FAR SEC 12

Question 1

What is a lease?

Answer 1

A lease is a contractual agreement in which the lessor (owner) conveys to the lessee the right to control the use of specific property, plant, or equipment for a stated period in exchange for a stated payment.

Question 2

Does the lease standard apply to leases of intangible assets or inventory?

Answer 2

No. The lease standard does not apply to leases of intangible assets or inventory.

Question 3

What determines the amount and timing of lease revenue recognized by lessor and lease expenses recognized by lessee?

Answer 3

The amount and timing of lease revenue recognized by the lessor and lease expenses recognized by the lessee depend on the initial classification of the lease.

Question 4

What is the commencement date of the lease?

Answer 4

The commencement date of the lease is the date on which a lessor makes a leased asset available for use by a lessee.

Question 5

What is the lease term? (2 elements)

Answer 5

1) The lease term is the noncancelable period for which the lessee has the right to use the leased asset. Periods covered by an option to extend the lease are included in the lease term if (1) the lessee is reasonably certain to exercise that option or (2) the option is controlled by the lessor.

2) The periods covered by the option to terminate the lease are included in the lease term only if the lessee is reasonably certain not to exercise that option.

Question 6

What is a right-of-use-asset?

Answer 6

A right-of-use asset represents a lessee’s right to use a leased asset for the lease term.

Question 7

Lease payments at the lease commencement date consist of the following: (3 elements)

Answer 7

1) Rental payments are the periodic amounts owed by the lessee minus any incentives paid or payable to the lessee.
2) A purchase option is the exercise price of an option to purchase the leased asset if the lessee is reasonably certain to exercise the option.
3) Penalties for terminating the lease (nonrenewal penalties) are included if the lessee is expected to exercise the option to terminate the lease.
-For a lessee, the lease payments also include the amounts probable of being owed by the lessee under residual value guarantees.

Question 8

What is guaranteed residual value?

Answer 8

The guaranteed residual value is a guarantee made to a lessor that the value of a leased asset returned to the lessor at the end of a lease term will be at least a specified amount. This residual value can be guaranteed by the lessee or any other third party unrelated to the lessor.

Question 9

What is the discount rate for the lease? (4 elements)

Answer 9

1) The discount rate for the lease is the rate implicit in the lease. If the lessee cannot determine the rate implicit in the lease, the lessee uses its incremental borrowing rate.
2) The rate implicit in the lease is the interest rate that on the lease commencement date causes (a) the fair value of the leased asset to equal (b) the present value of the lease payments plus the present value of the amount that the lessor expects to derive from the leased asset following the end of the lease term.

Fair value of the leased asset = PV of the lease payments
+PV of the amount that the lessor
expects to derive from the leased asset
following the end of the lease term

3) The amount that a lessor expects to derive from the asset following the end of the lease term includes
i) The guaranteed residual value and
ii) The unguaranteed residual value of the leased asset.

4) A lessee that is not a public business entity can use a risk-free discount rate for the lease instead of its incremental borrowing rate.

Question 10

What are the five criteria for classifying a lease as a finance lease by the lessee and as a sales-type lease by the lessor?

Answer 10

A lease is classified as a finance lease by the lessee and as a sales-type lease by the lessor if, at lease commencement, at least one of the five criteria below is met:
1) The lease transfers ownership of the leased asset to the lessee by the end of the lease term.
2) The lease includes an option to purchase the leased asset that the lessee is reasonably certain to exercise.
3) The lease term is for the major part of the remaining economic life of the leased asset.
i) A lease term of 75% or more of the remaining economic life of the leased asset generally is considered to be a major part of its remaining economic life.
ii) This criterion is inapplicable if the beginning of the lease term is at or near the end of the economic life of the leased asset. This period generally is considered to be the last 25% of the leased asset’s total economic life.
4) The present value of the sum of (a) the lease payments and (b) any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the leased asset.
-A present value of 90% or more of the fair value of the leased asset generally is considered to be substantially all of its fair value.
5) The leased asset is so specialized that it is expected to have no alternative use to the lessor at the end of the lease term.

Question 11

If the five criteria for financing lease/lessor and sales-type lease/lessee are not met, how is the lease classified by lessor or lessee? (2 elements)

Answer 11

When none of the five classification criteria described above are met, the lease is classified as
1) An operating lease by the lessee.
2) An operating lease or a direct financing lease by the lessor.

Question 12

When does the lessor classify the lease as a direct financing lease? (3 elements)

Answer 12

The lessor classifies a lease as a direct financing lease only when
1) The lease is not a sales-type lease,
2) The present value of the sum of (a) the lease payments and (b) any residual value guaranteed by the lessee or any other third party equals or exceeds substantially all of the fair value of the leased asset, and
3) It is probable that the lease payments and any residual value guarantee will be collected.

Question 13

What are the conditions for a lease to be classified as an operating lease by the lessor? (3 elements)

Answer 13

1) If the lease is not a direct financing lease, it is classified as an operating lease by the lessor.
2) Classification of a lease as a direct financing lease is rare. It happens only when the lease includes residual value guaranteed by a third party other than the lessee that results in meeting the “substantially all of the fair value” classification criterion (the 90% of the fair value of the leased asset criterion).
Thus, a lessor classifies a lease without residual value guaranteed by a third party (not the lessee) as either
i) A sales-type lease or
ii) An operating lease.
3) In most cases, when none of the five classification criteria are met (when the lease is not a sales-type lease), the lessor classifies the lease as an operating lease.

Question 14

What is shown on the Decision Tree: Classification of the Lease by the Lessor Flow Chart

Answer 14

Question 15

For the classification of the lease by the LESSOR decision tree, what branches from: Are any of the five lease classification criteria met? (YES/NO)

Answer 15

YES => Sales-Type Lease
NO => ASK: Does the lease include a residual value guarantee by a third party that is not the lessee that result in meeting the “substantially all of the fair value” classification criterion?

Question 16

For the classification of the lease by the LESSOR decision tree, what branches from: ASK: Does the lease include a residual value guarantee by a third party that is not the lessee that result in meeting the “substantially all of the fair value” classification criterion? (YES/NO)

Answer 16

YES => Direct Financing Lease
NO => Operating Lease

END OF DECISION TREE

Question 17

What are the attributes of a short-term lease? (3 elements)

Answer 17

1) A short-term lease is a lease that, at the commencement date, has a lease term of 12 months or less and does not include a purchase option that the lessee is reasonably certain to exercise.
2) As an accounting policy for short-term leases, a lessee may elect not to recognize the right-of-use asset and lease liability.
3) Under this short-term lease exception, the lessee recognizes lease payments as rent expense on the straight-line basis over the full lease term.

The lessee records the following journal entry:

Rent expense $XXX
Cash or rent payable $XXX

Question 18

What is shown on the Decision Tree: Classification of the Lease by the Lessee?

Answer 18

Question 19

For the Classification of the Lease by the LESSEE decision tree, what branches from: Is the lease a short-term lease (lease term of 12 months or less with no purchase option)? (YES/NO)

Answer 19

YES => ASK: Was the short-term lease exception elected by the lessee?

NO => Are any of the five lease classification criteria met?

Question 20

For the Classification of the Lease by the LESSEE decision tree, what branches from: Was the short-term lease exception elected by the lessee? (YES/NO)

Answer 20

YES => The lease is a regular rental contract, and no right-of-use asset and lease liability are recognized.

NO=> ASK: Are any of the five lease classification criteria met?

Question 21

For the Classification of the Lease by the LESSEE decision tree, what branches from: are any of the five lease classification criteria met? (YES/NO)

Answer 21

YES => Finance Lease
NO => Operating Lease

END OF DECISION TREE

Question 22

What is the general rule for lease accounting - initial measurement? (3 elements)

Answer 22

1) For finance and operating leases, a lessee must recognize a lease liability and a right-of-use asset at the lease commencement date.
2) Finance and operating leases result in the same accounting for
i) Initial recognition and measurement of the lease liability,
ii) Initial recognition and measurement of the right-of-use asset, and
iii) Subsequent measurement of the lease liability.
3) The accounting for subsequent measurement of a right-of-use asset differs under finance and operating leases.

Question 23

What are the attributes of the lease liability? (4 elements)

Answer 23

1) At the lease commencement date, a lease liability is measured at the present value of the lease payments to be made over the lease term.
2) The lease payments are discounted using the discount rate for the lease.
i) It is the rate implicit in the lease, if known to the lessee.
ii) If not, it is the lessee’s incremental borrowing rate.
3) The lease payments used to calculate the lease liability depend on the specific terms of each lease contract.
i) If the lease includes a purchase option that the lessee is reasonably certain to exercise, the lease payments consist of the
-Rental payments
-Exercise price of the purchase option
ii) If no purchase option exists, the lease payments may have the following three components:
-Rental payments
-Any penalties for terminating the lease (nonrenewal penalties)
-Amounts probable of being owed by the lessee under residual value guarantees
NOTE: For the “substantially all of the fair value” lease classification criterion, the present value of the full amount of the residual value guaranteed by the lessee is included in the test. However, in measuring the lease liability, only the amounts probable of being owed by the lessee under residual value guarantees are included.
4) In a balance sheet, the total lease liability is allocated between current and noncurrent portions. The current portion at a balance sheet date is the reduction of the lease liability in the forthcoming year.

Question 24

How is the lease liability measured at the lease commencement date?

Answer 24

At the lease commencement date, a lease liability is measured at the present value of the lease payments to be made over the lease term.

Question 25

How are the lease payments discounted? (3 elements)

Answer 25

1) The lease payments are discounted using the discount rate for the lease.
2) It is the rate implicit in the lease, if known to the lessee.
3) If not, it is the lessee’s incremental borrowing rate.

Question 26

If the lease includes a purchase option that the lessee is reasonably certain to exercise, the lease payments consist of the________________. (2 elements)

Answer 26

The lease payments used to calculate the lease liability depend on the specific terms of each lease contract.
If the lease includes a purchase option that the lessee is reasonably certain to exercise, the lease payments consist of the
1) Rental payments
2) Exercise price of the purchase option

Question 27

If no purchase option exists, the lease payments may have the following three components: (3 elements)

Answer 27

If no purchase option exists, the lease payments may have the following three components:
1) Rental payments
2) Any penalties for terminating the lease (nonrenewal penalties)
3) Amounts probable of being owed by the lessee under residual value guarantees

Question 28

How is the total lease liability presented on the balance sheet?

Answer 28

In a balance sheet, the total lease liability is allocated between current and noncurrent portions. The current portion at a balance sheet date is the reduction of the lease liability in the forthcoming year.

Question 29

What is shown on the figure for the calculation of the present value of the full amount of the residual value under the “substantially all of the fair value” test?

Answer 29

Question 30

What are the attributes of a right-of-use asset? (3 elements)

Answer 30

1) At the lease commencement date, a right-of-use asset is measured at the amount at which the lease liability was recognized plus initial direct costs incurred by the lessee.
2) When no initial direct costs were incurred by the lessee, a right-of-use asset equals the lease liability recognized.
-The following journal entry is recorded by the lessee:

Right-of-use asset $XXX
Lease liability $XXX

3) Subsequent to initial recognition, the right-of-use asset is reported in the balance sheet at cost minus accumulated amortization and any impairment losses.

Question 31

What are the attributes of interest expense and amortization of a lease liability? (3 elements)

Answer 31

1) Each periodic lease payment made by the lessee has two components: interest expense and the reduction of the lease liability.
-If the first periodic lease payment is made at the commencement date of the lease, its only component is the reduction of the lease liability. No interest expense is recognized for the first payment because no time has elapsed between the lease commencement date and the payment.
2) Interest expense is calculated using the effective interest method (also known as the effective-rate method or the interest method).
-It is calculated as the carrying amount of the lease liability at the beginning of the period times the discount rate of the
lease.

Interest expense = Lease liability at the beginning of the period × Discount rate

3) The reduction of the lease liability is the excess of the periodic lease payment over the interest expense recognized during the period.

Reduction of lease liability = Periodic lease payment – Interest expense

Question 32

What are the two components of each periodic lease payment made by the lessee? (2 elements)

Answer 32

1) Each periodic lease payment made by the lessee has two components: interest expense and the reduction of the lease liability.
2) If the first periodic lease payment is made at the commencement date of the lease, its only component is the reduction of the lease liability. No interest expense is recognized for the first payment because no time has elapsed between the lease commencement date and the payment.

Question 33

For lessee accounting for finance leases -subsequent measurement, how is interest expense calculated? (2 elements)

Answer 33

1) Interest expense is calculated using the effective interest method (also known as the effective-rate method or the interest method).
2) It is calculated as the carrying amount of the lease liability at the beginning of the period times the discount rate of the lease.

Interest expense = Lease liability at the beginning of the period × Discount rate

Question 34

For lessee accounting for finance leases -subsequent measurement, what is the reduction of lease liability?

Answer 34

The reduction of the lease liability is the excess of the periodic lease payment over the interest expense recognized during the period.

Reduction of lease liability = Periodic lease payment – Interest expense

Question 35

How is a right-of-use asset amortized? (3 elements)

Answer 35

1) A lessee amortizes the right-of-use (ROU) asset on a straight-line basis.
2) The right-of-use asset is amortized over the shorter of (1) its useful life or (2) the lease term.
3) However, if, at the end of the lease term, (a) the ownership of the leased asset is transferred to the lessee or (b) the lessee is reasonably certain to exercise the purchase option, the amortization period is the useful life of the leased asset.

Lease Classification Criterion Satisfied &
Amortization Period of the ROU Asset:

Criterion 1 - Transfer of ownership:
Useful life of the leased asset
Criterion 2 - Exercise of purchase option:
Useful life of the leased asset
Criterion 3 - Major part of the remaining economic life:
Shorter of ROU asset’s useful life or lease term
Criterion 4 - Substantially all of the fair value:
Shorter of ROU asset’s useful life or lease term
Criterion 5 - No alternative use to the lessor:
Shorter of ROU asset’s useful life or lease term

Question 36

What are the five lease classification criteria?

Answer 36

Lease Classification Criterion Satisfied &
Amortization Period of the ROU Asset:

Criterion 1 - Transfer of ownership:
Useful life of the leased asset
Criterion 2 - Exercise of purchase option:
Useful life of the leased asset
Criterion 3 - Major part of the remaining economic life:
Shorter of ROU asset’s useful life or lease term
Criterion 4 - Substantially all of the fair value:
Shorter of ROU asset’s useful life or lease term
Criterion 5 - No alternative use to the lessor:
Shorter of ROU asset’s useful life or lease term

Question 37

What is shown on the table for the five lease classification criteria?

Answer 37

Question 38

How are leasehold improvement amortized? (2 elements)

Answer 38

1) Leasehold improvements are amortized over the shorter of (1) their useful life or (2) the remaining lease term.
2) If, at the end of the lease term, (a) the ownership of the leased asset is transferred to the lessee or (b) the lessee is reasonably certain to exercise a purchase option, the amortization period is the useful life of the leasehold improvements.

Question 39

For lessee accounting for finance leases, subsequent measurement, what is the financial statement presentation? (3 elements)

Answer 39

1) In the income statement, interest expense on a lease liability and amortization of a right-of-use asset must be reported separately.
2) In the statement of cash flows, repayment of the principal portion of a finance lease liability is classified as a cash outflow from financing activities.
-Payment of interest on a lease liability is classified as a cash outflow from operating activities.
3) In the footnotes to the financial statements, the lessee must disclose the total finance lease cost for the period. The total finance lease cost should be segregated between the amortization of the right-of-use assets and interest expense on the lease liabilities.

Question 40

For finance leases vs. operating leases, what three elements are in common between them?

Answer 40

As noted in Subunit 12.2, accounting for finance leases and operating leases is the same for
1) Initial recognition and measurement of the lease liability,
2) Initial recognition and measurement of the right-of-use asset, and
3) Subsequent measurement of the lease liability.

Question 41

For finance leases vs. operating leases, what three elements are differ between them?

Answer 41

The following are the differences in accounting for finance and operating leases:
1) Subsequent accounting for (amortization of) the right-of-use asset
2) Income statement presentation of interest expense and amortization of the right-of-use asset
3) Statement of cash flow classification of cash lease payments

Question 42

For lessee accounting for operating expenses, subsequent measurement, what are the three attributes of recognition of lease expense in operating leases?

Answer 42

1) A single (equal) lease expense is recognized in each period. It is calculated so that the total undiscounted lease payments are allocated over the lease term on a straight-line basis.

Single periodic lease expense = Total undiscounted lease payments ($) ÷ Lease term (years)

-Initial direct costs incurred by the lessee are included in the total undiscounted lease payments. Thus, they are recognized in the single periodic lease expense on a straight-line basis over the lease term.
2) The single periodic lease expense has two components, (1) interest expense on the lease liability and (2) amortization of the right-of-use asset.
3) In the income statement, a single amount for the total lease expense for the period is reported in income from continuing operations.
-Thus, interest expense for the lease liability and amortization expense for the right-of-use asset are not reported separately.

Question 43

What are the two components of the single periodic lease expense?

Answer 43

The single periodic lease expense has two components, (1) interest expense on the lease liability and (2) amortization of the right-of-use asset.

Question 44

What are the two components of the single periodic lease expense?

Answer 44

Question 45

How is a right-of-use asset amortized? (2 elements)

Answer 45

1) Amortization of the right-of-use asset is the difference between the (1) single periodic lease expense and (2) interest expense on the lease liability recognized for the period.

Amortization expense on right-of-use asset = Single periodic
lease expense – Interest expense on lease liability

2)Interest expense equals the carrying amount of the lease liability at the beginning of the period times the discount rate of the lease.

Question 46

For lessee accounting for operating expenses, subsequent measurement, what is the financial statement presentation?

Answer 46

1) In the balance sheet, finance lease liabilities and operating lease liabilities must not be presented together in the same line item.
-They are presented in the balance sheet or disclosed in the notes, separately from each other and separately from other liabilities.
2) In the balance sheet, finance lease right-of-use assets and operating lease right-of-use assets must not be presented together in the same line item.
-They are presented in the balance sheet or disclosed in the notes, separately from each other and separately from other assets.
3) In the statement of cash flows, payments for operating leases (repayment of the lease liability and interest expense on the lease liability) are cash outflows from operating activities.
-Payments for leases classified as short-term leases are cash outflows from operating activities.

Question 47

For lessor accounting for sales-type leases, what is the lease receivable? (3 elements)

Answer 47

1) The lease receivable is the (1) present value of the lease payments plus (2) the present value of the residual value guaranteed by the lessee or any other third party.

Lease receivable = PV of lease payments + PV of guaranteed residual value

2) The present value is calculated using the discount rate implicit in the lease.
3) The lease receivable is the revenue recognized at the lease commencement date.

Question 48

For lessor accounting for sales-type leases, what is the unguaranteed residual value?

Answer 48

The unguaranteed residual value is the amount that the lessor expects to derive from the leased asset at the end of the lease term that is not guaranteed by any party.

Question 49

For lessor accounting for sales-type leases, what is the net investment in the lease? (4 elements)

Answer 49

1) The net investment in the lease is the present value of the total of cash and other assets that the lessor expects to receive over the lease term.
2) It consists of (a) the lease receivable plus (b) the present value of unguaranteed residual value.
3) Because the present value is calculated using the rate implicit in the lease, the net investment in the lease is the fair value of the leased asset.

Net investment in the lease = PV of lease payments
+ PV of guaranteed residual value + PV of unguaranteed residual value

Net investment in the lease = Lease receivable + PV of unguaranteed residual value = Fair value of the leased asset

4) Selling profit or loss on the lease is determined on the lease commencement date. Assuming no initial direct costs and prepayments, selling profit or loss (gross profit) is calculated as follows:

Lease receivable = Revenue –
[(Carrying amount of the leased asset) – (PV of unguaranteed residual value)] = Cost of goods sold = Selling profit or loss

-A lease can be classified as a sales-type lease even if it does not result in the recognition of any selling profit or loss.

Question 50

For lessor accounting for sales-type leases, what are the rules? (3 elements)

Answer 50

1) On the lease commencement date, the lessor must derecognize the leased asset and recognize all of the following:
i) Net investment in the lease
ii) Selling profit or loss calculated as
-Revenue equal to the lease receivable minus
-Cost of goods sold, which equals the carrying amount of the leased asset minus the present value of any unguaranteed residual value. Thus, when no residual value is unguaranteed, the cost of goods sold is the carrying amount of the leased asset.

2) The following journal entry is recorded at the lease commencement date:

Net investment in the lease $XXX
Cost of goods sold $XXX
Revenue $XXX
Leased asset $XXX

-The leased asset (property held for lease) is derecognized (credit) at its carrying amount at the lease commencement date.

3) When the collectibility of the lease payments and the residual value guaranteed by the lessee is not probable, the lessor does not derecognize the leased asset and does not recognize the net investment in the lease and selling profit or loss.
The lease payments received from the lessee are recognized as a deposit liability.

Cash $XXX
Deposit liability $XXX

Question 51

For lessor accounting for sales-type leases, what are the attributes of subsequent measurement? (4 elements)

Answer 51

1) Each periodic lease payment received has two components: interest income and the reduction of net investment in the lease.
2) Interest income is calculated using the effective interest method.
-It equals the carrying amount of the net investment in the lease at the beginning of the period times the discount rate implicit in the lease.

Interest income = Net investment in the lease at the beginning of the period × Discount rate

3) The reduction of the net investment in the lease is the difference between lease payments received from the lessee and the interest income recognized.

Reduction of net investment in the lease = Periodic lease payment received – Interest income recognized

-If the first lease payment is received at the commencement date of the lease, its only component is the reduction of the net investment in the lease. No interest income is recognized for the first payment made at the lease commencement date.

4) After the leased asset is derecognized, no depreciation expense for the leased asset is recognized by the lessor.

Question 52

For lessor accounting for sales-type leases, what is the financial statement presentation (2 elements)

Answer 52

1) In the balance sheet, the net investments in the lease assets resulting from sales-type and direct financing leases are aggregated and presented together.
i) The net investment in the lease assets is presented separately from other assets in the balance sheet.
ii) The net investment in the lease account should be allocated between current and noncurrent portions. The current portion at a balance sheet date is the reduction of the net investment in the lease in the forthcoming year.
2) In the statement of cash flows, cash receipts from all leases (sales-type, direct financing, and operating leases) are classified as cash inflows from operating activities.

Question 53

What are the attributes of lessor accounting for operating leases? (3 elements)

Answer 53

1) Lease payments are recognized as lease (rental) income by the lessor.
i) If rental payments vary from a straight-line basis (e.g., if the first month is free), rental income should be recognized over the full lease term on the straight-line basis.
ii) Thus, an equal amount of rental income is recognized each period over the lease term as follows:

Rental income recognized each period = Total lease payments to be received ÷ Lease term

iii) The lessor records the following journal entry:
Cash or lease receivable $XXX
Rental (lease) income $XXX
The leased asset continues to be reported on the lessor’s balance sheet. No net investment in the lease is recognized.
The lessor depreciates the leased asset according to its normal depreciation policy for owned assets.
Initial direct costs, such as realtor fees, are initially deferred by the lessor.
Subsequently, they are expensed by the lessor over the lease term on a straight-line basis.

Question 54

What are the attributes of initial direct costs (for those leases having them)? (2 elements)

Answer 54

1) Initial direct costs (IDCs) are incremental costs of a lease that would not have been incurred if the lease had not been obtained. An example is a commission.
2) The following are the effects of initial direct costs on the accounting for leases:
i) In the equation to calculate the rate implicit in the lease (defined in Subunit 12.1), deferred IDCs of the lessor are added to the fair value of the leased asset.
ii) In sales-type leases, IDCs are expensed when the fair value of the leased asset differs from its carrying amount.
-In this case, for the purpose of assessing the “substantially all of the fair value” lease classification criterion, the IDCs are excluded from the calculation of the rate implicit in the lease.
-If the fair value of the leased asset equals its carrying amount, IDCs are deferred and included in the calculation of the rate implicit in the lease. Thus, they are automatically included in the investment in the lease. They need not be added separately.
iii) In the initial calculation of the right-of-use asset, the IDCs of the lessee are added to the lease liability.

Question 55

What are initial direct costs for leases?

Answer 55

Initial direct costs (IDCs) are incremental costs of a lease that would not have been incurred if the lease had not been obtained. An example is a commission.

Question 56

Do all leases have initial indirect costs?

Answer 56

No. Most of the CPA Exam questions about leases are without initial direct costs. However, knowing the effect of initial direct costs on accounting for leases may be useful if a question asks about it.

Question 57

What are the effects of initial direct costs on the accounting for leases? (3 elements)

Answer 57

The following are the effects of initial direct costs on the accounting for leases:
1) In the equation to calculate the rate implicit in the lease (defined in Subunit 12.1), deferred IDCs of the lessor are added to the fair value of the leased asset.
2) In sales-type leases, IDCs are expensed when the fair value of the leased asset differs from its carrying amount.
i) In this case, for the purpose of assessing the “substantially all of the fair value” lease classification criterion, the IDCs are excluded from the calculation of the rate implicit in the lease.
ii) If the fair value of the leased asset equals its carrying amount, IDCs are deferred and included in the calculation of the rate implicit in the lease. Thus, they are automatically included in the investment in the lease. They need not be added separately.
3) In the initial calculation of the right-of-use asset, the IDCs of the lessee are added to the lease liability.

Question 58

What in the sale and leaseback transaction graphic?

Answer 58

Question 59

What are the basic attributes of the sale and leaseback transactions? (4 elements)

Answer 59

1) A sale-leaseback involves the sale of property by the owner (seller-lessee) and a lease of the property back from the buyer-lessor.
2) The initial transfer of the asset to the buyer-lessor is not a sale of the asset if the leaseback is classified as a finance lease or a sales-type lease.
-Generally, the transfer of the asset is not a sale if, based on lease terms, the seller-lessee has the option to repurchase the asset.
3) If the leaseback is classified as an operating lease, the initial transfer of the asset to the buyer-lessor can be accounted for as a sale of an asset if all the criteria for revenue recognition are met.
4) If the initial transfer of the asset is a sale, the seller-lessee should
i) Recognize the transaction price for the sale of the asset.
ii) Derecognize the carrying amount of the asset.
iii) Recognize any gain or loss on the sale of the asset, adjusted for off-market terms, if needed.
iv) Account for the leaseback of the asset.

Question 60

For the sale and leaseback transactions, what should the seller-lessee do if the initial transfer of the asset is a sale? (4 elements)

Answer 60

If the initial transfer of the asset is a sale, the seller-lessee should
1) Recognize the transaction price for the sale of the asset.
2) Derecognize the carrying amount of the asset.
3) Recognize any gain or loss on the sale of the asset, adjusted for off-market terms, if needed.
4) Account for the leaseback of the asset.

Question 61

For the sale and leaseback transactions, what are the attributes if the transfer of an asset is a sale? (5 elements)

Answer 61

1) An entity needs to determine whether the sale-leaseback transaction is at fair value and based on market terms. The more readily determinable of the following should be considered:
i) The difference between (a) the sale price of the asset and (b) its fair value.
ii) The difference between (a) the present value of the lease payments and (b) the present value of market rental payments.
2) If the transaction is at fair value, the gain or loss on sale recognized by the seller-lessee is the difference between the selling price and the carrying amount of the asset.

Gain (loss) on sale = Selling price of the asset – Carrying amount of the asset

3) When the sale-leaseback transaction is not at fair value and not based on market terms, off-market adjustments are needed to recognize the sale at fair value.
i) The off-market adjustment equals the difference between the
a) Fair value of an asset and its selling price or
b) Present value of the lease payments and the present value of the market rental payments.
ii) The gain or loss on sale is adjusted for the off-market adjustment.

Gain (loss) on sale = Fair value of the asset –
Carrying amount of the asset

iii) The buyer-lessor recognizes the purchased asset at its fair value.
4) When the selling price of an asset (or leaseback payment) is greater than fair value (or market value), the difference is essentially additional financing received from the buyer-lessor.
i) This additional financing should be accounted for separately from the lease liability.
ii) A financial liability (asset) is recognized by the seller-lessee (buyer-lessor) for the off-market adjustment (e.g., the excess of the selling price of an asset over its fair value).
When the selling price of an asset (or leaseback payment) is lower than fair value (or market value), the difference is essentially a rent prepaid by the seller-lessee.
The off-market adjustment (the excess of the fair value of an asset over its selling price) is recognized by the seller-lessee as an increase of the right-of-use asset.
The buyer-lessor recognizes the prepaid rent as a liability. Subsequently, under an operating lease, the prepaid rent is recognized as rental income on a straight-line basis over the lease term.

Question 62

For sale and leaseback transactions in the case of the transfer of an asset is a sale, how does the entity determine whether the sale-leaseback transaction is at fair value and based on market terms? (3 elements)

Answer 62

1) An entity needs to determine whether the sale-leaseback transaction is at fair value and based on market terms. The more readily determinable of the following should be considered:
2) The difference between (a) the sale price of the asset and (b) its fair value.
3) The difference between (a) the present value of the lease payments and (b) the present value of market rental payments.

Question 63

How is the gain or loss on sale recognized by the seller-lessee if the transaction is at fair value?

Answer 63

If the transaction is at fair value, the gain or loss on sale recognized by the seller-lessee is the difference between the selling price and the carrying amount of the asset.

Gain (loss) on sale = Selling price of the asset –
Carrying amount of the asset

Question 64

What is the formula for how the gain or loss on sale recognized by the seller-lessee is calculated if the transaction is at fair value?

Answer 64

Gain (loss) on sale = Selling price of the asset –
Carrying amount of the asset

Question 65

What is done when the sale-leaseback transaction is not at fair value and based on market terms?

Answer 65

When the sale-leaseback transaction is not at fair value and not based on market terms, off-market adjustments are needed to recognize the sale at fair value.

Question 66

When the sale-leaseback transaction is not at fair value and not based on market terms, what procedure is used to account for the transaction? (3 elements)

Answer 66

When the sale-leaseback transaction is not at fair value and not based on market terms, off-market adjustments are needed to recognize the sale at fair value.
1) The off-market adjustment equals the difference between the
i) Fair value of an asset and its selling price or
ii) Present value of the lease payments and the present value of the market rental payments.

2) The gain or loss on sale is adjusted for the off-market adjustment.

Gain (loss) on sale = Fair value of the asset –
Carrying amount of the asset

3) The buyer-lessor recognizes the purchased asset at its fair value.

Question 67

When the sale-leaseback transaction is not at fair value and not based on market terms, what is the formula to calculate the gain (loss) on sale?

Answer 67

Gain (loss) on sale = Fair value of the asset –
Carrying amount of the asset

Question 68

When the selling price of an asset (or leaseback payment) is greater than fair value (or market value), what is the accounting procedure? (3 elements)

Answer 68

1) When the selling price of an asset (or leaseback payment) is greater than fair value (or market value), the difference is essentially additional financing received from the buyer-lessor.
2) This additional financing should be accounted for separately from the lease liability.
3) A financial liability (asset) is recognized by the seller-lessee (buyer-lessor) for the off-market adjustment (e.g., the excess of the selling price of an asset over its fair value).

Question 69

When the selling price of an asset (or leaseback payment) is lower than fair value (or market value), what is the accounting procedure? (3 elements)

Answer 69

1) When the selling price of an asset (or leaseback payment) is lower than fair value (or market value), the difference is essentially a rent prepaid by the seller-lessee.
2) The off-market adjustment (the excess of the fair value of an asset over its selling price) is recognized by the seller-lessee as an increase of the right-of-use asset.
3) The buyer-lessor recognizes the prepaid rent as a liability. Subsequently, under an operating lease, the prepaid rent is recognized as rental income on a straight-line basis over the lease term.

Question 70

What is the accounting treatment for the sale and leaseback transactions when the transfer of an asset is not a sale? (3 elements)

Answer 70

1) If the transfer of the asset is not a sale, the transaction is a financing transaction.
2) The seller-lessee will continue to report the transferred asset and depreciate it. The initial proceeds received from the buyer-lessor are recognized as a financial liability (e.g., loan payable).
Subsequently, each annual rental payment has the following two components:
i) Interest expense equals the beginning of the period balance of the financial liability times the discount rate for the lease, and
ii) The reduction of the financial liability equals the difference between the periodic lease payment and interest expense recognized for the period.
3) The buyer-lessor will not recognize the transferred asset. The amounts paid to the seller-lessee are recognized as a financial asset (e.g., loan receivable).
-Subsequently, each periodic rental payment received consists of interest income and a principal repayment of the financial asset.

Question 71

If the transfer of the asset is not a sale, what is the classification of the sale and leaseback transaction?

Answer 71

If the transfer of the asset is not a sale, the transaction is a financing transaction.

Question 72

If the transfer of the asset is not a sale, how does the seller-lessee report the sale and leaseback transactions? (2 elements)

Answer 72

1) The seller-lessee will continue to report the transferred asset and depreciate it. The initial proceeds received from the buyer-lessor are recognized as a financial liability (e.g., loan payable).
2) Subsequently, each annual rental payment has the following two components:
i) Interest expense equals the beginning of the period balance of the financial liability times the discount rate for the lease, and
ii) The reduction of the financial liability equals the difference between the periodic lease payment and interest expense recognized for the period.

Question 73

If the transfer of the asset is not a sale, how does the buyer-lessor report the sale and leaseback transactions? (2 elements)

Answer 73

1) The buyer-lessor will not recognize the transferred asset. The amounts paid to the seller-lessee are recognized as a financial asset (e.g., loan receivable).
2) Subsequently, each periodic rental payment received consists of interest income and a principal repayment of the financial asset.

Question 74

What is the definition of contingency? (2 elements)

Answer 74

1) A contingency is “an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (a gain contingency) or loss (a loss contingency) to an entity that will ultimately be resolved when one or more future events occur or fail to occur.”
2) A contingency may be
i) Probable. Future events are likely to occur.
ii) Reasonably possible. The chance of occurrence is more than remote but less than probable.
iii) Remote. The chance of occurrence is slight.

Question 75

What are the three levels of likelihood for a contingency?

Answer 75

A contingency may be
1) Probable. Future events are likely to occur.
2) Reasonably possible. The chance of occurrence is more than remote but less than probable.
3) Remote. The chance of occurrence is slight.

Question 76

What are the three attributes of probable loss contingencies? (3 elements)

Answer 76

1) Criteria for accrual. A contingent loss must be accrued (debit loss and credit liability) when two conditions are met. Based on information available prior to the issuance of the financial statements, accrual is required if
i) It is probable that, at a balance sheet date, an asset has been impaired or a liability has been incurred, and
ii) The amount of the loss can be reasonably estimated.
2) Measurement of the loss. When the assessment of a range of probable losses is provided, the amount that appears to be a better estimate than any other within this range must be accrued.
-If no amount within that range appears to be a better estimate than any other, the minimum of the range should be accrued.
3) Disclosures. Disclosure in the financial statements of the nature of the accrual and the amount or the range of loss is required.

Question 77

For probable loss contingencies, what are the criteria for accrual? ( 3 elements)

Answer 77

1) Criteria for accrual. A contingent loss must be accrued (debit loss and credit liability) when two conditions are met. Based on information available prior to the issuance of the financial statements, accrual is required if
2) It is probable that, at a balance sheet date, an asset has been impaired or a liability has been incurred, and
3) The amount of the loss can be reasonably estimated.

Question 78

For probable loss contingencies, what is the accounting for measurement of the loss? (2 elements)

Answer 78

1) Measurement of the loss. When the assessment of a range of probable losses is provided, the amount that appears to be a better estimate than any other within this range must be accrued.
2) If no amount within that range appears to be a better estimate than any other, the minimum of the range should be accrued.

Question 79

For probable loss contingencies, what are the disclosures?

Answer 79

Disclosures. Disclosure in the financial statements of the nature of the accrual and the amount or the range of loss is required.

Question 80

What disclosures are required for reasonably possible loss contingencies? (3 elements)

Answer 80

1) Disclosure must be made if any condition to accrue a loss contingency is not met, but the probability of the loss is at least reasonably possible. The following should be disclosed:
2) The nature of the contingency
3) An estimate of the possible loss or range of loss or a statement that such an estimate cannot be made

Question 81

What is the accounting treatment for remote loss contingencies? (3 invoices)

Answer 81

1) These loss contingencies ordinarily are not disclosed.
2) However, a guarantee (e.g., of the indebtedness of another or to repurchase receivables) must be disclosed even if the probability of loss is remote. The disclosure should include the nature and amount of the guarantee.
i) A guarantee is a noncontingent obligation to perform after the occurrence of a triggering event or condition. It is coupled with a contingent obligation to make payments if such an event or condition occurs.
-Thus, recognition of a liability at the inception of a guarantee is required even when it is not probable that payments will be made.
ii) The initial measurement of a noncontingent obligation ordinarily is at fair value. If a contingent loss and liability also are required to be recognized, the liability recognized by the guarantor is the greater of the fair value measurement or the contingent liability amount.
3) No accrual is permitted for general or unspecified business risks, for example, those related to national and international economic conditions. No disclosure is required.

Question 82

What is the accounting treatment for unasserted claims? (2 elements)

Answer 82

1) With respect to unasserted claims, an entity must determine the degree of probability that a suit may be filed and the possibility of an unfavorable outcome.
2) If it is probable that a suit will be filed against an entity and the two conditions to accrue a contingent liability are met (i.e., the loss is probable and can be reasonably estimated), a contingent loss must be accrued.