Financial 6 - Leases

Question 1

Criteria for a Finance Lease

Answer 1

Under US GAAP, the terms of the lease must meet any one of the finance lease criteria (OWNES):

1. Ownership transfers at the end of the lease
2. Written purchase option the lessee is reasonably certain to exercise
3. PV of minimum lease payments = FV of Asset (approximately 90% of FV leased property)
4. Lease term is >= a Major part (75%) of useful life of leased property
5. Asset is specialized such that it has no alternative use to the lessor

When a lease is capitalized, the lessee reports the leased asset as an asset and the lease obligation as a liability on the BS

**For a lessor, if any of the 5 OWNES criteria are met, they will treat the lease as a “Sales-type” Lease. Without meeting that criteria, the lessor must treat the lease as an Operating lease

Question 2

Sales-Leaseback Transaction

Answer 2

• GAAP requires that a loss be recorded immediately in a Sales-leaseback transaction when the FV of the property at the time of leaseback is less than BV. - Accordingly, the company will recognize a loss in the current year
• RULE: If the underlying lease in a sale-leaseback is a finance lease, it is considered equivalent to a repurchase and therefore be considered a “failed sale”

Question 3

Lease Receivable Computation

Answer 3

• Lessors recording a lease receivable for direct-financing lease should include the minimum lease payments PLUS any residual value.
• The reason is that the lessor can expect to collect this residual value from the lessee at the culmination of the lease

Question 4

Timing of Recognition of Leases (Revenue and Expenses)

Answer 4

** The lessee must begin the recognition of leases expenses at the commencement date of the lease.

The commencement date is the date the underlying asset is made available to the lessee for use

Question 5

Lease Expensing Rules

Answer 5

• When lease rates are fluctuating and when reduced costs are given, the average lease rate must be computed.

Must take total lease expense over the life and then divide by years of useful life to get average annual expense. Use this amount accordingly depending on the question