leases Flashcards
why are you forced to recognized lease assets on the BS?
Leaving leased assets off the balance sheet means that firms that lease, rather than own, show higher profitability ratios and lower financial leverage (both of which are generally desirable).
To address the problem, both the IASB and the FASB have created rules that require lessees to capitalize leases, i.e., to account for their leases as if they were purchases.
how are lease assets initially recognized on the BS? which leases are exempt from being shown on the bs?
At the inception of the lease, the lessee recognizes on its balance sheet
the lease asset (or right-of-use asset), valued at the present value of the future lease payments; and
a lease obligation liability equal to the lease asset value. (The only exception is leases of low value or short duration, whose costs may be expensed as incurred, without balance sheet recognition.)
what is the difference between operating and finance lease? are these rules applicable under IFRS or US GAAP?
Under US GAAP, a lease is considered a finance lease if at least one of the following criteria is met (and is considered an operating lease otherwise):
title to the asset transfers to the lessee at the end of the lease term; or
the lessee may purchase the asset at a low price at the end of the lease (bargain purchase option); or
the lease term covers the major part of the lease asset’s useful life; or
the present value of the minimum lease payments is close to the fair value of the lease asset; or
the lease asset is so specific that only the lessee can use it without major modifications.
what are periodic expenses under a financing lease?
In a finance lease, the lessee recognizes, in each period of the lease term,
depreciation (or amortization) expense on the lease asset; and
interest expense on the lease obligation.
The difference between interest expense and lease payments reduces the lease obligation.
which rate is used to discount the payments of a financing lease?
The interest (discount) rate is either
the implicit rate, i.e., the one that equates the present value of lease payments plus residual value to the fair value of the asset; or
the lessee’s marginal borrowing rate (if no implicit rate can be found).
how are operating leases accounted for?
In an operating lease, the lessee
periodically reduces both the lease asset and obligation by an amount such that the obligation equals the present value of the remaining lease payments at the end of each period; and
records periodic lease expense according to a straight-line allocation of the total lease payments over the lease term.
Temporary differences between lease payments and expenses are debited or credited to the lease asset.
