Chapter 15 Power Point Notes Flashcards
capital lease
One that transfers substantially all the risks and rewards of ownership to the lessee
operating lease
One that does not transfer the risks and benefits of ownership to the lessee; a rental agreement
JEs for both the Lessee and Lessor of an operating lease
Lessee: Dr. Rent expense XXX Cr. Cash XXX Lessor: Dr. Cash XXX Cr. Rent revenue XXX Dr. Depreciation expense YYY Cr. Accum depreciation YYY
Capital Lease Lessee
Records asset and obligation on balance sheet
Interest expense on obligation
Depreciation on asset
Capital Lease Lessor
Removes leased asset from balance sheet
Records lease receivable
Earns interest/financing income over the lease term
Direct Financing (Capital Lease)
(similar to a loan)
Typically lessor is a financing company
No gross profit is recorded at the signing of the lease; considered to be a financing arrangement (with financing income to the lessor)
Sales-type (Capital Lease)
(similar to a sale of an asset and a loan)
Typically lessor is a manufacturer or dealer
Gross profit is recognized at the inception of the lease, and financing income is recognized over the lease
Capital lease criteria
- Does the lease transfer ownership?
- Does the lease contain a bargain purchase option (BPO)?
- Is the lease term at least 75% of the estimated economic life of the asset?
- Is the present value of the minimum lease payments at least 90% of the fair value of the leased property?
If any of these criteria are satisfied, the lease is a capital lease to the lessee
Bargain Purchase option
Option to purchase asset at end of lease term at a price sufficiently below expected market value that exercise of option appears reasonably assured
Suggests that the contract is written in a way to make a transfer likely
Economic life test
After 75% of life, most risk/rewards would have been transferred
Use non cancelable term as lease term
Bargain renewal options may extend lease and should also be included
Recovery of investment
If PV (payments) = fair value, we essentially have a purchase
Rule is: PV greater than 90% of fair value =capital lease
However, determination of PV of minimum lease payments can be complex
Interest rate (a.k.a. discount rate)
What is included in minimum lease payments?
Executory costs
Additional Lessor Conditions for a Capital Lease
Collectability of lease payments must be reasonably predictable,
Any future costs must be reasonably predictable
How do you calculate PV of Minimum lease pmts
Lease Pmt * PVOAF(N=years I=interest rate PMT = 1)
PV = $79,139.18 × PVOAF (5 years, 10%)
= $79,139.18 × 3.79079
=300,000.
Lessee JE for Captial Lease
Inception of Lease:
JE to record leased asset and lease obligation at present value of MLP
Dr. Leased asset 300,000
Cr. Lease obligation 300,000
JE to record depreciation on a lease
Depr exp (PV of Lease/lease life)
Accumulated depr (PV of Lease/lease life)JE for lease payment
Journal entry for first lease payment: Dr. Interest expense ($300,000 10%) $30,000 Dr. Lease obligation $49,139 Cr. Cash $79,139 Journal entry for second lease payment? Dr. Interest expense ($250,861 10%) $25,086 Dr. Lease obligation $54,053 Cr. Cash $79,139
Direct financing (similar to a loan)
Typically lessor is a financing company
No gross profit is recorded at the signing of the lease; considered to be a financing arrangement (with financing income to the lessor)
Sales-type (similar to a sale of an asset and a loan)
Typically lessor is a manufacturer or dealer
Gross profit is recognized at the inception of the lease, and financing income is recognized over the lease
Lease Term 4 Asset's Useful Life 6 Annual Lease Payment(Beg of Year) 10000 Interest Rate 5% What amount should we record as the asset and liability for the lessee?
What amount should we record as the receivable for the lessee?
PV = 37233
Lessee:
Leases Asset 37233
Lease Liability 37233
Lease Liab 10000
Cash 10000
Lessor:
Lease Receivable 37233
Lease Asset 37233
Cash 10000
Lease Receivable 10000Lease Term 4 Asset's Useful Life 6 Annual Lease Payments (Beg of Year) ? Interest Rate 5% Fair Value of Equipment 37233 BPO, paid at the end of the lease 1000
Fair Value of Equipment: 37,233
PV of BPO = 1,000 PVSSF(5%, 4 yrs) = 1,000.82270 = -822.70
Amount to be received from periodic payments = 36,410.3
Installment Amount = 36,410.3/PVADF (5%, 4yrs) =
= 36,410.3/3.72325 = $9,779.17
ADVANCE PAYMENTS
Advance payments are considered prepayments of rent. They are deferred and allocated to rent over the lease term.
Leasehold Improvements
Sometimes a lessee will make improvements to leased property that reverts back to the lessor at the end of the lease.
If a lessee constructs a new building on or makes modifications to existing structures, that cost represents an asset just like any other capital expenditure. Like other assets, its cost is allocated as depreciation expense over its useful life to the lessee, which will be the shorter of the physical life of the asset or the lease term.
DEPRECIATION
The lessee normally should depreciate a leased asset over the term of the lease. However, if:
(a) ownership transfers or
(b) a bargain purchase option is present
(i. e., either of the first two classification criteria is met) the asset should be depreciated over the asset’s useful life. This means depreciation is recorded over the useful life of the asset to the lessee.
JE for Sales Type Leases:
Company leased a copier from compudec at a price of 479079
Annual pmt 100000 beginning Jan 1, 2013 then at each Dec 31 through 2018 lease is equal to life of copier
Interest Rate 10%
Lease Receivable PV of pmts 479079
COGS lessors cost 300000
Sales Revenue PV of min lease pmts 479079
Inventory of equipment (lessor’s cost) 300000
bargain purchase option
gives the option for the lessee to buy it after
lessor: subtracts the PV of the BPO from the amount to be recovered
lessee: adds to the PV of the BPO price to the present value of periodic lease payments
What happens to the lease term if a BPO is exercised before the end of the lease?
It changes the lease term
Minimum Lease Payments exclude
executory costs(maintenance, insurance, taxes, etc.
The lessee should use its own incremental borrowing rate when….
the lessor’s implicit rate is unknown
Right of Use Model(Where we’re headed
Operating leases are eliminated
lessee reports both the right to use asset and the corresponding liability
The lessor records a lease receivable from its books
Direct financing and sales type leases are eliminated
Records a residual asset for the portion of the asset they still own
If the PV of the lease payments > carrying amount of the asset transferred, immediate profit is recognized in addition to interest revenue earned during the lease
Residual value increases as the residual value approaches the ending residual value of the lease and revenue is recorded
