Leases

Question 1

What does OWNES stand for?

Answer 1

For a lessee to account for a lease as a finance lease under U.S. GAAP, the terms of the lease must meet at least one of the finance lease criteria. There are 5 criteria and only one criteria has to be met in order to capitalize.

1) Ownership transfers at the end of the lease
2) Written purchase option the lessee is reasonably certain to exercise
3) PV of minimum lease payments = FV of asset (approx. 90% of FV of leased property)
4) Lease term = Major part (75%) of asset useful life
5) Asset is specialized such that it has no alternative use to the lessor

Question 2

How is amortization of leasehold improvements calculated?

Answer 2

The leasehold improvements should be amortized over the lesser of the remaining lease term or the life of the improvements.

Question 3

If any one of the OWNES criteria are met, how is the lease classified by the lessee and lessor?

Answer 3

The lease will be classified as a finance “capital” lease by the lessee and a sales-type lease by the lessor.

Note - Not capitalized if term is “short term” (less than 12 months)

Question 4

If the OWNES criteria is not met, how is the lease classified by the lessor?

Hint: PC

Answer 4

For the lessor, if none of the OWNES criteria are met, but both of the PC criteria are met, then it’s a direct financing lease.

If none of the OWNES criteria are met, and either one or no PC criteria are met, then it’s an operating lease.

PC:

1) Present value of the sum of the lease payments, lessee guaranteed residual value not included in the lease payments, and any third-party guaranteed residual value is equal to or substantially exceeds the underlying asset’s fair value
2) Collection of the lease payments and any amounts necessary to satisfy residual value guarantees is probable.

When both of the criteria above are met, the lessor will classify the lease as a direct financing lease.

If only one or neither are met, the lessor will classify the lease as operating.

Question 5

In the calculation of the lease payments, the lessee with include all of the following:

Answer 5

REPORTS

Question 6

Under a sales-type (finance) lease, how does the lessee, using straight-line depreciation, recognize depreciation on the equipment in the current year?

Answer 6

The lessee records the lease as an asset and a liability at the present value of the minimum lease payments. The lease should be depreciated (amortized) over the lease term if the lessee does not take ownership of the asset by the end of the lease or if there is not a written purchase option.

Question 7

How is a finance lease recorded for the lessee?

Answer 7

Finance leases should be recorded as both an asset and liability at the present value of the minimum lease payments. The asset is depreciated. The liability is amortized using the interest method. Each payment is allocated between principal and interest. The liability is reduced by the amount of principal reduction. The lease liability should be segregated between current (due within one year) and non-current (due beyond one year). Accordingly, the reduction in lease liability each year is equal to the current liability at the end of the previous year.