Leases

Question 1

What is the lease period?

Answer 1

Lease period is the sum of the following periods:

1) noncancellable period
2) renewal periods the lessee is “reasonably certain” to exercise (lessee control)
3) periods covered by a termination option that the lessee is “reasonably certain” to NOT exercise (lessee control)
4) renewal periods controlled by the lessor

Question 2

What amounts are included in lease payments?

Answer 2

1) fixed lease payments
2) variable lease payments dependent on an index or a rate
3) renewal, purchase, and termination options
4) residual value guarantees

Question 3

What amounts are NOT included in lease payments?

Answer 3

1) variable lease payments NOT dependent on an index or a rate
2) guarantee of the lessor’s debt

Question 4

What are initial direct costs in a lease?

Answer 4

Incremental (variable) costs of a lease that would not have been incurred if the lease did not exist. These costs are capitalized and amortized ratably over the lease term.
E.g. commissions; payments made to the current tenant to encourage them to terminate the lease

Question 5

What is guaranteed residual value?

Answer 5

The amount that the lessee guarantees to the lessor that the asset will be worth at the end of the lease term.

Question 6

What are the three types of leases under ASC 842?

Answer 6

Short-term lease
Operating lease
Finance lease

Question 7

What is the preferred discount rate for the lessee?

Answer 7

rate implicit in the lease (think IRR)

PV of lease payments + PV of guaranteed & unguaranteed residual value = fair value + initial direct costs

Question 8

What is the alternative discount rate for the lessee?

Answer 8

Incremental borrowing rate (used if implicit rate is not available)
Rate to borrow a loan with similar terms and conditions

Question 9

What is a short-term lease?

Answer 9

A short-term lease is one with a lease term of 12 months or less.

Question 10

How to account for short-term lease payments?

Answer 10

Lessee: rent expense on a SL basis over lease term
lease expense DR
cash CR
deferred lease exp* CR
*(bal b/w cash paid and SL lease expense)

Lessor: treated as income on SL Basis over lease term
cash DR
accrued lease inc* DR
lease income CR
*(bal b/w cash rec’d and SL lease income)

Question 11

How to account for leasehold improvements?

Answer 11

Improvements made by lessee are amortized over lower of remaining lease life or useful life

Leasehold assets DR
cash CR
Amortization DR
A/A CR

Question 12

How to account for a lease bonus?

Answer 12

Lessee: deferred (prepaid) rent expense SL amort
lease bonus (BS) DR
cash CR
lease expense DR
lease bonus (BS) CR

Lessor:  deferred rent income SL amort
cash                              DR
       lease bonus (BS)         CR
lease bonus (BS)          DR
       lease income               CR

Question 13

What is a lease bonus?

Answer 13

Cash paid by the lessee to the lessor for the execution of the lease. Treated as deferred rent expense / deferred rent income and amortized SL over lease term.

Question 14

How to account for lease payment made in advance?

Answer 14

Lessee: treat as deferred (prepaid) rent expense until earned by the lessor

Lessor: treat as deferred rental income until earned

Question 15

How to account for non-refundable security deposit?

Answer 15

Lessee: treat as deferred (prepaid) rent expense unless considered earned by lessor
lease expense DR
cash CR
prepayments DR
lease expense CR

Lessor:  treat as deferred rental income until earned
cash                              DR
        lease income               CR
lease income                DR
         deferred inc                 CR

Question 16

How to account for refundable security deposit?

Answer 16

Lessee: treat as asset receivable at end of lease term
receivable DR
cash CR

Lessor: treat as payable at the end of lease term
cash DR
payable CR

Question 17

Finance Lease - Lessee

Answer 17

A lease is a finance lease if it meets ONE of the following:

1) ownership transfer: by the end of the lease term, the lessor transfers ownership of the underlying asset to the lessee
2) purchase option: lessee has the option to purchase the asset and the lessee is reasonably certain to exercise the option
3) economic life: lease term covers the majority of the rest of the economic life of the asset. (if the lease term starts near the end of the economic life, this criterion should not be used)
4) PV >= FV: present value of the sum of lease payments + residual value guaranteed by the lessee equals or exceeds substantially all the fair value of the asset
5) specialized: asset is specialized with no alternative use at the end of the lease term

Question 18

Right-of Use Asset - asset value calculation

Answer 18

\+    Lease liability
\+    initial direct costs
\+    prepaid lease payments
-     lease incentives
=    right of use asset

aka…the total amount you will pay for the asset (already paid plus have to pay)

Question 19

Lease liability - liability value calculation

Answer 19

PV of lease payments using the rate implicit in the lease or the incremental borrowing rate (IBR)
includes the guaranteed residual value in excess of salvage
aka….the amount you have yet to pay on the lease
NOTE: under ASC 842, lease liability cannot exceed FV of the asset

Question 20

Lease Framework

Answer 20

1) classify lease (what type)
2) calculate lease liability (PV of lease payments and guaranteed salvage value
3) calculate ROU asset
4) amortization schedule for lease liability
5) amortization schedule for ROU asset

Question 21

What is a sales-type lease for a lessor?

Answer 21

A lease that meets one of the five criteria for a financing lease for a lessee:

1) transfer of ownership
2) bargain purchase option
3) PV >= FV
4) Lease term >= economic life
5) specialized asset

Question 22

What are the three types of leases for a lessor

Answer 22

Sales-type lease
Direct financing lease
Operating lease

Question 23

What is a direct financing lease for a lessor?

Answer 23

If none of the sales-type lease criteria are met, but BOTH of following criteria are met, then it is a direct financing lease.

1) PV of sum of lease payments + residual value guaranteed by the lessee AND/OR any unrelated 3rd party >= FV of asset
2) it is probable that the lessor will collect the lease payments plus any amount required to meet the guaranteed residual value

Question 24

What are the opening journal entries for a direct financing lease for a lessor?

Answer 24

net investment in lease - receivable DR
net investment in lease - GRV DR
net investment in lease - UGRV DR
asset CR
cash (initial direct costs) CR
net investment in lease - deferred selling profit CR

Question 25

Direct Financing Lease for Lessor - Balance Sheet Accounts & Type of Income Stream

Answer 25

net investment in lease - receivable: asset, annuity
net investment in lease - GRV: asset, single future payment
net investment in lease - UGRV: asset, single future payment
net investment in lease - deferred selling profit: liability,

Question 26

Direct Financing Lease for Lessor - Balance Sheet Accounts & Type of Income Stream

Answer 26

net investment in lease - receivable: asset, annuity
net investment in lease - GRV: asset, single future payment
net investment in lease - UGRV: asset, single future payment
net investment in lease - deferred selling profit: liability,

Question 27

What are the closing journal entries for a direct financing lease for a lessor?

Answer 27

asset                                        DR (GRV + UGRV)
     net investment in lease            CR

Question 28

When is the profit recognized in a sales-type lease for a lessor?

Answer 28

Immediately (opening journal entries)

net investment in lease DR
asset (CV) CR
profit CR