F6 - Leases, Derivatives, FX Accounting, and Income Taxes

Question 1

How should Operating Lease expense be recorded during the lease?

What happens if Lessee doesn’t take ownership of it?

Answer 1

Operating Lease expense must be recorded equally

• Rent is reported on a straight line basis
• Make sure to include free months as they’ll LOWER the average monthly payments

Question 2

What is the Lessee Capital Lease Criteria?

Answer 2

OWNS

Ownership - Transfer at end of lease
Written - Bargaining purchase Option
Ninety - PV of minimum lease payment is above 90%
Seventy-five - 75% of lease term

Question 3

FX transactions. In AR (denominated in foreign currency) what happens if USD weakens and strengthens.

In AP, what happens if USD weakens and strengthens?

Also, what is the direct quotation of FX?

Where are FX transactions recorded? and how often recorded?

What would be a JE for gain or loss in AR and how is it settled (both in the foreign currency and in USD)?

Answer 3

AR:
USD Weakens - Gain
USD Strengthens - Loss

AP:
USD Weakens - Loss
USD Strengthens - Gain

remember this is represented in foreign currency

Direct - 1.00 EUR = 1.13 USD

• Component of Income from continuing operations.
• Every period, so if i enter into agreement in Nov and pay amount in Feb. I have to account for gain/loss in Dec 31.

Initial:
AR xxx
Sales xxx

Gain: (loss opposite)
AR xxx
FX transaction xxx

Settled (in Foreign currency)
Investment in FX xxx
AR in FX xxx

Covert to USD
Cash xxx
Investment in FX xxx

Question 4

Difference between permanent and temporary difference for pretax GAAP financial and taxable income?

Examples

Answer 4

Permanent - do not affect deferred tax computation

• Interest on municipal bonds, life insurance, proceeds/expense (enter pretax GAAP financial statements but not taxable)
• Penalty to IRS for late payment of taxes

Temporary - difference between tax basis of asset or liability that will result in future taxable/deductible amounts

• Revenues/gains
• Expenses/losses (bad debt expense, impairment loss, depreciation)

Question 5

• 10 year lease agreement (useful life 10)
• Lessor expects 10% return from lease
• Lessee has 12% incremental borrowing rate
• Annual lease payments = 30,000
• 3rd party guarantees residual/expected value/bargain purchase option of 50,000 at the end of lease
• PV of ordinary annuity at 12% is 5.6502; 10% is 6.71008
• PV of $1 at 12% is .3220; 10% is .46319

1) Lessee: How do you calculate the lease liability/principal amount of the lease obligation for the Lessee’s account when Lessee guarantees residual/bargain purchase option?
2) Lessor: If lessee continues to guarantee residual value or there’s a bargain purchase option. What is the Lease Receivable, COGS, Unearned Interest, Equipment value, and Sales for the lessor?
3) What would changed for both questions if residual value is not guaranteed by lessee but by a 3rd party? But for Q2, lessor equipment has BV of 150,000?

Answer 5

1) Lessee: In a capital lease, the lessee uses the LOWER of implicit return and incremental borrowing = 10%.

When a 3rd party guarantees the value then it is NOT included in the calculation for lease liability/principal. If problem does NOT say bargain purchase option you exclude it as below:

Leased Asset/Lease Liability/Principle
224,462 = 30,000(6.71008) + 50,000(.46319)

2) Lessor:

Lease Receivable
350,000 = (10)30,000 + 50,000

Equipment
224,462 = value of lease asset above

Unearned Interest
125,538 = Receivable - Equipment (FV)

• No entries for COGS or Sales*
  3) If lessee guarantee’s residual/expected value/bargain purchase option then:

Lessee:

Leased Asset/Liability/Principle
201,302 = 30,000(6.71008)

Lessor:

Lease Receivable
Same

COGS
150,000 = BV

Unearned Interest
Same because its subtracting FV of equipment not BV

Equipment
150,000 = BV

Sales
224,462 = Equipment FV