Leases

Question 2

What are the characteristics of a finance lease for a lessee?

Answer 2

Rule: If any ONE of the following is met, lease is a Finance lease + treated as if owned by lessee.

1. Risk of ownership passes to lessee by Title
2. Written Purchase Option lessee ‘reasonably certain’ will exercise
3. Lease term more than 75% of asset’s useful life
4. PV of minimum lease payments = FV of asset (approx. 90% of FV of leased property)
5. Asset is specialized and has NO alternative use to lessor

Question 3

How is a capital lease recorded?

Answer 3

Capitalize at cost:

Asset & Liability Recorded at Present Value of Future Lease Payments

Discount Rate = Lesser of Implicit Rate in the Lease or Market Rate

Question 4

What footnote disclosures are required for a capital lease?

Answer 4

Future minimum rental commitments

By year – for 5 years

All remaining years as a group

Question 5

What are the requirements for a capital lease for a lessor?

Answer 5

Same as for lessee (Title- BPO or Substance)- PLUS:

Collectibility of lease payments is predictable

No uncertainties about the lessor reimbursing the lessee for costs incurred

Question 6

What are the characteristics of an operating lease for a lessee?

Answer 6

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.

Question 7

What are the characteristics of an operating lease for a LESSOR?

Answer 7

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

Question 8

What are the characteristics of a direct financing lease?

Answer 8

Interest Revenue (or expense for lessor) decreases with passage of time

Principal amount increases with each payment

Carrying amount of Lease decreases

Question 9

How is a sale-leaseback recorded?

Answer 9

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

Question 10

What are the characteristics of lease payments under an annuity due situation?

Answer 10

Payments begin at the start of the lease period

Think: Rent/Mortgage payments are Due at the first of the month

Question 11

What are the characteristics of lease payments under an ordinary annuity situation?

Answer 11

Payments begin after the end of the first year

Think: An annuity that pays you at the end of each year