Section 12 - Accounting for Leases Flashcards
What is the goal for accounting for leases?
To recognize the true SUBSTANCE OVER THE FORM.
Maybe a true rental (Operating Lease) or it could be a purchase of sale, which transfers all the rights and risks of ownership (Capital Lease/Non-operating Lease)
How are Operating Lease costs under the Lessor (owner) treated?
- Depreciate assets
- Direct lease costs (commissions, legal fees) amortized S/L over the lease term
- Executory costs recognized as incurred
- Lease bonus is deferred (unearned revenue) and amortized over the life of the lease
- Rent received in advance is considered unearned (deferred revenue)
- Security Deposits
- Nonrefundable - unearned revenue until earned
- Refundable - liability until returned (db cash, cr Liab)
- Uneven rental payments are recognized uniformly over the lease term
JE - Lease payments
Cash or Rent receivable
Rent Revenue
How are Operating Lease costs under the Lessee (renter) treated?
- Risk of ownership does not pass
- No asset or liability recorded on F/S
- Lease rent is recognized uniformly (evenly)
- Lease bonus considered an asset and amortized S/L over the lease term
- Leasehold improvements are reported with PPE and amortized over the shorter of LEASE TERM or USEFUL LIFE
- Refundable security deposits are assets (receivable)
JE - Lease payments
Rent Expense
Cash or Rent Payable
What are executory costs?
Taxes
Insurance
Maintenance
What is a Capital Lease?
A lease where the RIGHTS and RISKS of ownership have transferred from the lessor to the lessee.
In substance its a purchase, although in form it’s a lease.
What are the 4 criteria a lease must meet to qualify as a Capital Lease?
Must meet one of these criteria:
1) TT - Title Transfer
2) BPO - Bargain purchase option
3) 75 - lease term is greater than or equal to 75% of the useful life
4) 90 - PV of Minimum Lease Payment (MLP) is greater than or equal to 90% of the FMV
What is included in the Lessee’s Minimum Lease Payments (MLP)?
1) Base rent
2) BPO
3) Penalties
4) Residual Value
What are not included in the MLP?
1) Contingent rents
2) Executory costs
These are recorded as income by Lessor and expense by Lessee.
What amount of the lease does the Lessee record?
Lower of FMV or PV of MLP
FMV (A new implicit interest rate must be calculated)
PV of MLP
- Periodic payments (annual payment)
- BPO (lump sum)
- Guaranteed Residual Value (only if guaranteed by Lessee, always recorded in Lessor’s book)
- Penalty for failure to renew (if any)
- DO NOT include executory costs. They are expense as incurred.
Which interest rate is used by the Lessee to PV the payments?
Lesser of Incremental Rate (from the bank) OR Lessor’s Implicit Rate (if it is known)
**Lessor will always use their implicit rate
What method is used to amortize the lease payments?
Effective Interest Method
Lease Liability X Interest Rate (incremental or implicit rate) = Interest expense/income - Lease payment = Amortization of lease liability
What are the J/Es for lease payments under Capital Lease for the Lessee?
Day One
Leased Asset
Lease Liability
First Payment (Day 1)
Lease Liability
Cash
Second Payment (one year later)
Lease Liability
Interest Expense (plug)
Cash
Depreciation
Depreciation expense
Accumulated Depreciation
What term/year does Lessee use to depreciates asset under a Capital Lease?
TT and BPO
- depreciate over USEFUL LIFE
- take out salvage value
- ownership has transferred
75/90
- depreciates over shorter of useful life or lease term
- ignore salvage value
JE
Depreciation expense
Accumulated Depreciation
What are the Disclosures requirement for Capital Lease?
- description of entity’s leasing activities
- gross amount of assets recorded under capital lease
- MLP for each of the next 5 years
- all remaining years (after the 5 years) as a total group (aggregate)
What are the 2 Non-Operating Leases for Lessor?
1) Sales Type Lease
2) Direct Financing Lease
