FAR - Specific Transactions, Events, & Disclosures - Leases Flashcards
Background Operating Leases
Leasing allows firm to use asset without owning
Lessee:
- lower down payment
- lower sales tax
- under warranty
- greater flexibility - obsolescence
- newer styles
Lessor: (always owner)
- increases sales
- maintain long-term relationship
- knowledge of customers trade in
Types of Leases
1) Operating: doesn’t convey “most” of benefits/costs of owning asset
2) Capital: lessee obtains “most” or all benefits/costs of owning asset under lease
Capital/Operating Lease Criteria
1) Title/Ownership transfer
(installment purchase)
2) Bargain purchase option
(lessee purchases asset for less than est. FV @ end of term)
3) Lease term > = 75% of leased asset’s remaining life @ inception
- useful life of asset when new = 10 yrs
- after 3 yrs, asset leased for 6 yrs, criteria 3 met: 6/7 > 75%
4) PV of lease payments =/> 90% FV of asset @ inception
EX: lease asset FV $45,000 & 5 yr lease term
Annual lease yr-end payment = $11,000
Lessor implicit rate 10% = 3.79 PV factor
Lessee’s borrowing rate 9% = 3.89 PV factor
Use lower rate = 9% (3.89 PV factor)
= 3.89 X $11,000 = $42,790 PV of min. lease payment
= $42,790 / $45,000 = 95% > 90% = YES CAPITAL LEASE
*If any one of these criteria is met = Capital Lease, if not -> Operating Lease
2 Additional Criteria for Capital Lease for the Lessor (1 above + 2 additional = 3 criteria in total must be met)
1) lease payments are collectible (realizable)
2) no material cost uncertainties for the lessor (guarantee against obsolescence)
Acct for Operating Leases
Accted as rental agreements, with no transfer of effective ownership associated with lease, lessor records rent revenue & carries asset on its books
*improvements not capitalized/debited to leasehold improvements and amortized over remaining lease term/useful life, whichever shorter
Acct for Capital Leases
Accted as if lease agreement transfers ownership of asset from lessor to lessee
Operating Lease Acct Details
Annual Rent Exp/Rev
Avg rental per period used for expense/revenue recognition
Annual rent expense/revenue =
(1) total rentals (excluding damage deposits/amounts paid for other services) / (2) lease term in years
* total rentals include bonus payments/free periods
* leasehold improvements capitalized as intangible asset
Damage Deposit
noncurrent receivable (lessee) and liab (lessor)
Leasehold Improvements Acct
Lessee improves the leased space
Rules:
- capitalized to a “leasehold improvement” asset acct
- amortized over shorter of 1) remaining lease term or 2) useful life of improvement
- improvements made in place of rent expensed in period incurred
- if lease contains option to renew and it unlikely to renew, the improvement is amortized over original life of lease term/useful life - whichever is less
- amort expenses = separate from lease/rent exp
How is depreciation recorded by the lessee in an operating lease?
Lessee has no asset on books to depreciate
Lessor depreciates asset over economic life
How is depreciation recorded by the lessor in a capital lease?
Lessor has no asset on book to depreciate
true/false
operating leases, rent expense is recognized on a straight-line basis unless the lessee is receiving benefits from the leased asset in some other manner. This is true even if the payment schedule is uneven
true
true/false
The security deposit is never expensed because it will be returned at the end of the lease. The amount is carried in a long-term receivable
true
true/false
Thus, the lessor should recognize interest revenue rather than rent revenue (which would be recognized under an operating lease). Each lease payment includes principal and interest. Therefore, a lower principal balance exists at the beginning of 2005 than at the beginning of 2004 because more principal would have been paid off by the time the 2005 payments were made.
true
Inception of lease
Lease term
Executory costs
Beginning of lease term
period lease is expected to cover, including:
1) fixed non-cancelable portion
2) periods covered by bargain renewal options
Insurance, maintenance, property taxes -> expensed by:
- lessor in operating lease
- lessee in capital lease
Minimum Lease payments
expected to be made under lease including:
- annual lease (rental) payments
- rental payments under bargain renewal
- BPO
- guaranteed residual value
*used in lease capitalization (PV = >/= 90% of FV)
Lessor’s implicit interest %
Lessee’s incremental borrowing %
Lessee’s interest %
rate earned by lessor on lease
- rate = PV of min. lease payments + unguaranteed residual value with asset’s FV
- unguaranteed resid. value not in min lease payment, part of total value to lessor*
rate on similar debt
criterion#4 - PV >/= 90% of FV
- Lower of: 1) lessor’s implicit rate
OR: 2) lessee’s incremental borrowing rate
*interest rates may differ, use lower rate in PV calculations
two classifications of capital leases for the lessor
1) direct-financing
2) sales type
*lease type affects ONLY lessor
rate is the lessor required to use to calculate the present value in a capital lease?
interest rate implicit in lease
Determine Direct Financing or Sales Type Lease
DFL:
- leased asset BV = FV
STL:
- leased asset BV doesn’t = FV
- lessor earns:
1) immediately: gross margin (FV - BV)
2) interest over lease term
*inception = different for DFL & STL
Direct Financing Lease
Inception J/E
2 types: 1) gross 2) net
Lessor Acct
1) Gross Method
DR: Lease Receivable (total min lease payment)
CR: Unearned Interest (contra-receivable)
CR: Asset @ Cost/BV
2) Net Method
DR: Lease Receivable (net)
CR: Asset
Sales Type Lease
Inception J/E
DR: Lease Receivable (sum of lease payments)
DR: COGS (asset BV)
CR: Unearned Interest (total interest over life)
CR: Asset
CR: Sales
basis for the lessor’s computation of periodic interest revenue?
beginning net lease receivable for period
two ways to compute net lease receivable under the gross method
1) gross lease receivable - unearned interest
2) PV of remaining lease payments
rate is the lessee required to use to calculate the present value in a capital lease?
Lower of implicit rate or incremental borrowing rate
What amount of revenue is recognized by the lessor on a direct financing lease (DFL)?
interest revenue only
contra account for lessor using the gross method?
unearned interest
true/false
In a capital lease, the lessor no longer has a physical asset to depreciate. The lessee depreciates the asset, assuming it is capitalized by the lessee
true
true/false
net lease receivable initial balance is the present value of the minimum lease payments (payments expected to be received under the lease) plus the present value of the residual at the end of the lease term. The value used for the residual (before discounting) is the estimated fair value of the asset at the end of the lease term, not the end of the asset’s useful life
true
true/false
Total interest over the term equals the difference between total lease payments and the fair value of the property at inception
true
IFRS - Lease Criteria
Must meet 1 criteria = capital lease
1) title transfer
2) BPO
3) term = major portion of remaining life of asset
4) PV of min. lease payments = substantially ALL of FV of asset
5) asset under lease = specialized/unique such that only the specific lessee can use it w/o major modification
income is derived from a sales-type lease for the lessor?
1) interest revenue
2) gross profit
amount is the lease payment based on for a simple sales-type lease?
FV of asset leased
effect of a sales-type lease on a lessor’s pretax income over the lease term?
Increase by total interest (sum of lease payments less fair value of asset) + gross profit (asset FV - asset BV)
true/false
first payment, which is made at inception, is completely a principal payment because no time has elapsed in the lease term. Thus, the entire payment is applied to principal and reduces the lease liability by the amount of the payment.
true
true/false
For all capital leases, the lessor uses the effective interest method to compute interest over the period of the lease. The interest revenue recognized each period equals the interest rate implicit in the lease multiplied by the beginning net lease receivable.
true
unguaranted residual value& Sales Lease
this portion isn’t sold
- PV of value s subtracted from Sales/COGS
- Sales/COGS reduced by same amount/no effect on net income
Capital lease & land
- apply only to criterion 1 & 2
- no depre. exp by lessee
Land & Building, criteria 1/2 met
- lessee separates leases based on FV
- lessor has 1 lease
Land & Building, neither 1/2 met
- land FV = 25% of total FV: separate leases, land = operating lease
Capital Lease - Executory costs*****
lease payments include:
1) insurance
2) maintenance costs
3) taxes
- executory costs are NOT included in min. lease payments*
- subtract from lease payments before capitalizing lease payment - expensed by lessee
Initial Direct Costs
incurred by lessor negotiating/completing lease
Operating Lease: lessor capitalizes/amortizes costs to expense in proportion to revenue
STL: recognize immediately as selling expense
DFL: no separate acct, treat as reduction in receivable
*total interest revenue reduced by costs
Contingent Rentals
Changes in lease payments (increase/decrease) result from future event
ex: contingent on future sales by lessee or changes in inflation
Contingent rentals
ACCT
recognized as expense (lessee)/revenue (lessor) as occur
- not used in rent expense/revenue computation for operating leases
- no included in min. lease payments
4 important items to consider concerning leases
1) BPO
2) unguaranteed residual (residual value @ end of term)
3) lessee guarantee of residual
4) 3rd party guarantee of residual (insurance company/other financial institution)
BPO
included in min lease payments
Therefore, it’s capitalized, included in:
- leased asset/liab @ PV (lessee)
- gross lease receivable @ nominal value (lessor)
- net lease receivable @ PV (lessor)
Unguaranteed residuals
excluded from min. lease payments
- not included in lessee’s accts
- included in gross lease receivable @ nominal value (lessor)
- included in net lease receivable @ PV (lessor)
Lessee Guarantee
Part of the lease
- included in min. lease payments for both parties
- inlcuded in leased asset/liab @ PV (lessee)
- included in gross lease receivable @ nominal value
3rd party guarantee
lessee not involved with guarantee
Excluded from lessee min. lease payments
Included in lessee min. lease payments and accts FOR LESSOR
Depreciation
based on initial capitalized amount @ inception
- if criterion 1/2 met, asset remains with lessee after lease term
lessee uses:
1) useful life of asset @ inception
2) residual value @ end of asset’s life
- if criterion 3/4 met, neither 1/2 met, asset returns to lessor @ end of lease term
lessee uses:
1) lease term
2) no residual unless lessee guarantee (guarantee used for residual)
Under BPO, what amount capitalized by lessee?
Sum of PV lease payments + PV of BPO
Under STL with unguaranteed residual, total interest revenue recognized?
Sum of lease payments + unguaranteed residual (nominal) less asset FV
Initial recorded amount for lease receivable under gross method for lease with lessee guarantee of residual value?
Sum of lease payments + less guarantee
two ways of computing the current portion of a lease liability.
1) PV of next payment
2) change in total lease liab for year following balance sheet date
two ways of describing the amount of sales revenue recognized when the lessor capitalizes a sales-type lease with a bargain purchase option
1) Sum of PV lease payments + BPO PV
2) FV of asset sold
amount is capitalized by a lessee when the lessee guarantees residual value at the end of the term?
Sum of PV of lease payments + PV of guaranteed amount
amount should be recorded for sales for a sales-type lease with an unguaranteed residual?
Asset FV - PV of unguaranteed residual
initial recorded amount for a lease receivable under the gross method for a lease with bargain purchase option (BPO)?
Sum of all payments + BPO
true/false
Depreciation on a capital lease for which the title to the asset transfers to the lessee is the initial capitalized cost less residual value at the end of the asset’s life, all divided by the useful life of the asset.
True motherfucker
Sales Leaseback
Owner of asset sells it/immediately leases back
- provides instant capital w/o losing asset use
- owner-seller becomes borrower-lessee, and uses leasing for financing
- affects only lessee, and only recognition of gain/loss on sale
*issues of inflation/deflation
Major Leaseback, gain
- lessess wants to retain FULL use of asset
- PV of min pease pymt >/= 90% of FV
- gain on sale = deferred/recognized over lease
Major Leaseback Gain - types
Capital lease:
- defer & classify gain as contra-leased asset account
- amortize contra account reducing depreciation expense
Operating lease:
- defer & classify gain as liability account
- amortize liability as reduction in rent expense
Lessee - Capital Lease Depreciation
Meets Criteria 1/2:
depreciate asset based on useful life of asset AND account for residual value as salvage value
Meets Criteria 3/4:
depreciate asset based on lease term AND account for residual value as either guaranteed/unguaranteed residual
deferral of gain on a lease transaction when the seller does not maintain total use of the asset
When PV of lease pymt 10%
rule regarding deferral of gain in a sale-leaseback for an operating lease
1) Lessee records the gain in a deferred credit
2) amortizes the deferred gain over the lease term by reducing the recorded rent expense in proportion to the amount of rent expense recognized
situation in which there is no deferral of gain when seller/lessee retains only minor use?
PV lease pymts = 10%/- of FV asset, -> no gain/loss deferred
rule regarding deferral of gain in a sale-leaseback for a capital lease
1) Lessee will record the gain as an asset valuation allowance account (contra to the leased asset)
2) amortize the deferred gain over the lease term by reducing the recorded depreciation expense
exceptions to the general rule of deferring gains on sale-leaseback transactions
1) Seller/lessee retains a minor portion of the use of the asset
2) Seller/lessee does not retain all use of an asset.
