leases Flashcards
The first annual lease payment, paid on December 31, Year 4, consists of which of the following?
Under the effective-interest method, interest is recognized to account for a change in value due to the passage of time. Given that the first payment is made at the inception of the lease, no time has passed. Thus, the first payment reduces the lease liability, but no interest is recognized.
Finance lease
A lease is classified as a finance lease by the lessee, not the lessor, if the lease meets one of the five classification criteria.
Direct financing lease
The lessor classifies a lease as a direct financing lease only when (1) the lease is not a sales-type lease, (2) the PV 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 (90%) 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
Reduce the lease liability
A lease payment has two components: interest expense and the portion applied to the reduction of the lease liability. The effective-interest method requires that the carrying amount of the liability at the beginning of each interest period be multiplied by the appropriate interest rate to determine the interest expense. The difference between the lease payment and the interest expense is the amount of reduction in the carrying amount of the lease liability.
Finance lease liability, Net of current portion
First calculate the total lease liability (which is noncurrent portion + current portion). Each periodic lease payment made by the lessee has two components: interest expense and reduction of lease liability. After the Year 4 payment, which included the current portion, the lease liability was $75,000. Consequently, the Year 5 payment included interest of $7,500 ($75,000 carrying amount during Year 4 × 10% lessor’s implicit rate, which is known to the lessee and a principal component of $1,500 ($9,000 cash – $7,500 interest). The latter is the current portion of the lease liability on 12/31/Year 4. The finance lease liability at December 31, Year 4, net of current portion, is therefore $73,500 ($75,000 – $1,500)
What amount is the carrying value of the asset related to this lease at December 31 of the current year?
Tree Co. should record the finance lease as an asset and a liability at the present value of the lease payments, (Present value of lease payments+Present value of the purchase options). Contains a purchase option that the lessee is reasonably certain to exercise, the amortization of the asset is over its entire estimated economic life (i.e., 10 years). Using the straight-line amortization method, the right-of-use asset will be amortized at $7,000 ($70,000 ÷ 10 years) per year. The carrying value of the right-of-use asset on December 31 of the current year should be $63,000 ($70,000 – $7,000).
what is the appropriate subsequent accounting for, or presentation of, the right-of-use asset
The lease is classified as a finance lease by the lessee because a classification criterion is met. The present value of the sum of (1) the lease payments and (2) any residual value guaranteed by the lessee ($0) 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. When the lease (1) transfers ownership or (2) contains a purchase option reasonably expected to be exercised, amortization is over the useful life of the leased asset.
Should JCK recognize rent or interest revenue in Year 3, and should the revenue recognized in Year 3 be the same or smaller than the revenue recognized in Year 2?
JCK classifies the lease as a sales-type lease because the lease term is for the major part (80% = 8 years ÷ 10 years) of the remaining economic life of the leased equipment. 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. In a sale-type lease, each periodic lease payment received has two components: interest income and the reduction of the net investment in the lease. 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. The amount of interest income declines over the lease term. As the carrying amount of the investment in the lease decreases, the interest component of the periodic lease payment also decreases.
Sales-type lease
In a sales-type lease, the lease receivable recognized by the lessor at the commencement of the lease is measured at the present value of the lease payments plus the present value of residual value guaranteed by the lessee or any other third party. In sales-type leases, initial direct costs are expensed when the fair value of the leased asset differs from its carrying amount.
Answer (D) is correct.
In sales-type and direct financing leases, subsequent to the lease commencement date, each periodic cash payment received by the lessor includes both interest income and a reduction of the net investment in the lease. In an operating lease, lease payments are recognized as lease (rental) income by the lessor. If rental payments vary from a straight-line basis, rental income should be recognized over the full lease term on the straight-line basis. In a sales-type lease, selling profit or loss on the lease is calculated on the lease commencement date. In a direct-financing lease, no selling profit is recognized on the lease commencement date. Any selling profit is deferred and reduces the initial amount of the net investment in the lease.
