Chapter 15 Power Point Notes

Question 1

capital lease

Answer 1

One that transfers substantially all the risks and rewards of ownership to the lessee

Question 2

operating lease

Answer 2

One that does not transfer the risks and benefits of ownership to the lessee; a rental agreement

Question 3

JEs for both the Lessee and Lessor of an operating lease

Answer 3

Lessee:
Dr. Rent expense 			XXX
	Cr. Cash 				XXX
Lessor:
Dr. Cash 				XXX
	Cr. Rent revenue 			XXX
Dr. Depreciation expense 	YYY
	Cr. Accum depreciation 	YYY

Question 4

Capital Lease Lessee

Answer 4

Records asset and obligation on balance sheet
Interest expense on obligation
Depreciation on asset

Question 5

Capital Lease Lessor

Answer 5

Removes leased asset from balance sheet
Records lease receivable
Earns interest/financing income over the lease term

Question 6

Direct Financing (Capital Lease)

Answer 6

(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)

Question 7

Sales-type (Capital Lease)

Answer 7

(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

Question 8

Capital lease criteria

Answer 8

1. Does the lease transfer ownership?
2. Does the lease contain a bargain purchase option (BPO)?
3. Is the lease term at least 75% of the estimated economic life of the asset?
4. 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

Question 9

Bargain Purchase option

Answer 9

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

Question 10

Economic life test

Answer 10

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

Question 11

Recovery of investment

Answer 11

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

Question 12

Additional Lessor Conditions for a Capital Lease

Answer 12

Collectability of lease payments must be reasonably predictable,
Any future costs must be reasonably predictable

Question 13

How do you calculate PV of Minimum lease pmts

Answer 13

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.

Question 14

Lessee JE for Captial Lease

Answer 14

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

Question 15

JE to record depreciation on a lease

Answer 15

Depr exp (PV of Lease/lease life)
       Accumulated depr (PV of Lease/lease life)

Question 16

JE for lease payment

Answer 16

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

Question 17

Direct financing (similar to a loan)

Answer 17

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)

Question 18

Sales-type (similar to a sale of an asset and a loan)

Answer 18

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

Question 19

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?

Answer 19

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 10000

Question 20

Lease 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

Answer 20

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

Question 21

ADVANCE PAYMENTS

Answer 21

Advance payments are considered prepayments of rent. They are deferred and allocated to rent over the lease term.

Question 22

Leasehold Improvements

Answer 22

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.

Question 23

DEPRECIATION

Answer 23

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.

Question 24

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%

Answer 24

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

Question 25

bargain purchase option

Answer 25

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

Question 26

What happens to the lease term if a BPO is exercised before the end of the lease?

Answer 26

It changes the lease term

Question 27

Minimum Lease Payments exclude

Answer 27

executory costs(maintenance, insurance, taxes, etc.

Question 28

The lessee should use its own incremental borrowing rate when….

Answer 28

the lessor’s implicit rate is unknown

Question 29

Right of Use Model(Where we’re headed

Answer 29

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