Leases Flashcards
Capital lease entries:
Lessee side:
Leased asset (bldg). 1000 Lease liability. 1000
Lessor side:
What’s the Definition of Capital Lease?
A lease that transfers the risks and rewards of the ownership to the lessee. The lessee places the asset and a lease liability on its books and recognizes interest expense and depreciation over the lease term. The lessor removes the asset from its books, replaces it with a financial asset, and recognizes interest revenue over the lease term.
Most important rule to remember for operating leases.
Rent expense and revenue are recognized on a straight-line basis, without regard to the schedule of rental payments.
Lease expense/revenue Formula:
Annual rent Exp. or Rev. = Total rentals over the lease term / # of years in lease term
How are leasehold improvements treated under the operating lease accounting?
They are capitalized by the lessee and depreciated over the shorter of either the lease duration or the useful life of the improvement. If the renewal of lease is more likely than not, then include the renewal period as well when depreciating the leasehold improvements.
This is treated as an expense separate from rent expense.
What happens if criteria 1 & 2 are met in a capital lease to residual value calculation?
If criteria 1&2 are met then lessee retains the asset at the end of the lease term. There’s no residual to the lessor at the end of lease term.
However, if only one or both criteria 3&4 are met, but not 1 or 2, then the asset reverts to the lessor. The lessor obtains the residual at the end of the term, which becomes important to the accounting. The residual can be (a) Unguaranteed (b) Guaranteed by lessee, or (c) guaranteed by third party.
Lease equation where either BPO or residual is involved.
Market or fair value of asset under lease at inception =
PV of annual lease pmts. + PV of a single pmt
PV of single payment is either the residual value or BPO, but not both because they both cannot occur in the same situation.
Is Un-guaranteed residual included in minimum lease payments of the lessee or lessor?
Although the un-guaranteed residual is not included in any party’s minimum lease payment calculation, it is part of the return to the lessor. The larger the residual the smaller the lease payments.
If criteria 2,3,&4 are met can the asset be depreciated over its useful life?
Nope! Even though the BPO is there and the lessee should be able to depreciate it over the useful life but the trick is “Useful life or lease term whichever is shorter”. Why because it’s the useful life at the inception of the lease because what if the asset had been in use prior to lease and it’s useful life is now less
Treatment of un-guaranteed residual
Un-guaranteed residual is included in gross lease receivable at $10,000, and in net lease receivable at present value.
$10,000 is just an example amount, the concern here is that it’s not present valued when included in gross lease amount but it is present valued in net lease receivable. So be very careful.
How is a sale leaseback classified?
If it meets the 4 criteria, then it’s a capital lease and if not then it’s an operating lease.
How is the gain/loss recognized on sale leaseback?
It’s deferred if the transaction is in substance a lease not a sale and the PV of minimum lease payments are greater than 90% of fair value of the asset. If not then the gain is immediately recognized. Real losses are always recognized immediately.
Info on the side:
If sale price is higher than FMV of the asset, the difference will be returned to lessor in the form of higher rental payments. If it’s lower than the FMV of the asset, then the rentals will be reduced.
If the leaseback is a capital lease, how is gain recorded?
The gain is recorded in a contra-leased asset account and amortized as a reduction depreciation expense in the same proportion as depreciation expense is recognized. The gain is thus recognized gradually over the lease term.
If the leaseback is an operating lease, how is gain recorded?
The gain is recorded in a liability account and amortized as reduction in rent expense.
Treatment of gain - less than major but more than minor leaseback.
If the sake price and FMV if the asset is $900,000 and the book value or carrying value is $300,000 and the PV of the minimum lease payments is $450,000, then the portion of the $600,000 gain upto the PV of minimum lease payments is deferred and the remaining portion is recognized immediately. So upto $450,000 is deferred and $150,000 is recognized immediately.
Treatment on losses - real or artificial
A loss occurs when FMV is less than BV.
Real losses are recognized immediately.
Artificial loss would occur when the asset is willingly undersold at a price which is less than fair value. For example the asset was on books at $10,000 and the FMV was $12,000. We clearly had a gain of $2,000 but we still sold it at $8,000, at a loss of $2,000. This is an artificial loss and it will be amortized over the duration of the lease term by an increase in depreciation expense for capital lease and an increase in rent expense if operating lease.
If the asset was on books at $12,000 and the FMV was $10,500, we clearly had a loss of $1,500. But we sold the asset at $10,000, at a price less than FMV. Then the natural loss if $1,500 will be recognized immediately and the artificial loss of $500 will be amortized over the lease term.
