Present Value - Leases

Question 1

Sales-Type Lease - lessor reports interest revenue

Answer 1

ASC Topic 840, revenue is to be recognized for a sales-type lease over the lease term in order to produce a constant rate of return on the net investment in the lease. This requires the use of the interest method.

Question 2

Lessor

Answer 2

Owns the asset

Question 3

Lessee

Answer 3

Using the asset

Question 4

Leasehold improvements

Answer 4

Amortized over the lease life, not th useful life of the leasehold improvements

Question 5

Capital Lease conditions

Answer 5

Lessee must meet ONE of the following:
TT - Title Transfer
BPO - Bargain Puchase Option
75 - Lease term is 75% or more of the useful (econimic) life of the asset.
90 - PV of minimum lease payments is 90% or more of the net of the FV of the asset
Capital lease JE - records the PV of the minimum lease pmts (unless the PV exceeds FV)
Dr. Asset
Cr. Liability

Question 6

Amount to be capitalized

Answer 6

Title Transfer: PV of future payments & PV of required buyout
BPO: PV of payments & PV of bargain buyout

75% - PV of lease payments (no option buyout)
90% - PV of lease payments (no option buytout)

Question 7

Conditions to treat lease as a “sale”

Answer 7

Lessor must meet all 3 conditions to have the “LUC” to capitalize

1. Lessee owns the lease property (1 of the 4 criteria are met by the lessee
2. Uncertanties do not exist regarding any unreimburseable costs to be incurred by the lessor. (reasonably estimable future cost).
3. Collectibility of the lease payments is reasonably predictable.

Question 8

Sales-type capital lease

Answer 8

Cost basis does not equal FV
Cost basis - the carrying amount of the asset being leased on the books of the lessor.
FV - PV calculation or what lessor should sell it for.

Question 9

Direct Financing Capital Lease

Answer 9

Cost Basis = FV

Question 10

Sales Leaseback

Answer 10

Seller of the asset bcomes the lessee, buyer becomes the lessor.
IF:
PV of futuer lease pmts/Selling price =
less than or equal 10%: Minor- not a sales leaseback
>10% Major: sale leaseback.

Question 11

Losses on sale leasebacks

Answer 11

Generally recongnized immediately
2 types of losses:
Recognized immediately “real economic loss”
Carrying amount of the asset is higher than FMV
Deferred “artificial loss” Sales price is below the carrying amount, but FMV is above the Carrying amount.

Question 12

Finance Lease - IFRS

Answer 12

IFRS refers to capital leases as finance leases.

US GAAP: 75% rule is IFRS: Use major part
US GAAP 90% rule is IFRS substantially all

Question 13

Sales Leasebacks - gains

Answer 13

PV of future lease pmts/Selling Price
less than or equal to 10%: not a sales lease back, recognize the entire gain in the year of the sale- there is no deferred gain.
>10% part of the gain is deferred (up to the PV of the lease)
Gain= Sales Price - Carrying amount

Question 14

Operating lease rental revenue

Answer 14

recognized in each accounting period on a straight-line basis unless another systematic and rational basis is more representative of the decline in the asset’s service potential.

Question 15

Rate to compute the PV of the minimum lease payments

Answer 15

Use the lesser of the lessee’s incremental borrowing rate (14% in this case) or the implicit rate used by the lessor if known (10% in this case). The PV of the minimum lease payments should be computed using the implicit rate of 10% because it is known by the lessee and is lower than the incremental rate.

Question 16

When to use the present value of the minimum lease payments

Answer 16

to determine the liability under a capital lease.

Question 17

Sale-type Lease - Depreciation Expense

Answer 17

The leased asset should be recorded at the present value of the future lease payments because it is less than or equal to the fair value of the leased asset. Since the facts do not indicate that title is transferred to the lessee or a bargain purchase or lease option exists, the leased asset should be depreciated over the lesser of the lease term or the asset’s useful life

Question 18

How lessee records a capital lease

Answer 18

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 19

Initial direct costs

Answer 19

costs incurred in connection with the negotiation and consummation of leases, such as legal fees, commissions, etc. For sales-type leases, profit or loss is recognized upon inception of the lease. In keeping with the matching principle, the costs of consummating that lease should be taken into income at the same time as the resulting profit or loss. Therefore, initial direct costs for sales-type leases are expensed currently.