FAR 4 Module 7

Question 1

lease

Answer 1

-a contractual agreement between a lessor and a lessee
-the lessor conveys the right to use asset (real or personal property) and a lessee agrees to pay consideration to lessor for this right

Question 2

sublease

Answer 2

a lessee enters into a contract with another lessee for specific property

Question 3

qualifications for a lease

Answer 3

1) lessor cannot have substantive substitution right
2) contract must depend on identifiable asset (distinct from other components of the same asset)
3) contract should describe right to control asset over lease term to lessee.
4) Lessee has right to almost all economic benefits of lease and direct its use

Question 4

finance lease criteria if any one of these are met

Answer 4

Ownership transfers at end of lease
Written purchase option the lessee is reasonably certain to exercise
PV of minimum lease payments = FV of asset (approximately 90% of FV of lease property)
Lease term = major part (75%) of asset useful life
Asset is specialized such that it has no alternative use to the lessor

Note: if none met, or its less than 12 months, operating lease
Note: PV of min. lease payments also includes PV from bargain purchase option

Question 5

operating lease criteria

Answer 5

1) lease term does not equal 75% or more of economic life of asset
2) no written purchase option agreement
3) no transfer of ownership at end of lease

Question 6

when to recognize lease expenses

Answer 6

-at the commencement date, the date the underlying asset is made available to the lessee for use
-lessee calculates lease payments at commencement of lease based on PV of fixed payments, variable payments, exercise price of purchase option, termination penalties, and probable amt owed of guaranteed residual

Question 7

how are lease expenses allocated

Answer 7

they are allocated equally over the lease period of the full term according to revenue and expense recognition principles (recognize expenses in which they are incurred)

Question 8

over what period of time should a lessee amortize the leased property?

Answer 8

-the economic life of the asset when there is a purchase option or when lessee takes ownership of asset at end of lease term

Question 9

how is lease expense amortized

Answer 9

lease expense is reported on straight-line basis over the life of the lease

Question 10

interest expense formula

Answer 10

=lease liability * interest rate

Question 11

lease liability

Answer 11

PV factor * annual/monthly etc. payments

Question 12

carry value or book value of ROU asset

Answer 12

PV of lease payments (under implicit rate) + any initial direct costs - any depreciation incurred for the year (if any)

Question 13

expected residual value due

Answer 13

must be multiplied by the PV of $1 at implicit rate along with PV of lease payments to get book value of asset

Question 14

when lease contracts should be combined

Answer 14

1) one or more contracts contain a lease
2) contracts entered into approximately the same time
3) parties to contract are the same, or are related parties
4) performance or price of one contract impacts other contracts
5) contracts have same commercial objectives and part of a package
6) do not meet separate lease components

Question 15

separate lease components

Answer 15

1) identify each right to use asset within contract
2) for contract that includes lease and non-lease options:
Option 1: lease components are separate units of account from nonlease components
Option 2: each separate lease component is combined with related nonlease components into one unit of account

Question 16

identify each right to use asset within contract

Answer 16

-one right to use asset = separate lease component
-more than one right to use an asset = lessee determines if each right counts as separate lease component
-separate lease component if:
1) benefits lessee on stand-along basis or together with other assets (must be readily available)
2) right neither highly dependent on each other or interrelated

Question 17

calculation of consideration for a contract

Answer 17

all components of lease payments + other required payments in contract - incentives owed/provided to lessee not accounted for in lease payments

Question 17

right to use land

Answer 17

accounted for as a separate lease component unless accounting effect of doing so would be insignificant

Question 18

option 1 consideration of contract treatment

Answer 18

allocated to separate lease and nonlease components based on stand-alone prices

1) determine the percentage of stand-alone prices of each component from the total market of contract
2) take percentage and multiply by the total of the contract amt based on its lease payments over the term

Question 19

option 2 consideration of contract treatment

Answer 19

consideration allocated to each combined unit of account based on relative stand-alone prices
-observable stand-alone prices preferrable, but if not available, estimated prices used

use same process of allocation as in option 1, except that you combine other components if related to the same contract (ex. microscope + maintenance services)

Question 20

what creates a non-enforceable lease

Answer 20

a lease that can be terminated by both parties with only minor penalties

Question 21

option to terminate lease

Answer 21

1) periods covered by option to extend lease are included if lessee is reasonably certain to exercise option
2) periods covered by option to terminate lease included if lessee reasonably certain not to exercise option
3) periods covered by option to either extend or terminate lease are included if exercise is controlled by lessor

Question 22

lease payments include

Answer 22

1) required contractual fixed payments
2) exercise option reasonably assured
3) purchase price at end of lease
4) only indexed or rate variable payments
5) residual guarantees likely to be owed
6) termination penalties reasonably assured

Question 23

required contractual fixed payments

Answer 23

will include any variable payments that are “in-substance” fixed payments less and lease incentives paid or payable to lessee

Question 24

only indexed or rate variable payments

Answer 24

no increase or decrease to future lease payments should be assumed based on increases or decreases in index or rate
-any difference in payments due to changes in index or rate are expensed in period incurred

Question 25

residual guarantees

Answer 25

-a guarantee by lessee to lessor that value of asset returned to lessor at end of lease will be at the specified amt
-lessee includes full amount of residual value guarantee at end of lease term in present value test
-lessee does not consider unguaranteed residual value as part of PV test

Question 26

lessee payments not included in lease payment calculations

Answer 26

1) nonlease components
2) guarantees of lessor debt by lessee
3) other variable lease payments

Question 27

if have the option to purchase asset at end of term but likely lessee will not exercise option

Answer 27

not included in lease payment calculation

Question 28

if lease payments based on asset usage

Answer 28

not included in lease payment calculations because contingent on asset usage and can fluctuate significantly each period

Question 29

discount rate

Answer 29

-lessee uses implicit rate designated by lessor in contract when calculating PV of lease payments
-if implicit rate not determinable, then use the incremental borrowing rate of lessee

Question 30

incremental borrowing rate

Answer 30

the rate the lessee would be charged for a collateralized loan with equal payments and similar lease term to lease

Question 31

initial direct costs

Answer 31

-included in value of ROU asset. Costs are only incurred as a result of executing lease
-any costs incurred prior to signing lease, such as lease term negotiations, document preparation, credit checks etc. are NOT included in direct costs

Question 32

operating lease

Answer 32

-B/S reflects ROU asset and lease liability
-ROU asset and liability will be amortized over life of lease using effective interest method
-asset and liability amts calculated using PV of lease payments using discount rate
-I/S reflects lease expense recognized each year over lease term using SL method for expense
-interest expense included in lease expense

Question 33

PV of annuity due vs PV of annuity

Answer 33

PV of annuity due means the beginning of the period

PV of annuity means at the end of the period

Question 34

purchase option and guaranteed residuals

Answer 34

use PV of $1

Question 35

initial and subsequent JEs for operating leases

Answer 35

To record asset
Dr. ROU asset
Cr. lease liability

To record lease expense
Dr. Lease expense
Cr. Cash/lease liability

To record amortization of lease
Dr. Lease liability
Cr. Accumulated amortization - ROU asset

Question 36

finance lease

Answer 36

-lessee recognizes an ROU asset and liability on B/S
-liability = PV of lease payments owed
-ROU asset includes initial direct costs (ex. commissions paid, legal and consulting fees etc.) and lease payments made by lessee at or before commencement date
-any incentives received by lessee from lessor will reduce value of asset

Question 37

initial and subsequent JEs for financing leases

Answer 37

To record asset
Dr. ROU asset
Cr. lease liability

To record lease expense
Dr. Lease expense
Dr. Interest expense
Cr. Cash/lease liability

To record amortization of lease
Dr. Amortization expense
Cr. Accumulated amortization - ROU asset

Question 38

amortization expense calc for financing lease

Answer 38

carrying value of asset/number of periods of lease term

Note: carrying value can include PV of annuity due or annuity + initial direct costs + any lease payments made at beginning or lease commencement

Question 39

total lease expense calculation for financing lease

Answer 39

amortized expense amt + interest expense

Question 40

interest expense calculation for financing lease

Answer 40

lease liability * implicit rate

Note: lease liability = (lease payment - interest expense)

Question 41

reporting a lease the combines contracts

Answer 41

Dr. ROU asset
Cr. Lease liability (PV of annuity or annuity due of lease payments at implicit rate)
Cr. Cash (initial payment + initial direct costs)

Question 42

in early years of finance lease vs operating lease and later years

Answer 42

in early years, financing leases will have higher total expense than operating lease due to front loading interest expense and amortization

in later years, finance leases will have lower total expense than operating lease. However, total expense will be the same for both for the entire lease

Question 43

accounting policy election

Answer 43

-lessees can make an election and choose not to recognize ROU assets and lease liabilities for leases with terms of 12 months or less
-If election made, must be done by class of asset and not include purchase options for asset lessee is reasonably certain to exercise

Question 44

F/S presentation of leases

Answer 44

-lease assets and liabilities either recognized as separate line items on B/S OR
-included with other assets and liabilities and disclosed separately in notes to F/S
-portion of lease liabilities due within a year should be reported in current section and remainder in non-current
-financing and operating lease assets and liabilities cannot be presented together
-ROU asset will be amortized and liability will be paid down over life of lease

Question 45

when are ROU assets amortized?

Answer 45

beginning on commencement date using straight-line basis

Question 46

criteria for determining amortization

Answer 46

-amortize asset over asset’s useful life if ownership or written option criteria are met
-amortize over shorter of lease term or useful life if NPV, economic life, or specialized asset criteria met

Question 47

I/S for operating and financing leases

Answer 47

-for operating, lease expense included in income from continuing operations on lessee’s income statement
-for finance, I/S includes amortization and interest expense

Question 48

cash flow statement for operating and financing

Answer 48

Operating: classified as cash flow from operations, including short-term leases; any payments to bring asset to make readily available is an investing activity

Financing: principal payments are financing activity, interest portion is operating activity; variable or ST payments not included in lease liability are operating activities

Question 49

lessee disclosures: qualitative

Answer 49

1) nature of leases, covenants or restrictions
2) basis of determining variable lease pymnts
3) options to extend or terminate
4) residual value guarantees
5) info on leases not commenced but create significant obligations and/or rights for lessee
6) significant assumptions
7) sale-leaseback terms and conditions
8) entity’s accounting policy for ST leases, especially combining lease and nonlease components

Question 50

lessee disclosures: quantitative

Answer 50

1) finance lease costs
2) operating lease costs
3) ST lease costs
4) variable lease costs
5) cash payments for lease liabilities segregated between operating and financing cash flows
6) supplemental noncash info on lease liabilities to obtain ROU assets
7) weighted average remaining lease term and discount rate
8) separate maturity analyses for operating and finance lease liabilities for 5 yrs

Question 51

operating vs financing depreciation

Answer 51

operating uses term life for depreciation

finance lease uses the economic life of the asset to depreciate

Question 52

amortization of leasehold improvements

Answer 52

should be over the life of the improvements or the remaining life of the lease, whichever is shorter