+10k.683=6830
=80k

pv of min lease payments
73pv/80fv=91% so its a capital lease

Lessor 1/1/x1
lease receivable(4*23083+10k) 102332
unearned interest (plug) 22332
asset 80k

Lessee
leased asset 73183
leased lia 73183

depn exp (73170/4) 18293
AD 18293
(will only use for 4 years)

there were three more questions i skipped. go back

Question 20

sale leaseback

Answer 20

owner of an asset sells it and immediately buys it back

Question 21

major leaseback

Answer 21

pv min lease payments>=90% of fv

gain on sale is deferred and recognized over lease term

Question 22

major leaseback gain -capital lease

Answer 22

defer and classify gain as a contra leased asset account

amortize the contra account reducing depn expense

Question 23

major leaseback gain-operating lease

Answer 23

defer and classify gain as a liability

Question 24

major leaseback example
on 1/1/x1 a firm sells a plant asset for 24 (cost 32 and ad 18)
remaining useful life is 5 yrs (S/L)
asset is leased back for 5 years
annual year end lease payments based on selling price and a 10% implicit rate are(24/3.791) 6,331.
gain on sale 10,000. (24-14)

Answer 24

if this is a capital lease
cash    24
ad        18
          asset            32
          def gain       10
(sale of asset)

leased asset 24
leased lia 24

depn expense (24/5)  4800
   AD                                         4800

deferred gain              2000
       Depn Expense (10/5)     2000
(the gain gets recognized through the reduction of DEPN expense each year)

if this was an operating lease 
cash    24
ad        18
          asset            32
          Gain Lia       10
(sale of asset)

deferred gain Lia 2000
Rent Expense 2000

Question 25

What is the proper depreciation for a lessee on a capital lease. depreciation depends on which criteria was used to determine if it was a capital lease. Very Important

Answer 25

if criteria 1 and 2 are met then use economic useful life of the asset and residual value at that time.
if criteria 1 and 2 are not met and either of criteria 3 and 4 then use the length of the lease as the depreciation term.

Question 26

included in minimum lease payments are

Answer 26

rental payments(excluding executory costs)
bpo(if any)
guaranteed residual (if any)
penalty for failure to renew (if any)

ex
pvoa or rental payments
less pv of unguaranteed residual
=pv of lease payments

ex
pvoa or rental payments
plus pv of guaranteed residual
=pv of lease payments

ex
pvoa or rental payments
plus bpo
=pv of lease payments

a guaranteed residual value or bpo is an additional lease payment that the lessee will pay