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ACC 422 > Chapter 21 > Flashcards

Chapter 21 Flashcards

1
Q

What is a lease?

A

contractual agreement between the lessor and lessee

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2
Q

What right does the lease give to the lessee?

A

the right to use specific property

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3
Q

What does the lease specify?

A

the duration of the lease and rental payments

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4
Q

Who assumes the obligations for taxes, insurance, and maintenance?

A

The lessor or lessee

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5
Q

Who is the lessee?

A

the temporary user of an asset

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6
Q

Who is the lessor?

A

the titleholder and true owner of the property

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7
Q

What are the advantages of leasing?

A

1) Leases may not require any money down, 2) Lease payments are often fixed, 3) Leases reduce the risk of obsolescence to the lessee (don’t want to be stick with older model), 4) Leases may contain less restrictive covenants than other types of lending arrangements, 5) Leases may be a less costly means of financing, 6) Certain leases may not add to existing debt on the balance sheet

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8
Q

What kind of balance sheet item are leases?

A

off-balance sheet items

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9
Q

According to the FASB, when should a lease be capitalized?

A

when a lease transfers substantially all of the benefits and risks of ownership

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10
Q

According to the FASB, when can transfer of ownership be assumed?

A

only if there is a high degree of performance to the transfer, that is, the lease is non-cancelable

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11
Q

According to the FASB, what are operating leases?

A

leases that do not substantially transfer benefits and risks and can be cancelled

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12
Q

Which standard applies to leases?

A

SFAS 13

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13
Q

What is the effect on assets and liabilities when a lease is capitalized?

A

debit asset and credit liability

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14
Q

What is the effect is a lease is classified as operating?

A

debit rent expense

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15
Q

What are the four criteria for classifying a lease as a capital lease?

A

1) Leases transferring ownership, 2) Leases with bargain purchase options, 3) Leases with lease terms equal to 75% or more of the economic life (75% rule), 4) Leases where the present value of lease payments is equal to 90% or more of the fair market value (90% rule)

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16
Q

How many criteria must a lease meet in order to be capitalized?

A

One

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17
Q

What type of accounting bases does the lease standard follow?

A

Bright-line accounting

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18
Q

In what order does the evidence for capitalization of leases go?

A

Strongest to weakest, with 1 being the strongest and 4 being the weakest

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19
Q

Which two principles of lease accounting are non-controversial and are similar between IFRS and GAAP?

A

the first two principles

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20
Q

Why are the first two principles of lease accounting non-controversial?

A

1) If it says anywhere that there will be a transfer of title, is a transfer of ownership, no matter when the transfer occurs, 2) If option is to purchase for less than FV, then will probably be exercised

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21
Q

How do you determine the value of a bargain purchase option?

A

Compare purchase prices at end to FV (10% less than FV)

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22
Q

Which two principles of lease accounting are controversial?

A

the last two principles

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23
Q

Why are the last two principles controversial?

A

1) no rounding, calculations must be exact, 2) life of the asset can change, 3) what discount rate to use, 4) what really is fair value, 5) where do percentages come from

24
Q

What does the GAAP method of accounting for leases allow companies to do?

A

manipulate around standards so don’t have to capitalize leases

25
Q

How does IFRS differ from GAAP?

A

IFRS does not specify percentages that must be used for last two principles and uses judgement and principles-based accounting

26
Q

What is the lessee entry in a capital lease transaction?

A

records asset and liability

27
Q

What is the lessee required to do with the with the asset?

A

depreciate it over the economic life of the asset

28
Q

What is the lessee required to do with the rental payments?

A

allocate them between principal and interest

29
Q

What method is used to allocate rental payments?

A

the effective interest method

30
Q

Are depreciation of the asset and discharge of the lease similar accounting procedures?

A

no, independent accounting procesudures

31
Q

What are the 3 levels of lessor lease classification?

A

1) Operating lease, 2) Direct financing lease, 3) Sales-type lease

32
Q

How does IFRS say lessors must classify leases?

A

Operating or direct financing

33
Q

What is the lessee process for recording a lease

A

1) Debit asset and credit liability, 2) Depreciate asset, 3) Set up to determine interest, 4) Determine what it’s really worth compared to what discharge is

34
Q

What criteria must be met in order for a lessor to classify a lease as an operating lease?

A

1) The lease does not meet any group 1 criteria (same as lessee’s) OR 2) Collectibility of payments isn’t reasonably assured OR 3) Lessor’s performance isn’t substantially complete

35
Q

What is used to determine the collectibility of payments

A

the revenue recognition principle and the lessor will check the party’s ability to pay

36
Q

When is a lessor’s performance not complete?

A

if the lessor is still responsible for maintenance

37
Q

What criteria must be met in order for a lessor to classify a lease as a direct financing lease?

A

Lease must meet group 1 criteria (same as lessee’s), and the following group 2 criteria: 1) Collectibility of payments must be reasonably assured, AND 2) Lessor’s performance must be substantially complete, AND 3) Asset’s fair value must be equal to lessor’s book value

38
Q

Can a lessee and lessor classify leases differently?

A

Yes

39
Q

What biases are present amongst lessors and lessees?

A

Lessor biased toward operating leases while lessee is biased toward capitalized leases

40
Q

What information is needed by the lessor to record a direct financing lease?

A

lease investment (lease receivable), consisting of the minimum lease payments and any residual value at the end of the lease term

41
Q

What determines the residual value?

A

the nature of the asset

42
Q

What information is needed by the lessor to record a sales lease?

A

Lease receivable plus sales (equal to lease receivable) and COGS (equal to asset book value)

43
Q

What statements do sales and lease receivable appear on?

A

Sales - Income Statement, Lease Receivable - Balance Sheet

44
Q

Why are sales leases most beneficial for the lessor?

A

Because they make a profit on sale and ongoing profits through interest revenue

45
Q

What is a residual value?

A

the estimated fair value of an asset at the end of the lease term

46
Q

What are the two types of residual values?

A

Guaranteed or Unguaranteed

47
Q

Does a lessor care is a residual value is guaranteed or not?

A

do not care after the lease rate is determined

48
Q

Do lessee’s care if a residual value is guaranteed or not?

A

Yes, guaranteed residual values affect the minimum lease payment calculations and unguaranteed residual values do not

49
Q

What is the difference between a guaranteed and unguaranteed residual value?

A

Guaranteed: what part you are staking, Unguaranteed: kind of nebulous

50
Q

What are executory costs?

A

Maintenance and extra costs

51
Q

What is an annuity due?

A

When interest payments are made at the beginning of the year

52
Q

How is residual value treated in regards to depreciation?

A

residual value is seen as the salvage value but is not subtracted when it is not included within the asset value and only depreciate for term of lease

53
Q

How does strong vs. weak criteria effect depreciation?

A

When strong evidence is used, use the entire asset life and strong vs. weak only changes years of depreciation

54
Q

What indicates if the collection of payments is reasonably uncertain?

A

If says have liquidity concerns or payment problems

55
Q

What is the main difference between sales type and direct financing leases?

A

Sales type leases are presented on the income statement in the form of COGS and sales, while direct financing leases are not

56
Q

What journal entry occurs if the equipment leased out is taken back and not purchased?

A

Debit equipment and credit lease receivable

ACC 422 (7 decks)

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