Leases Flashcards
How is a Capital Lease recorded?
Capitalize at cost: Asset & Liability Recorded at Present Value of Future Lease Payments
What footnote disclosures are required for a Capital Lease?
Future minimum rental commitments by year - for 5 years
And the total in aggregate
What are the requirements for a lease to be a Capital Lease?
Same for Lessee and Lessor:
(TT, BPO 75 of life or a 90% FMV- Substance) PLUS:
Collectability of lease payments is predictable
No uncertainties about the lessor reimbursing the lessee for costs incurred
What are the characteristics of an Operating Lease for a lessee?
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.
If payments fluctuate over the term of the lease - rent expense recognized on a straight line basis
What are the characteristics of an Operating Lease for a LESSOR?
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
What are the characteristics of a Direct Financing Lease?
Interest Revenue (or expense for lessor) decreases with passage of time
Principal amount increases with each payment
Carrying amount of Lease decreases
How is a sale-leaseback recorded?
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 recognizedIf 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
What are the characteristics of lease payments under an annuity due situation?
Payments begin at the start of the lease period
Think: Rent/Mortgage payments are Due at the first of the month
What are the characteristics of lease payments under an ordinary annuity situation?
Payments begin after the end of the first year
Think: An annuity that pays you at the end of each year
What are the characteristics of a Capital Lease for a lessee?
Risk of ownership passes to lessee by:
TT, BPO, 75% of leased property’s life, or PV of MLP is 90% or more of the FMV of the property at inception
“TT ,BPO,75 or a 90”
In a capital lease, what are the journal entries to be recorded by Lessee?
1) Record Lease at the PV of Minimum Lease Payments:
Leased Asset XX
Leased Liability XX
2) Record the 1st payment (day 1)
Lease Liability XX
Cash XX
3) Record the 2nd payment (year 2)
Lease Liability XX
Interest Expense XX
Cash XX
4) Depreciation:
Depreciation Expense XX
A/D XX
How is the value of the leased asset calculated by a Lessee?
Lower of:
FMV (a new implicit interest rate must be calculated)
PV of Minimum Lease Payments
How does a Lessee PV the Lease Payments?
Use “Incremental Borrowing Rate” - Discount rate the lessee would pay in the lending market to purchase the leased asset
UNLESS BOTH:
1) Lessee knows the lessor’s implicit rate AND
2) Implicit Rate is lower than the incremental borrowing rt
How does a Lessor PV the Lease Payments
Always uses the implicit rate in the lease
How are Capital Leases amortized?
Effect Interest Method
Lease Liability (unamortized) x Implicit or Incremental rate = Interest Expense
- Lease Payment (fixed)
=Amortization of Lease Liability
Same way you amortize Discounts/Premiums in Bonds
What is included in calculating the PV of a Lease Payment?
- Annual Payment
- BPO as a Lump Sum
- Guaranteed Residual Value as a Lump Sum
How are the executory costs of leases recorded?
Expensed as incurred
In a Capital Lease, what are the two criteria that must be met for a Lessor to record a Sales-Type Lease or Direct Financing Lease?
1) Collectabilty of the lease payments is reasonably assured
2) No significant uncertainties regarding reimbursable costs to be incurred by Lessor
What is a sales-type lease?
A lease where the seller is a manufacturer or dealer of the asset, and uses the lease as a way of selling the asset on an installment basis.
The FV of the leased property differs from the cost, which creates a dealer’s profit or loss
Includes: Profit/Loss in period of sales AND Interest Revenue to be earned
What is a Direct Financing Lease?
A lease where equipment is not acquired by purchasing it but instead by entering into a lease agreement with the leasing company
Differs from a Sales-Type Lease in that only Interest Income arises - no profit or loss
What is a Sale-Leaseback?
The property owner sells the property, then immediately leases all or part of it back from the new owner.
Considered 2 separate and distinct economic transactions.
Either an operating lease or a Capital Lease
When is a Sale-Leaseback considered an Operating Lease or a Capital Lease?
If PV of Rental Payments:
>90% of FV of property = Capital Lease
>10% and <90% of FV of property = Operating Lease
Capital Sales Leaseback:
Gain or Loss is deferred and amortized over the period as a reduction to depreciation expense
Depreciation Expense 50
A/D 50
Deferred Gain 20
Depreciation Expense 20
Operating Sales Leaseback
Gain or Loss is deferred and amortized over the lease term as a reduction to rent expense
Rent Expense 50
Cash 50
Deferred Gain 20
Rent Expense 20
If there is a change in the provisions of a capital lease that gives rise to a new agreement classified as an operating lease - how should this lease now be classified?
Sale Leaseback Requirements
When do you use the lease life vs the lease’s useful life in recording depreciation under a capital lease?
When the criteria of 75/90 is met - lease life
When the criteria of BPO/TT is met - asset’s useful life
If both met - lessor of the 2
Under an operating lease, what does the lessee record as a liability at the time the lease is initiated?
What does the lessee record on the income statement on an annual basis?
No liability is recorded
Rent expense is recorded annually throughout the lease life
Under a capital lease, what does the lessee record as a liability at the time the lease is initiated?
What does the lessee record on the income statement on an annual basis?
The liability is the present value of the minimum lease payments
Depreciation and interest expense are recorded on an annual basis. Once the lease expires, if the lessee takes over ownership (TT/BPO) the asset continues to be depreciated.
