FAR 6 - Leases + other Flashcards
Lease definition
A contract that:
1) depends on an identifiable asset
2) conveys the right to control the use of the asset over the lease term to the lessee. The lessee will have the right to obtain all economic benefits from using the asset
Separate lease components
Step 1: Identify each right to use an underlying asset within the contract
Step 2: For a contract that includes both lease and nonlease components, the lessee has two options:
1) Lease components are separate from nonlease components
2) Each separate lease component is combined with related nonlease components
* Find relative stand-alone %s and allocated based on total consideration amount (see ex page F6-6)
OWNES
- Ownership transfers to the lessee at the end of the lease term
- Written purchase option which lessee is reasonably certain to exercise
- Net present value equal or exceeds 90% or more of the fair value of the underlying asset
- Economic life - term of lease is 75% or more of economic life of asset
- Specialized asset such that it will not have an expected, alternative use to lessor
PC (leases)
- Present value of the sum of the lease payments and any third party guaranteed residual value is equal to or substantially exceeds the underlying asset’s fair value
- Collection of the lease payments is probable
Lease Classification (lessee)
If any of OWNES is met: Finance Lease (capitalize)
If none are met or lease is short term (12 months or less): Operating Lease (capitalize)
Lease Classification (lessor)
If OWNES is met:
Sales-type lease
If no OWNES, but both of PC is met:
Direct Financing lease
If no OWNES and one or none of PC:
Operating Lease
Lease term beginning
Begins on the commencement date, the date the lessor makes the asset available for use. From the date the lease contract was signed to commencement date is a footnote, not JE
Lease payments
REPORT
- Required contractual fixed payments
- Exercise option REASONABLY assured
- Purchase price at the end of the lease
- Only indexed or rate variable payments
- Residual guarantees likely to be owed
- Termination penalties reasonably assured
Lessee lease payments have the option to include:
NGO
-Nonlease components
-Guarantees of lessor debt by lessee or third parties
-Other variable lease payments
Initial direct costs
Capitalize, these are included in the valuation of ROU asset
Sales Leaseback
To qualify as a sale a contract must exists and control has transferred from the seller to the buyer.
If sale criteria met:
Take equipment off the books and recognize a gain on the sale of equipment
If sale criteria not met:
Treated as a financing transaction. Book as a financing liability, recognize interest expense and continue to book depreciation
Operating Leases - lessee
ROU asset and lease liability are initially booked. Effective interest method is used. There is 1 expense on the income statement as interest is part of this lease expense which is calculated on a straight line basis (Total payments/Total periods)
1) Capitalize lease:
Dr ROU asset
Cr Lease liability
2) Subsequent Entries:
Dr Lease expense (straight line)
Dr Lease liability (principal reduction)
Cr Cash
Cr Accumulated amortization - ROU asset
Finance Lease - lessee
ROU asset and lease liability are initially booked. Effective interest method. There are 2 expense in the form of lease expense and interest expense that are booked.
1) Capitalize lease:
Dr ROU asset
Cr Lease liability
2) Subsequent Entries:
Dr Interest expense
Dr Lease liability
Cr Cash
Dr Amortization expense
Cr Accumulated amortization - ROU asset
Operating lease - lessee (calculations)
1) Initial Lease liability = PV of payments
2) Lease expense = straight line annual payments
3) Interest expense = CV x rate
4) Reduction in ROU = Lease expense - Reduction in ROU
Capitalize lease:
Dr ROU asset (1)
Cr Lease liability (1)
Subsequent Entries: Dr Lease expense (2) Dr Lease liability (4) Cr Cash (2) Cr Accumulated amortization - ROU asset (4)
Finance Lease - lessee (calculations)
1) Initial Lease liability = PV of payments
2) Interest expense = CV x rate
3) Amortization expense = PV/# of periods
4) Total lease expense = 2 + 3 (greater than cash paid)
5) Lease expense = straight line annual payments
6) Reduction in ROU = Lease expense - Reduction in ROU
Capitalize lease:
Dr ROU asset (1)
Cr Lease liability (1)
Subsequent Entries:
Dr Interest expense (2)
Dr Lease liability (6)
Cr Cash (5)
Dr Amortization expense (3)
Cr Accumulated amortization - ROU asset (3)
Sales-Type Lease - lessor
All risks and rewards to lessee.
1) Derecognize asset (at CV)
2) Recognize gain
3) direct costs are EXPENSED
Dr Lease expense (direct costs) Dr Residual asset (value of leftover asset) Dr Lease receivable (PV of payments) Cr Cash (amount of direct costs) Cr Gain Cr Truck (asset removal at NBV)
Direct Financing Lease - lessor
Lessee does not gain control of the asset.
1) Derecognize asset (at FV)
2) Defer gain
3) Direct costs included in receivable and cash
Dr Residual asset (value of leftover asset)
Dr Lease receivable (includes direct costs)
Cr Truck (asset removal at FV)
Cr Cash (amount of direct costs)
Operating Lease - lessor
Keep the asset on the balance sheet.
1) Asset stays on books - continue to depreciate
2) Defer gain
3) Direct costs deferred
Dr Cash
Cr Rental income
Dr Depreciation expense
Cr Accumulated depreciation
ROU amortization
1) Useful life if: ownership or written option criteria are met
2) Shorter of the lease term and useful life if: net present value, economic life, or specialized asset criteria are met
Underlying
A specified price, rate, or other variable that may or may not occur
Call
Gives the holder the right to buy from the option writer at a specified price (holder hoping prices go up)
Put
Gives the holder the right to sell to the option writer at specified price (holder hoping prices go down)
Futures Contract
An agreement to exchange a commodity, currency or other asset. One party takes a LONG position (buy/profit if price goes up) one party takes a SHORT position (sell/profit if price goes down)
*Publicly traded, more liquid
Forward Contract
Similar to futures except they are private
Accounting for derivatives on Balance sheet
All derivatives are recognized as an asset or liability and are measured at FAIR VALUE
Accounting for derivatives on IS (G/L)
Included in current earnings:
- No hedge designation
- Fair value hedge
- Ineffective portion of cash flow hedge
Included in OCI
-Effective portion of cash flow hedge
Reporting Currency
The currency of the entity ultimately reporting financial results of the foreign entity (USD)
Functional Currency
The currency of the primary economic environment in which the entity operates, usually the local currency or the reporting currency
Translation vs. Remeasurement
Translation - restatement of the FS denominated in the functional currency to the reporting currency
Remeasurement - restatement of the FS from the foreign currency to the functional currency when the reporting is the functional
Remeasurement Method (Temporal Method)
Dysfunctional
1) Convert BS to $
- Monetary items = current/year-end rate (spot rate) (fixed amounts such as AR)
- Nonmonetary items = historical rate (assets and liabilities that fluctuate with inflation)
2) Covert IS to $
- Non-BS related items = weighted average rate
- Balance sheet related items (depreciation, COGS) = Historical rate
3) Plug “currency gain/loss” to get NI required amount to adjust RE in order to make BS balance (G/L on IS)
Translation Method (Current Rate Method)
Functional
1) Convert IS to $
- All IS items = Weighted average rate
- Transfer NI to RE
2) Convert BS to $
- Assets/Liabilities = current/year-end rate (spot rate)
- CS/APIC = Historical rate
3) Plug “translation adjustment” to OCI.
Permanent Tax Differences
NO deferred taxes, ignore. Affects only income per books or taxable income, but not both. Main examples include:
- Tax-exempt interest (municipal, state)
- Life insurance premium
Total tax expense can be depicted as
Current income tax payable (taxable income x tax rate) +/- change in deferred income tax asset(-) or liability(+) (temporary differences x future/enacted rate)
= total tax expense
*NEVER FS income x current tax rate
Temporary tax differences
1) Revenues or gains that are included in taxable income after they have been included in financial accounting income, results in a deferred tax liability (contractors accounting)
2) Revenues or gains that are included in taxable income before they have been included in financial accounting income, results in a deferred tax asset (Prepaid rent - gift certificate)
3) Expenses or losses deducted from taxable income after they have been deducted from financial accounting income, results in a deferred tax asset (Bad debt expense - gift certificate)
4) Expenses or losses deducted from taxable income before they have been deducted from financial accounting income, results in a deferred tax liability (Depreciation/Amortization)
*when there are multiple temporary difference, use net amount
Temporary difference example
FS income = $225,000
Book depreciation > tax depreciation = $25,000
200,000 x .21 (tax rate)
+ 25,000 x .21 (same, but is enacted rate)
= 42,000 + 5,250 (+ because tax liability)
Income tax expense - current 42,000
Income tax expense - deferred 5,250
Deferred Tax liability 5,250
Income tax payable 42,000
*If deferred tax asset
Income tax expense - current 42,000
Deferred tax asset 5,250
Income tax benefit - deferred 5,250
Income tax payable 42,000
**Valuation account set up for any limitations on recognizing deferred assets
More likely than not test
Must win more than 50% of the time to recognize in the financial statements. Used with aggressive tax positions.
If test fails: tax expense goes up
If test passes: Recognize the largest amount that has greater than 50% likelihood of being realized
Rate to use when temporary differences reverse itself
Tax rate in effect
NOT: Anticipated, proposed or unsigned rates
