Chapter 5 Section 2: Accounting for Leases

Question 1

Who are the two parties in a lease agreement?

Answer 1

Lessor: leases their property
Lessee: uses the leased property

Question 2

What are the types of leases, and what do the different parties in the agreement call them?

Answer 2

Lessee: operating and capital
Lessor: operating and sales-type and direct financing
Note: IFRS has operating and financing and both parties call it that.

Question 3

What is a lease bonus and how is it accounted for?

Answer 3

It’s a prepayment of future expenses and is classified as an asset and amortized straight line over the life of the lease.

Question 4

Define leasehold improvement

Answer 4

One that is permanently affixed to the property and reverts back to the lessor at the termination of the lease. They should be capitalized and added to PP&E

Question 5

How do you depreciate leasehold improvements under an operating lease?

Answer 5

LESSER of lease life or asset/improvement life

Question 6

What do you do with free or reduced rent consideration?

Answer 6

Take the new total of all the rent payments you’ll make and divide by the number of payments. Use that number in the JE for an equal expense each time.

Question 7

How are nonrefundable and refundable security deposits handled?

Answer 7

Nonrefundable: lessor defers as unearned rev, lessee capitalizes until earned by lessor
Refundable: lia for lessor and receivable for lessee

Question 8

How do operating and capital leases differ?

Answer 8

Operating is just like renting

Capital is like a sale

Question 9

What are the lessee capital lease criteria?

OWNS

Answer 9

Ownership transfers
Written option for bargain purchase
Ninety (90%) of leased property FV is less than or equal to PV of lease payments
Seventy-five (75%) of asset life is committed in lease term

Question 10

How does IFRS differ from GAAP regarding OWNS?

Answer 10

They’re less strict. Have the majority of the last two.

Question 11

What are the lessor capital lease criteria?

LUC

Answer 11

Lessee owns the leased property
Uncertainties don’t exist regarding costs incurred by the lessor
Collectibility of payments is predictable

Question 12

What’s the different between sales-type and direct financing?

Answer 12

Sales type = 2 profits: gain on sale and interest income
Direct financing = 1 profit: interest income

It’s direct financing if FV = cost. There is therefore no COGS

Question 13

Under a capital lease, what does the lessee record the least at?

Answer 13

LESSER of FV of asset at inception of lease or cost (PV of minimum lease payments - exclude executory costs)

Question 14

Under a capital lease, what interest rate does the lessee use?

Answer 14

LESSER of the rate implicit in the lease or the lessee’s incremental borrowing rate

Question 15

For disclosures, how many years do they like?

Answer 15

Five

Question 16

In lessor accounting for a sales-type lease, what does gross investment mean?

Answer 16

Lease payment + unguaranteed residual value

Question 17

What is net investment?

Answer 17

Gross investment x PV

Question 18

What is unearned interest revenue (to be received in the future)?

Answer 18

Gross investment - net investment

Question 19

How do you calculate COGS?

Answer 19

Cost of asset - PV of unguaranteed residual value

Question 20

How do you calculate operating lease excess profit in a sale-leaseback?

Answer 20

Sale price 
-Asset NBV
=Tentative gain
-PV of min lease pmts
=excess gain

Question 21

How do you calculate capital lease excess profit in a sale-leaseback?

Answer 21

Sale price
-Asset NBV
=Tentative gain
-leaseback asset
=excess gain

Question 22

What are the ways a seller/lessee can record gains in a sale-leaseback?

Answer 22

Retain >90% of rights
Means PV of pmts > 90% of FV of property
Defer all gain and amortize with asset
Retain 10-90% of rights
Defer gain up to PV of min leaseback pmts or capitalized asset. Gain above this is recognized now
Retain

Question 23

How are losses accounted for by the seller/lessee in a sale-leaseback?

Answer 23

If they’re real, recognize now.

Artificial (SP

Question 24

How does IFRS account for gains and losses by the seller/lessee?

Answer 24

Finance: defer and amortize
Operating: recognize

Question 25

How does the lessor’s accounting change if the lessee subleases?

Answer 25

It doesn’t.

Question 26

How does the lessee classify the sublease?

Answer 26

If original was operating, it’s operating.
If original was capital because O or W, it’s capital.
If original was capital because N or S, it’s operating