CHP 20 - Leases

Question 1

CHP 20 - Leases

• calculator @begin period,1
• • pmt, -fv = 0 or guaranteed res value

Question 2

QUIZ 1 Questions

Question 3

IMPORTANT

Answer 3

1) ASPE = classification approach
2) IFRS = contract based approach (right of use)
3) MRP = minimum rent payments = determined by lessor
4) Guaranteed residual value = determined by lessee
5) Lessee doesn’t consider unguaranteed res value in PV of MLP calculations but lessor does
6) Executory costs = insurance/maintenance/property costs, not included in MRP

Question 4

IMPACT

Answer 4

1) higher res value = lower rent pmt
2) operating lease = lower D/E, lower interest @begin, higher inc @begin, higher current ratio
3) capital lease = higher D/E, higher interest @begin, lower inc @begin, lower current ratio

Question 5

Operating Lease

Answer 5

1) don’t control benefits
2) don’t record on B/S
3) I/S = interest expense
4) CF = operating CF

Question 6

Capital Lease

Answer 6

1) control benefits
2) record on B/S
3) I/S = depreciation + interest
4) CF = financing and operating CF

Question 7

Lessee criteria (ASPE vs IFRS)

Answer 7

1. ASPE (4) - one has to be met

1) Transfer ownership/control benefits
2) Bargain purchase option (price < or equal to 90% of fair value )
3) Lease term is > or equal to 75% (n/estimated life)*
4) PV of MLP is > or equal to 90% of fair value

2. IFRS (same 4) but no 75%/90%

Question 8

Lessor criteria (ASPE vs IFRS)

Answer 8

1. ASPE (4 same + 2 add where both met)

1) Lessee credit normal
2) Cost of asset sold must be known

2. IFRS (4 same + 1 add have to be met) + 2 types
   1) requires capitalization of lease if asset is specialized

2 types

1) Direct financing (carry amount = fair value)
2) Sales type (carry amount doesn’t equal fair value)

Question 9

3 criteria MLP (3)

Answer 9

1) Lessor calculates it
2) rate = implicit
3) rate not always disclosed, if not then use incremental borrow rate

Question 10

3 forms of MLP (3)

Answer 10

1) Guaranteed Residual Value
2) Bargain Purchase option (over economic life)
3) Penalties failing to renew

Question 11

4 PV of MLP criteria (4)

Answer 11

1) MRP
2) guaranteed res value
3) bargain purchase option
4) penalties failing to renew lease

Question 12

PV of MLP calculations Lessor (ASPE vs IFRS)

Answer 12

1. ASPE

1) choose lower of fair value and PV
2) PV (i/y = lower of implicit and incr rate)

2. IFRS

1) choose lower of fair value and PV
2) @implicit but use incremental if not known

Question 13

TO DO: Sales Leaseback (sell asset then lease it back) ASPE vs IFRS

Answer 13

1. ASPE
   sales type, direct financing, operating lease, defer profit from sale and amortize in proportion to rental payments over lease term
2. IFRS

right of use, operating lease, gain recorded @inception for seller/lessee, carrying amount (PV of MLP - deferred gain) recorded by buyer/lessor

3. Notes 20-7 (ASPE) , 20-8 (IFRS)

Question 14

TO DO: Real estates Leases (ASPE)

Answer 14

1) ASPE, capital lease, transfer of ownership or bargain option present, lessee capitalize @fair value, land and building separate
2) don’t transfer ownership and fair value of land is minor, land and building are single unit (economic life = building life)
3) don’t transfer ownership and fair value of land is significant, lessor land and building separate

Question 15

Example (Lessor, guaranteed res value, bargain purchase option, choose fair value over PV of MLP, calculate pmt)

Answer 15

1. PV of MLP

2. pmt (n,implicit rate, -pv = fair value, fv = guaranteed res val or bargain option or unguaranteed (if lessor)*, 1)

Question 16

Example (ASPE, Lessee, capital lease, PV of MLP, guaranteed residual value, PV calculations, journal entry)

Answer 16

1. Lessee PV of MLP

1) choose lower of PV and fair value
2) PV (choose lower of implicit and inc borrow rate)
3) PV of MLP (n=lease term, I/Y = lower of impli and incr, -pmt = pmt given, fv = 0, 1)
4) with guaranteed res value (-fv = guaranteed res value)

2. Journal entries

Jan 1/1

Dr Leased Equipment (lesser of fair val and PV)
Cr Lease obligation

Dr Lease obligation (pmt)
Cr Cash

Dec 31/1

Dr Dep Exp (lesser amount - res val)/n
Cr Acc Dep

Dr Interest exp (lesser amount - res val)/n
Cr Int pay

Jan 1/2

Dr Int Payable (same as dec31/1)
Dr Lease obligation (plug)
Cr Cash (pmt)

Dec 31/2

Dr Dep exp (same)
Cr Acc dep

Dr Int exp (lower amount - pmt - lease obligation jan 1/2)*lower rate
Cr Int pay

Question 17

Example (IFRS, Lessor, capital lease –> direct financing (equal) , sell price, lease price, journal entry)

Answer 17

Dr Lease pmts receivable (lease price) 
Cr Inventory (sell price) 
Cr Unearned int inc (plug) 

*Lessor considers/includes (+) unguaranteed residual value in lease price

Question 18

Example (IFRS, Lessor, capital lease –> sales type (not equal), sell price, lease price, cost, interest, journal entry)

Answer 18

Dr Lease pmts receivable (sell price + int) 
Dr COGS (cost) 
Cr Sales (sell price) 
Cr Inventory (cost)  
Cr Unearned int inc (int) 

• carry amount = cost
• fair value = sell price

Question 19

Example (ASPE, Lessee, capital lease, prorate, steps, journal entries)

Answer 19

1. Is it capital lease ? Only needs to meet 1 of 4 criteria
2. If yes, choose lower of fair value and PV of MLP
3. PV of MLP (lower of implicit and incr rate)
4. Journal Entries

Jan 1/1

Dr Lease Equipment (lower of fair val and PV)
Cr Lease Obligation

Dr Lease obligation (pmt)
Cr Cash

April 1/1 (x=3/12 jan 1–>apr 1)

Dr Lease obligation 
Dr Interest (carry amt-pmt)*lower rate 
Cr Cash (pmt)

Dr Dep Exp (carry amount/lease term)*x/12
Cr Acc Dep

July 1/1

Dr Lease obligation (plug)
Dr Interest (carry amt-lease obligation april-pmt)*lower rate 
Cr Cash (pmt)

Dr Dep Exp (same)
Cr Acc Dep

Question 20

Example (ASPE, Lessor, capital lease –> direct financing, Journal entries)

Answer 20

1. Journal entries

Jan 1/1

Dr Lease pmts receivable (total pmts) 
Cr Unearbed int inc 
Cr Asset (carrying amount) 

Dr Cash (pmt) 
Cr Lease pmt receivable 

April 1/1

Dr Cash (pmt) 
Dr Unearned int inc (plug) 
Cr Lease pmts receivd (pmt) 
Cr Int inc (total pmts-unearned int inc jan1/1-pmt)*implicit rate 

July1/1

Dr Cash (pmt)
Dr Unearned int inc (plug)
Cr Lease pmts receivd (pmt)
Cr Int inc (below)

(unearned int inc jan1/1 - unearned int inc april1/1)] * implicit rate

Question 21

Example (IFRS, Lessor, capital lease –> sales type, journal entry)

Answer 21

Dr Lease pmts receivable (total pmts)
Dr COGS (carry amount) 
Cr Equipment (carry amount) 
Cr Sales Revenue (fair value) 
Cr Unearned int inc (total pmts - fair value)

Question 22

Example (IFRS, Lessor, capital lease –> direct financing,guaranteed/unguaranteed/ bargain, journal entries)

Answer 22

Jan1/1

Dr Lease pmts receivable (total pmts+guaranteed or unguaranteed or bargain) 
Cr Inventory (fair value = carry amount) 
Cr Unearned int inc (plug) 

Jan 1/2,3,4

Dr Cash (pmt) 
Cr Lease pmts received 

Dec 31/1,2,3

Dr Unearned int inc (fair value-pmt)*implicit rate
Cr Int revenue

Dec 31/4

Bargain option:

Dr Cash (bargain option) 
Cr Lease pmts received 

Guaranteed or unguaranteed:

Dr Equipment (guaranteed or unguaranteed) 
Cr Lease pmts received 

*If sold price < guaranteed or unguranteed

Dr Cash (sell price)
Dr AR from lessee (plug) 
Cr Equipment (guaranteed or unguaranteed) 

*If sold price > guaranteed or unguranteed

Dr Cash (sell price)
Dr Gain on sale (plug) 
Cr Equipment (guaranteed or unguaranteed)

Question 23

Example (IFRS, Lessor, capital lease –> sales type, guaranteed/unguaranteed/ bargain, journal entries)

Answer 23

1. Guaranteed or bargain

Jan 1/1

Dr Lease pmts receiv (total pmts+guaranteed or bargain)
Dr COGS (carry amount)
Cr Equip (carry amount)
Cr Sales Revenue (fair value)
Cr Unearned int inc (total pmts - fair value)

12. Unguaranteed

Jan 1/1

1) PV (n,implicit,pmt=0, -fv(unguaranteed),1)
2) Jan 1/1

Dr Lease pmts receiv (total pmts+unguaranteed)
Dr COGS (carry amount-pv)
Cr Equip (carry amount)
Cr Sales Revenue (plug)
Cr Unearned int inc (total pmts - fair value)

Question 24

Example Paper Notes (Lessee, Journal entries for guaranteed res vs unguaranteed res vs bargain)

Question 25

Example (Lessee, amortization table with guaranteed res or bargain option
, n=4 -> 5 periods table)

Answer 25

Period | open | pmt | interest | princip | end

1. Period 1
open = fair v or PV
pmt = pmt   
interest = 0
principal = pmt - interest 
end = open - principal 

2. Period 2
   open = end#1
   interest = open x imp rate
3. Period 5

pmt = 0
princ = 0 
end = guaranteed res or bargain

Question 26

Example (Lessee, amortization table with unguaranteed res, n=4 -> 5 periods table)

Answer 26

1. Period 1
   open = PV of MLP (fv=0)
   interest = 0
2. Period 4
   end = 0
3. Period 5
   all values = 0

Question 27

Example (Lessor amortization table)

Answer 27

1. Period 1
   open = fair value
   pmt = compute pmt
   interest = 0
2. Period 2
   open = end#1
3. Period 5
   pmt = 0
   principal = 0
   end = guaranteed res/unguaranteed res/ bargain option

Question 28

Example (Lessor pmt, Lessee PV, rent, implicit > incremental, unguaranteed res, interest for the first year formula)

Answer 28

1. Lessor
   1) pmt (n,implicit, -pv=sell price, fv=unguaranteed res, 1)
2. Lessee
   1) PV (n, lesser imp and incr, -pmt of lessor, fv=0, 1)
3. Interest 1st year = new rate * (Lessee PV or fair value - lessor pmt)