Leases

Question 1

How is a Capital Lease recorded?

Answer 1

Capitalize at cost: Asset & Liability Recorded at Present Value of Future Lease Payments

Question 2

What footnote disclosures are required for a Capital Lease?

Answer 2

Future minimum rental commitments

By year - for 5 years

All remaining years as a group

Question 3

What are the requirements for a Capital Lease for a lessor?

Answer 3

Same as for lessee (Title- BPO or Substance)- PLUS:

Collectability of lease payments is predictable

No uncertainties about the lessor reimbursing the lessee for costs incurred

Question 4

What are the characteristics of an Operating Lease for a lessee?

Answer 4

Risk of ownership does NOT pass

No asset or liability is recorded on the financial statements

Leasehold improvements - capitalized and depreciated over the lesser of lease life or leasehold improvement’s life.

Question 5

What are the characteristics of an Operating Lease for a LESSOR?

Answer 5

Rent revenue recorded

Leased property remains an asset and depreciated by lessor

If payments fluctuate over the term of the lease- rent revenue recognized on a straight line basis

Question 6

What are the characteristics of a Direct Financing Lease VS Sales type lease?
Pg. 11-1

Answer 6

Interest Revenue (or expense for lessor) decreases with passage of timePrincipal amount increases with each paymentCarrying amount of Lease decreases; only interest income arises => there is no manufacturers or dealer’s profit

A lease where the seller is a munufacturer or dealer of the asset, and uses the lease as a way of selling the asset on an installment basis

Question 7

How is a sale-leaseback recorded?

Answer 7

Any profit on the sale is deferred and amortized

Exception: If PV of lease payments is 10% or less of the asset’s FMV- the gain is recognized

If PV of lease payments is greater than 10% of FMV and the lease is operating- all of the gain is recognized except the amount of the PV of the lease payments

Question 8

What are the characteristics of lease payments under an annuity due situation?

Answer 8

Payments begin at the start of the lease period

Think: Rent/Mortgage payments are Due at the first of the month

Question 9

What are the characteristics of lease payments under an ordinary annuity situation?

Answer 9

Payments begin after the end of the first year

Think: An annuity that pays you at the end of each year

Question 10

What are the characteristics of a Capital Lease for a lessee? Pg. 11-3

Answer 10

Risk of ownership passes to lessee by:Title,Bargain Purchase Option (BPO),Substance - Lease is more than 75% of asset’s useful life or PV of minimum lease payments are more than 90% of fair value

Question 11

Sale-leaseback Pg. 11-6 How do you determine… and what do you defer?

a) Capital leaseback
b) Operating leaseback or Capital leaseback
c) Operating leaseback

Answer 11

a) PV of rental payments is greater than or equal to 90% FV of the property; defer all gain and offset against depreciation expense
b) PV of rental payment is >10% but < 90% of FV; defer all gain and offset against depreciation expense if capital lease, or offset against rent expense if operating
c) If PV of rental payments is <10% of FV; offset against rent expense; deferred gain will be ZERO

Question 12

Who ALWAYS uses the rate implicit in the lease? Pg. 11-3

Answer 12

The lessor

Question 13

What is the most important when using the amortization of lease liability table? Pg. 11-4

Answer 13

Look at when interest was paid; if it is immediately, then you should subtract the minimum lease payment immediately

Question 14

What if land is <25% FV compared to land and building, then it is considered NOT significant, therefore what should happen?

Answer 14

It would be accounted for like building

Question 15

How do find the revenue when rent is free for the first 6 months?

Answer 15

Find the total revenue for the whole lease then divide by how long the lease term is

Question 16

For leaseback problems, how do you find the gain on the sale of equipment? Pg. 11-6

What if the PV of the total lease payment is <10% of FV of item?

Answer 16

Get the gain, then depreciate it; DO NOT do it for losses

There is NO gain

Question 17

How do you approach a lease problem?

Answer 17

Think lease car payments

Think of the amortization table; the first column (lease liability) should be the lease payment that is present valued!!!

If you made the the payment when you started the lease, there wouldn’t be any interest for that time frame

Question 18

In a lease, what is the significance of the amortization of a lease? Think of amortization table?

Answer 18

It reduces the lease liability, and the lease liability will eventually turn to zero is it gets paid off

Question 19

How would you treat a sale leaseback? Pg. 11-6

a) PV rental payments is greater than or equal to 90% of FV of the property
b) PV of rental payments is greater than 10% but less than 90%
c) PV of rental payments is less than or equal to 10%

Answer 19

First find the gain, then depreciate the gain; make sure you classify them as a capital leaseback, operating, or minor => look at PV of payment in comparision to sales price

a) Capital: defer all gain and offset against depreciation expense
b) Operating or Capital
c) Minor: recognize all gain immediately