Leases Flashcards
Which type of lease agreement substantially transfers all of the benefits and risks of ownership of the asset to the lessee?
Capital Lease
Which type of lease agreement has all of the benefits and risks of ownership of the asset retained by the lessor?
Operating Lease
Are any special journal entries required to record the operating lease?
No. The lease payments are expensed as incurred.
How does the lessee record a Capital Lease?
Capitalize at cost: Asset & Liability Recorded at Present Value of Minimum Future Lease Payments (using the lower of the lessee’s incremental borrowing rate or the rate implicit in the lease, if known by the lessee)
*Minimum lease payments include payments, bargain purchase option, and guaranteed residual value. They do not include executory costs or an optional purchase
What are the criteria for determining if a lease is a capital lease for the lessee?
The transaction must meet one or more of the following criteria:
1) Transfers Title – Lease transfers ownership of the property to the lessee by the end of the lease term
2) Bargain Purchase Option exists in the written lease
3) The noncancellable lease term is equal to 75% or more of the estimated economic life of the property at inception
4) Present Value of the minimum lease payments is equal to 90% or more of the FMV of the property at inception
The last two items are qualifying criteria as long as the asset is not in the last 25% of the orignial estimated life
**”TT – BPO – 75 – 90”
What type of lease is effectively a rental?
Operating Lease
What type of lease is effectively a purchase and financing agreement?
Capital Lease
Are assets under an operating lease depreciated? On what schedule?
Trick question! No transfer or claim to the asset exists, so therefore no depreciation is recognized.
Are assets under a capital lease depreciated? On what schedule/length?
Yes. If the asset will eventually be returned (ala 75% or 90% tests), then depreciate the asset at the shorter of their legal or useful lives. If the asset will be completely transferred for good (ala title transfer or BPO), then use the full useful life.
If the beginning of the lease term happens to fall within the last 25% of the asset’s useful life, what happens to the criteria for determining if the lease is a capital lease?
Neither the 75% or 90% tests are permitted for consideration, only the title transfer and BPO tests are permitted.
For a capital lease, if the lease criteria falls within the 75% or 90% tests, what depreciation schedule is used?
Depreciate the asset at the shorter of its legal or useful life
For a capital lease, if the lease criteria falls within the title transfer or BPO tests, what depreciation schedule is used?
Depreciate the asset for its useful (economic) life
For a capital lease, if the lease criteria falls within the 75% or 90% tests, is salvage value factored into the depreciation schedule?
Since ownership hasn’t been fully transferred, you will ignore salvage value.
For a capital lease, if the lease criteria falls within the title transfer or BPO tests, is salvage value factored into the depreciation schedule?
Since ownership has been fully transferred, you will “take out” salvage value.
What are the characteristics of a Noncancellable Lease Term?
1) Initial lease term
2) Bargain renewal periods
3) Penalty for nonrenewal
4) Bargain Purchase Option
With regard to the minimum lease payments for a capital lease, what do they include?
1) Base rent
2) Bargain Purchase Option
3) Penalties (when nonrenewal penalties are minimal)
4) Residual value (either guaranteed by lessee or by third party or unguaranteed)
Are contingent rents included in the minimum lease payments?
No, they are expensed as incurred
Are executory costs included in the minimum lease payments?
No, they are expensed as incurred
What are contingent rents?
Rents subject to the occurrence of some event in the future
What are executory costs?
Cost for taxes, insurance, and/or maintenance of leased property.
What value does the lessee record the capital lease at?
PV of the minimum lease payments not to exceed FMV
Are penalties for failing to renew the lease included in the PV of the minimum lease payments?
Yes
What rate is used to discount the PV of the minimum lease payments when (capital) leasing an asset?
The incremental borrowing rate UNLESS the lessor’s implicit rate is LOWER and the lessee KNOWS the lessor’s implicit rate.
What is the incremental borrowing rate?
The discount rate the lessee would pay in the lending market to purchase the leased asset
What two criteria are required for the lessor to not use the incremental borrowing rate for discounting the PV of the minimum lease payments?
“LOWER” and “KNOWN”
1) The lessor’s implicit rate is lower than the incremental borrowing rate – and –
2) The lessee knows the lessor’s lower implicit rate
What interest rate for capital leases is the same for both the lessor and lessee?
The implicit rate (if the rate is lower and known by the lessee)
Is straight-line amortization appropriate for capital leases?
No, like bonds, the effective interest is used.
What method of amortization is used for capital leases?
The effective interest method (just like bonds)
How does a capital lease’s recorded value differ from its reported value?
The recorded value is simply the initial value of the lease liability, whereas the reported value is effectively the carrying value of the lease (ala net of principal payments made to date)
Capital leases are typically long-term, but is there a current liability component? How is it recognized?
There is a current portion of the capital lease, which is recognized as the upcoming year’s lease amortization amount.
What are the major footnote disclosures required of the lessee for a Capital Lease?
1) Description of the entity’s leasing activities
2) Gross amount of assets capitalized via capital leases
3) Future minimum lease payments for each of the next 5 years and in the aggregate
**And technically the amount of imputed interest to reduce net minimum lease payments to present value
With regard to Capital Leases, what value can the present value of minimum lease payments not exceed?
The fair market value of the leased asset
From the perspective of the lessor, what are Capital Leases referred as?
Non-operating leases
What are the types of non-operating leases (for a lessor)?
1) Sale-type lease
2) Direct-financing lease
If the lessee recognizes a capital lease on their books, does the lessor always recognize a capital lease on their books?
No, unless all criteria are satisfied, the lessor might still recognize the lease as an operating lease on their books.
What are the requirements for a Capital Lease for a lessor?
Same as for lessee, with at least one of the four (TT, BPO, 75% or 90%) - PLUS BOTH of:
1) Collectability of lease payments is predictable (reasonably assured)
2) Measurable: Uncertainties do not exist regarding any unreimbursable costs to be incurred by the lessor
What journal entry recognizes a sales-type lease for a lessor?
Dr. Lease Payment Receivable (Gross lease investment)
Cr. Sales Revenue (plug)
Cr. Unearned Interest Revenue (contra to gross investment)
Dr. COGS
Cr. Asset being parted with
What method of amortization is used for sales-type leases?
Effective interest method
How does a direct financing lease differ from a sales-type lease?
The direct-financing lease will only earn interest income, while the sales-type lease earns a profit/loss in addition to the interest income
When leases involve land only, what are the criteria for the lessee in determining if it is a capital lease?
1) Title transfer – OR
2) BPO
Is the 75% of useful life criteria applicable to determining whether a land lease is a capital lease?
No! Land is deemed to have an infinite, indefinite, or at a minimum indeterminable lifespan so the 75% of useful criteria cannot be satisfied.
When leases involve both land and building and the fair value of the land
The lease will be treated solely as a building lease, as long as EITHER transfer of title or BPO criteria are met, otherwise it will be treated as a single operating lease.
When leases involve both land and building and the fair value of the land > 25%, does the lessee capitalize them together or separately?
As long as EITHER the transfer of title or BPO criteria are met, they will be treated SEPARATELY, otherwise, it will treated as a single operating lease.
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.
What are leasehold improvements and how are they accounted for?
Leasehold Improvements are improvements that:Are made by a lessee to a building or property that the lessee is leasing. Cannot be removed by the lessee when the lease period is over. The cost of leasehold improvements should be amortized over the shorter of the remaining lease term or the useful life of the improvements.
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
Is a sale-leaseback treated as one or two transactions?
It is treated as two separate transactions: a sale, then a leaseback
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 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
In a sale-leaseback when a deferred gain is recognized and the PV of of rental payments is >10%, how is this deferred gain treated?
The deferred gain is straight-line amortized over the lease term, which offsets against any depreciation or rent expense incurred during that time.
Dr. Deferred gain
Cr. Expense type (depreciation if capital, or rent if operating)
*notice both are contra elements
In a sale-leaseback when a deferred gain is recognized and the PV of rental payments is
Since the seller retains only a minor/trivial portion of the rights to use the property, the ENTIRE gain is recognized IMMEDIATELY.
If a capital lease is converted to an operating lease, how this treated?
As a sale-leaseback
In a sale-leaseback where a loss has been realized between the book value and fair value, is this recognized? How?
Yes, and it is recognized immediately (as opposed to amortized)
In a sale-leaseback how is an incurred loss between the sales price and fair value treated?
Amortized as an addition to rent expense
Under IFRS, what are operating and capital leases known as?
Operating and “FINANCING” leases
Under IFRS, what is the general criteria for distinguishing between an operating and a capital lease?
If the risks and rewards of ownership are transferred, it’s a finance (capital) lease, otherwise it’s an operating
For IFRS, what is the useful life test for a capital lease?
For a FINANCING lease, the lease term is for the MAJOR PART of the asset’s useful life
For IFRS, what is the PV of minimum lease payments test for a capital lease?
For a FINANCING lease, the present value of the minimum lease payments is SUBSTANTIALLY EQUAL to the fair value of the asset
If a lease qualifies as a capital lease under GAAP, would it qualify as a capital (finance) lease under IFRS?
Yes
Under IFRS, can previously recognized impairment losses be recovered?
Yes
Under IFRS, what is the criteria for evaluating a lease of land and building?
They are considered separate leases, unless the value for the land element is immaterial
