Short-Term Leases and Operating Leases Flashcards
Types of questiosn:
Lessee: Lease Liability- Amount to cap Lease Expense - Interest Component - Amortization of right-of-use asset component
Lessor:
- Lease revenue
Why lease?
Use an asset without owning. Pay on a monthly basis. It might lower sales tax. No obsolesce.
For the lessor, it might make the asset more affordable.
What is a short-term lease? What is the journal entry for the lessee and lessor?
Less than 12 months.
Lease Expense XXX
Cash (XXX)
LESSOR:
Cash/receivable XXX
Lease Rev (XXX)
What is an operating lease?
Greater than 12 months.
Lease:
Lease Expense, interest component, and amortization of the right-of-use asset component.
Lessor: Lease revenue as time passes and lease performance obligation is fulfilled
Record deprecation expense.
How does the lessor calculate the payment for the lease?
Fair value of the equipment: XX
LESS: Present value of the residual Value (XX)
EQUALS: Amount to be recovered
Divide by the PV Factory of the Annuity
EQUAL LEASE PAYMENT
Journal Entry:
Cash XX
Revenue (XX)
From the lessee’s persepctive, how do they account for the operating lease?
Take the PV of the lease payment and capitalize that value as a right-of-use asset and record a lease liability
Right of use asset XX Lease liability (XX)
Subsequent payments:
Lease payment X Interest Rate
Interest Expense less payment is reduction to lease liability
Lease Expense XX
Right to use (XX)
Lease Liability (XX)- Increase for interest for the YR
Test Questions for a finance lease?
- Classification of the lease
- Annual lease expense/revenue
- Lease liability/receivable
What are the 5 criteria for a finance lease?
1) Title to the lease asset is transferred to the lessee
2) Lessee has the option to purchase at a bargain purchase
3) Lease term is the major part (75% or more) of the useful life of the asset
4) Present Value of the minimum lease payment to be 90% of the lease asset at lease inception
5) The asset is specialized in nature and has no alternative use to the lessor at the end of the lease term
If any one of these items are met, then you have a finance lease.
If none of the 5 criteria are met, how is it classified?
Lessor: Operating lease or direct financing lease
Lessee: Operating lease or short-term lease
IF one or more the 5 criteria are met, how is it classified?
Lessor: Sales-type lease
Lessee: Finance lease
What is the journal entry for a finance lease for the lessee at the beginning of the lease contract?
DR: Right of use asset
CR: Lease liability
Under an ordinary annuity, what is the journal entry for the first lease payment of a finance lease?
DR: Interest Expense
DR: Lease Liability
CR: Cash
Under an annuity due, what is the journal entry for the first lease payment?
DR: Lease Liability
CR: Cash
Under a finance lease, how does the lessee record the amortization of the asset?
DR: Amortization expense
CR: Right of use asset
Amortization Expense: Right of use asset / Shorter of the lease term or asset’s useful life
Example: A finance lease has the following information
- Equipment fair value= $25,771
- Lease payments due at the end of the year
- End of the lease term is 12/31/Y3
- Interest rate for both parties= 8%
- Useful life of the asset = 3 years
Present value factor, ordinary annuity = 2.57710
Lease payment calculation:
Fair value of the equipment $25771
Present value of residual 0
Amount to recover $25771
Divide by present value at 8% 2.57710
Annual lease payment $10,000
Lessee calculation:
Annual lease payment $10,000
Multiply by the PV 2.5771
Amount to cap: $25,771
Right-of-use asset $25,771
Lease Liability $25,771
Interest Expense $25771 * .08 = 2,062
Reduction liability $10,000-2062= 7,938
New Carrying Value = $17,833
Interest Expense 2,062
Lease Liability 7,938
Cash (10,000)
Amortization 25,771/3 years = 8,590
Example: A finance lease has the following information with a guaranteed residual value (GRV)
- Equipment fair value= $25,771
- Lease payments due at the end of the year
- End of the lease term is 12/31/Y3
- Interest rate for both parties= 8%
- Useful life of the asset = 3 years
Present value factor, ordinary annuity = 2.57710
- GRV: 3,000 expected residual 2,000
Lessor calculation:
Fair value of the equipment $25,771
Less PV of residual (3000*.79383) 2,381
Amount to be recovered through payment 23,390
Divide recoverable amount by annuity 2.57710
Annual lease payment 9,076
Lessee Calculation:
Annual Lease payment 9,076
PV of annual lease payment 2.5771
Present Value of the Annual Payment 23,390
Difference between GRV and Residual 1,000
Present value of expected residual .79383
PV of expected residual 794
Amount to CAP (23,390 + 794) = 24,184
Right of use asset 24,184
Liability (24,184)
In a sales-type lease, what is the journal entry for the lessor?
Lease Receivable DB
Unearned Interest CR
Sales Revenue CR
Cost of goods sold DB
Asset DB
Example: A finance lease has the following information
- Equipment fair value= $25,771
- Lease payments due at the end of the year
- End of the lease term is 12/31/Y3
- Interest rate for both parties= 8%
- Useful life of the asset = 3 years
Present value factor, ordinary annuity = 2.57710
What is the entry for the lessor??
Minimum lease payment: $9,259
Lease receivable $27,777 (3x9,259) Unearned Interest (2,006) (27,777-25771) Sales Revenue (25,771)
Cost of goods sold 20,000
Equipment (20,000)
What is a direct financing lease?
None of the 5 criteria are met
What is the journal entry at inception of the lease for the lessor?
DR: Lease Receivable
CR: Deferred GP (Contra Receivable Account)
CR: Equipment/Inventory (asset)
What is a sale-leaseback?
Seller-lessee sells the asset and immediately leases it back.
Provides instant capital without losing use of the asset
Essentially two transactions: the sale of the asset and the leaseback
Buyer- lessor purchases the asset and lease it back to the seller-lessee
What is the journal entry for a operating lease?
Lease Expense DB (AMOUNT OF CASH PAID)
CASH. CR
Lease Liability DB (AMORTIZATION OF THE ASSET)
Right-of-use asset CR.
Amortization comes for the amortization table. Lease expense less the interest component.
A seller of an asset which immediately leases the asset back and meets the criteria of a finance lease, the gain on the original sale should be reported as?
No gain reported. Because this is a finance lease, the buyer of the asset does not have control over the asset. The original owner of the asset still has the control; therefore, this is not a legitimate sale and the gain cannot be reported.
When amortizing under a finance lease, how is the asset amortized?
1 Lesser of the lease term or useful life of the asset
From the lessor’s perspective, if they have an operating lease, how do they depreciate the asset?
Continues to depreciate the asset using an acceptable depreciation method.
What are incremental costs and how are they accounted for?
Incremental costs are incurred BECAUSE OF the lease.
- Legal fees
- Fees paid for a third-party guaranteed
LESSEE:
- Include the cost in the right of use asset
- Amortize over the use of the right-of-use asset
- DO NOT include in the liability account
LESSOR:
- Sales-type lease: Expense the initial direct cost at inception
- Operating lease- Defers the initial direct cost and amortizes them as expenses over the term of the lease.
What are executory costs and how are they accounted for?
Common examples of executory costs:
- Property taxes
- Insurance
- Maintenance cost
Accounting depends on the payment structure
- if payment made directly to the third party, expense as incurred.
- If the payment are fixed amounts and made to the lessor, then it should be included in the lease liability
