Leases

Question 1

What is the difference between a leasee and a leasor?

Answer 1

• Lessee - the one who uses the equipment ( Construction Company )
• • Lessor - the one who owns the equipment (CAT Dealer)

Question 2

What is the difference between a finance lease and an operating lease?

Answer 2

• Financing lease: asset ownership transfers over to leasee. Think of it as a way to FINANCE a piece of equipment.
  
  • Lessee capitalizes the asset, records a lease liability, and recognizes interest and amortzation over the term of the lease.
  • Lessor removes assets from its books and replaces it with a financial asset (lease receivable). Recognizes interest revenue over term of lease.
• Operating lease: does NOT transfer control/ownership. Think of it as OPERATING (renting) the piece of equipment.
  
  • Lessee capitalizes the ROU asset

Question 3

What are the journal entries for a short term lease?

Answer 3

DR Lease expense (rent expense)

CR Cash or A/P

Question 4

What are the lessee’s journal entries to record an operating lease?

Initial measurement, Lease Payment, and ROU Asset Amortization

Answer 4

• Initial measurement:
  
  • DR ROU Asset
    
    • CR Lease Liability
• Lease Payment:
  
  • DR: Lease Liability
    
    • CR: Cash
• ROU Asset Amortization
  
  • DR: Lease Expense (stated payment)
    
    • CR: ROU Asset (difference similar to principal)
    • CR: Lease liability (CV of lease liability x interest rate )
• NOTE: Lease expense, not interest expense on operating
• Effect of interest is not included until passage of time (end of year)

NOTE: ROU Asset decreases over time because it will not remain with lessor at lease termination

Question 5

How does the lessor recognize an operating lease?

Answer 5

• Asset remains on balance sheet (since ownership does NOT transfer)
• Recognize lease income on straight line basis
• Any up front costs received are consdiered deposit liability, amortize over time to recognize income
• Operating on Stmt of Cash Flows

Question 6

How do you calculate the lease liability on an operating lease ?

Answer 6

Annual payment x PV of annuity

Plus BPO or +GRV discounted at PV of a single sum

Question 7

What are the 5 criteria to determine if a lease is a finance lease?

Answer 7

If any one of criteria are met, then it is a finance lease

• P- Present Value of lease payments equals 90% of FV or exceeds Fair Value
• O - Option to purchase (bargain purchase at end of lease)
• E - Economic life - Lease term is 75% of Economic Life
• T - Transfer of Ownership
• S - Specialized in nature - there is no alternative use to lessor at end of term

From a lessor perspective this would either be a sales type lease

Question 8

What interest rate should be used in lease calculations? Implicit or incremental?

Answer 8

• Leasor will always use implicit
• Lessee will use lower of:
  
  • incremental borrowing rate
  • lessors implicit rate (if it is known to them)

Question 9

What are the lease journal entries for the lessee for a finance lease?

Initial Measurement, Lease Payment, ROU Amortization

Answer 9

• Initial measurement:
  
  • DR ROU Asset
    
    • CR Lease Liability
• Lease Payment:
  
  • DR: Interest Expense
  • DR: Lease Liability
    
    • CR: Cash
• ROU Asset Amortization
  
  • DR: ROU Asset Amortization (expense)
    
    • CR: ROU Asset
      *

Question 10

What are the two additional criterias for a lessor to consider a finance lease a direct financing lease?

Answer 10

• P - PV of the sum of payments plus 3rd party GRV is equal or greater than FMV of asset
• C - Collections of lease payment is certain
• Both must be met to be considered direct financing lease
• Typically residual value is guaranteed by a third party
• Recognize net investment in the lease. De-recognize the carrying value of the asset
• Recognize any selling loss immediately, but not selling profit.

Question 11

What is recognized upon commencement of a sales type lease?

Answer 11

• Net investment in lease (financial asset)
• selling profit or loss recognized immediately
• initial direct cost as expense
• de-recognize the carrying value of the asset
• Interest income is recognized over the term of the lease.

Question 12

What are IFRS differences for leases?

Answer 12

• Leases of assets less than $5,000 are exempt under IFRS.
• Lessor accounting—IFRS does not distinguish between direct-financing leases and sales-type leases.
• IFRS does not include explicit guidance on accounting for amounts required to satisfy guaranteed residual value.
• IFRS does not have explicit guidance on the collectability of lease payments.
• IFRS allows for alternative measurement of the right-of-use asset such as a fair value model as opposed to GAAP’s present value of the minimum lease payments approach.

Question 13

What are the required lease disclosures ?

Answer 13

• Description of lease arrangements
• Cost of shor term and operating leases
• Future minimum lease payments for the next 5 years
• Infomation on lease receivables, rent expense, gross amount of assets under lease.

Question 14

How are initial direct costs treated for different type of leases?

For Lessee, for Lessor - sales type or operating

Answer 14

Lessee:

• Include initial direct costs in ROU asset
• Exclude cost from the ROU liability

Lessor:

• Sales type lease - expense at inception of lease
• Operating - defers direct costs and amortizes over life of lease

Question 15

What is recorded at lease inception for a bargain purchase option in a lease liability

Answer 15

• Discount BPO as a PV of a single sum
• Add it to the PV of the annuity for lease payments
• Total is lease liability

Question 16

What are the required lease disclosures for lessors of a sales type or direct financing lease?

Answer 16

• the lessor must disclose the net investment components,
• including: future MLP;
• unguaranteed residual value;
• unearned income;
• and the future MLP to be received in each of the succeeding 5 years.

Question 17

How are lease payments calculated ?

Answer 17

• FV of Equipment
• Plus BPO or less GRV (both discounted at PV of single sum)
• = amount to be recovered
• divided by PV of annuity (or due)
• = annual lease payments

Question 18

How do you calculate amortization of deferred gross profit on direct financing lease?

Answer 18

Amortization of net lease receivable,

less amortization of gross lease receivable

Question 19

What makes a sales - lease back a “failed sale”

Answer 19

If it doesn’t meet the revenue recognition criteria, it is a failed sale. Must pass control to buyer in order to meet revenue critera.

HINT: If they tell you it is a finance lease, then treat it like a failed sale. If it is a failed sale, treat it like a financing arrangement, not a sale.

Question 20

What should be recorded for lease liability if PV of lease payment exceeds Fair Value of Asset?

Answer 20

Fair value of asset.

Per ASC Topic 842, the lessee shall record a finance lease as a debit to an asset account and a credit to a liability account for an amount equal to the present value of the total of the minimum lease payments as of the beginning of the lease term. However, if the amount so determined exceeds the fair value of the leased property at the inception of the lease, the amount recorded as the asset and obligation shall be the fair value of the leased property.

Question 21

What does the lessor record as sales revenue for a sales type lease with an unguaranteed residual?

Answer 21

Sales revenue for fair value of the asset less the PV of the unguaranteed residual value