Chapter 21: Accounting for Leases Flashcards
What are the advantages of leasing transactions?
- Off-Balance-Sheet Financing
- Facilitates Asset Acquisition
- Reduce risk of obsolescence
- Less costly financing
What do we want to do when we facilitate asset acquisitions?
- we want to overcome cash flow problems
- fear of obsolescesces
Who are the parties in a leasing transaction?
- lessee (renter)
- lessor (owner)
The lessee is classified as what?
- operating lease
- capital lease
The lessor is classified as what?
- operating lease
- direct financing lease
- sales-type lease
For the lessee to consider a capital lease, it must meet how many criterias?
one
To be considered as a capital lease, one of these criterias have to be met by the lessee.
- transfer of title to lease
- there is a bargain purchase option
- lease term >= to 75% of the asset’s useful life
- the present value of minimum lease payment (PVMLP) >= to 90% of the asset’s fair vaule
How many criterias does the lessor have to meet to classify a lease as a capital lease?
two
What are the two conditions that have to be met by the lessor to be considered as a capital lease?
- collectibility of lease payments reasonably predictable
- performance by the lessor is substantially complete
If a lease does not meet the four criterias, it is consided to be what type of lease?
operating lease
In operating leases what four options occur?
- leases not meeting one of the four criteria
- ownership is retained by the lessor
- periodic rental payments
- advanced payments classified as prepaid rent (lessee) and unearned rent (lessor)
In periodic rental payments what does the lessee and the lessor recognize?
- rent expense (lessee)
- unearned revenue (lessor)
What type of lease is it if it includes “Transfers ownership” to the lessee (substance over form)?
capital lease
In a capital lease, what does the lessee record?
the lessee records a lease asset & liability = to PVMLP
Under the Net Method in a capital lease, the lessor will set up a…
- lease receivable = PVMLP
- remove the asset from the books
Interest on capital leases (liability side)…
- accrues at effective rate * outstanding balance
- rent payment (except usually the first) have an interest component and a residual portion
- interest must be accrued at each financial statement
In a capital lease, who records depreciation?
the lessee
How does the lessee record the depreciation of the asset?
- usually over the lease term, or
- the asset’suseful life if criteria 1 or 2 are met
What are the bargain purchase options in a capital lease?
- viewed as an additional cash flow for both the lessor and the lessee
- lessee: adds present value of BPO to the lease asset/liability
- lessor: subtracts present value of BPO from the fair market value to determine the amount of periodic lease payments
What are the classifications of a capital lease for the lessor?
- direct financing
- sales type lease
In the Direct Financing classification of a capital lease, when is profit not recognized?
if the lessor is NOT Manufacturer/Dealer
In Sales Type Lease classification of a capital lease, the lessor is who?
the manufacturer/Dealer
What type of capital lease classification records gross profict (GP = Rev (PVMLP) - COGS (Manufacturer’s cost)) & All subsequent enteries are the same, only difference occurs at inception?
Sale-Type Lease
Journal entries for the Sale of Goods in Direct Financing?
Sales - COGS = GP
Dr. A/R
Cr. Sales
Dr. COGS
Cr. Inventory
Journal enteries for the Sale of Goods in Sales-Type Lease?
Sales - COGS = GP
or
PVMLP - MfR Cost = GP
Dr. lease receivable (PVMLP)
Cr. Sales
Dr. COGS (MfR cost)
Cr. Asset
Other lease accounting issues are…
- executory costs
- discount rate
- financial statement disclosure requirements
- Sale-Leaseback transactions
What type of costs are considered executory costs?
- maintenance
- insurance
- taxes
- other costs assoicated with ownership
The executory costs are usually expensed as they are incurred by who?
lessee
The executory costs are excluded from MPL calculations if who retains responsibility?
lessor
With discount rate, the lessee uses the SMALLER of…
- rate implicit in lease or
- lessee’s own incremental borrowing rate
What are financial statement disclosure requirements?
- a “general description” of the leasing arrangement
- gross amount of assets categorized by nature
- future minimum lease payments, in the aggregate, and for each of the five succeeding fiscal years (operating anad capital leases)
- other disclosures are specific to the type of lease (i.e. residual values, contingent rentals, subleases, and executory costs)
- example: illustrations 21-32 and 21-32
In the sale-leaseback transaction, there are 2 transactions that take place which are…
- the owner of the asset sells it (transaction 1) and immediately leases it back (transaction 2) from the new owner
- Capital lease
- operating lease
The gain on sale is deferred as a contra lease asset account and amortized against depreciation expense.
captital lease in the sale leaseback transaction
The gain on sale is deferred as a liability and amortized against rent expense.
operating lease in the sale leaseback transaction
When are all the losses recognized in a Sale-Leaseback transaction?
immediately
In a Sale-Leaseback transaction, what is the journal entry for the sale of PPE?
Dr. Cash
Dr. Accumulated Depreciation
Dr./Cr. Loss/gain on sale of asset
Cr. PPE (Historical Cost)
