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106 Cards in this Set
- Front
- Back
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Accounting for Leases - Overview: |
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Lessee Accounting - Lease Rent Expense: |
The lessee records rent expense over the lease term, usually on SL basis.
Dr: Rent Expense CR: Cash/rent payable
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Lessee Accounting - Lease Bonus: |
Lease Bonus (prepayment)
Lease bonus (prepayment) for future expenses should be classified as an asset (deferred charge) and amortized using the straight-line method over the life of the lease. |
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Lessee Accounting - Leasehold Improvements - General: |
A leasehold improvement is one that is permanently affixed to the property and reverts back to the lessor at the termination of the lease. In general, if the property is not moveable from the premises by the tenant, it is a leashold improvement. Air conditioning ducts would be considered a leasehold improvement, while a painting hanging on a wall would not. |
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Lessee Accounting - Leasehold Improvements - Capitalize Leasehold Improvements |
The value of leasehold improvements should be capitalized and added to the property, plant, and equipment section or the intangible asset section of the balance sheet. |
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Lessee Accounting - Leasehold Improvements - Depreciation: |
Depreciation - Useful Life or Lease Term Leasehold improvements should be depreciated (amortized) over the lesser of:
(a) Lease life (b) Asset/improvement life |
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Lessee Accounting - Rent Kicker: |
A premium rent payment required for specific events. (1) Period expense |
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Lessee Accounting - Refundable Security Deposit: |
Reported as an asset until refunded by the lessor. |
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Lessee Accounting - Free or Reduced Rent Consideration: |
If consideration (free rental months or reduced rental charge at beginning) is part of package, lessee must take total rent expense to be paid for the entire lease term and divide it evenly over each period (matching principle). |
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Lessor Accounting - Fixed Asset: |
The cost of the property is included in the lessor's property, plant, and equipment.
(1) Depreciation - Over the asset's useful life. |
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Lessor Accounting - Rental Income: |
Rental income is reported using the SL or other systematic method.
Dr: Cash/rent receivable Cr: Rental income |
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Lessor Accounting - Security Deposits: |
(1) Nonrefundable - Deferred by lessor (unearned revenue) & capitalized by lessee (prepaid rent expense) until lessor considers the deposit earned.
(2) Refundable - Treat as receivable by lessee & liability by lessor until deposit is refunded to the lessee. Dr: Cash Cr: Refundable Deposit |
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Lessor Accounting - Temporary Difference: |
(1) GAAP rule: Report prepaid rental income when earned
(2) Tax rule: Report prepaid rental income when received |
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Lessor Accounting - Lease Bonus: |
The lease bonus is deferred (unearned income) and amortized (into income) over the life of the lease. |
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Lessor Accounting - Free or Reduced Rent Consideration: |
If consideration (free rental months or reduced rental charge at beginning) is part of package, lessor must take total rental income to be received over the entire lease term and divide it evenly over each period (matching principle/revenue recognition principle). |
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Lessor Accounting - Capital/Finance Lease: |
Transfers all benefits and risks to lessee. - This is essentially an installment purchase in the form of a leasing arrangement. - Lessee accounts for this as the acquisition of both an asset (leased asset under capital lease) & related liability (obligation under capital lease). - Lessor accounts for lease as a sales-type or direct financing lease. A sales-type (finance) lease results in a dealer's or manufacturer's profit or loss to the lessor. A direct financing (finance) lease does not result in a dealer's or manufacturer's profit or loss. |
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Lessee Capital Lease Criteria (U.S. GAAP) |
1. Must meet just one condition to capitalize. Ownership transfer at end of lease Written option for bargain purchase Ninety percent of lease property FV <= PV Seventy-five percent or more of asset economic life is being committed in lease term.
2. Criteria (N) & (S) can't be used for a lease that begins w/i last 25% of original estimated economic life of the leased property. |
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Lessee Capital Lease Criteria (U.S. GAAP) - Journal Entry: |
Dr: Fixed asset - leased property Cr: Liability - obligation under capital lease |
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Lessee Finance Lease Criteria (IFRS) - General: |
Under IFRS, lease classification depends on the substance of transaction rather than form of the contract. IFRS defines finance lease one where all the risks & rewards of ownership are transferred to lessee. Any lease that meets this definition is classifed as a finance lease. The 4 GAAP capital lease criteria meet this definition & therefore these criteria indicate a finance lease under IFRS. |
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Lessee Finance Lease Criteria (IFRS) - Situations that Lead to Finance Lease Classification |
1. The lease transfers ownership of the asset to the lessee by the end of the lease term. 2. The lease contains a written bargain purchase option. 3. Lease term is for major part of the economic life of the asset even if title is not transferred. 4. PV of minimum lease payments is at least substantially all of the FV of leased asset. 5. Gains & losses from the fluctuation in the FV of the residual accrue to the lessee. 6. Lessee has ability to continue lease for a sec- ondary period at rent lower than market rent. 7. Lessee can cancel lease & lessor's losses associated w/ cancelation are borne by lessee. 8. Leased assets are so specialized that only the lessee can use them w/o modification. |
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Lessor - Sales-Type/Direct Financing Type Criteria (U.S. GAAP) |
If lease, at inception, meets all 3 conditions, it is classified as sales-type/direct financing lease. - Lessee "owns" the leased property (meets any one of the 4 lessee's criteria). - Uncertainties do not exist regarding any unreimbursable costs incurred by the lessor. - Collectability of the lease payments is reasonably predictable.
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Comparison of Sales-Type and Direct Financing Leases for Lessors: Sales-Type Lease |
In a sales-type lease, the FV of the leased property at inception of lease differs from the cost or carrying amount to the lessor. This difference gives rise to a manufacturer's or dealer's profit or loss, if at the inception of the lease the FV differs from the cost or carrying amount. |
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Comparison of Sales-Type and Direct Financing Leases for Lessors: Direct Financing Lease |
In a direct financing lease, the fair value of the leased property at the inception of the lease is the same as the cost or carrying amount. Therefore, there are no manufacturers or dealers profit or loss. |
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Comparison of Sales-Type and Direct Financing Leases for Lessors: Transfer of Benefits & Risks |
Both sales-type and direct financing leases transfer substantially all of the benefits and risks inherent in the ownership of the leased property to the lessee, who records the transaction as a capital lease. |
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Lessor - Finance Lease Criteria (IFRS) |
A lessor classifies a lease as a finance lease if the lease transfers substantially all the risks & rewards to the lessee. As a result, under IFRS, the lessee & the lessor will classify a lease consistently as a finance lease or operating lease. IFRS do not specifically use th eterms sales-type lease & direct-financing lease. However, IFRS state that manufacturer or dealer lessors may recognize profit or loss @ inception of lease, similar to sales-type leasing. |
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Calculation of Leased Asset & Liability Amounts |
Lessee treats capital (finance) lease as if an asset were being purchased over time; i.e. a financing transaction in which an asset is acquired & corresponding obligation (liability) is created.
Dr: Fixed asset - leased property Cr: Liability - obligation under capital (finance) lease |
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Calculation of Leased Asset & Liability Amounts: Recording the Lease - Capitalized Amount |
The lessee records lease as asset & liability at the lower (lesser) of: (1) FV of asset at the inception of the lease, or (2) Cost = PV of the minimum lease payments. (a) Include (all payments that lessee is obligated to make). (i) Required Payments (ii) Bargain Purchase Option (iii) Guaranteed Residual Value (b) Exclude (i) Executory Costs (ii) Optional Buyout (not required & not a bargain) |
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Calculation of Leased Asset & Liability Amounts: Recording the Lease - Capitalized Amount- Bargain Purchase Option |
Bargain Purchase Option When the lease contains a bargain purchase option, the lease obligation includes the present value of the payment required to exercise the bargain purchase option in addition to the present value of the minimum lease payments. |
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Calculation of Leased Asset & Liability Amounts: Recording the Lease - Capitalized Amount- Guaranteed Residual Value |
Guaranteed Residual Value The amount guaranteed by the lessee to the lessor for the estimated residual value of the asset at the end of the lease term. The lease obligation includes the present value of any guaranteed residual value in addition to the present value of the minimum lease payments. |
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Calculation of Leased Asset & Liability Amounts: Recording the Lease - Capitalized Amount- Executory Costs |
Executory Costs Insurance, maintenance, and taxes can be paid by the lessor or lessee. If the lessor pays them, a portion of each lease payment representing executory costs is excluded from the calculation of minimum lease payments. If the lessee pays these costs directly, they are not included in the minimum lease payments. |
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U.S. GAAP vs. IFRS - Lease Assets & Obligations |
Under IFRS, initial direct costs of the lease paid by the lessee are added to the amount recognized as a finance lease asset. Therefore, at lease inception, the amount of the lease asset and the lease obligation may differ. |
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Calculation of Leased Asset & Liability Amounts: Recording the Lease - Interest Rate |
When calculating the present value of the minimum lease payments, the lessee uses the lower (lesser) of the: (1) Rate implicit in the lease (if known) (2) Lessee's incremental borrowing rate (the rate available in the market to the lessee (not)) |
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Calculation of Leased Asset & Liability Amounts: Recording the Lease - Summary |
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Lessee Capital (Finance) Lease Acccounting - Term to Use in Computing Depreciation of the Asset - Depreciation Method |
The leased asset should be depreciated in a manner consistent w/ the lessee's normal policies. Capitalized lease assets - salvage value = Depreciable Basis Depreciable Basis/Periods of benefit = Depreciation Expense (per period) |
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Lessee Capital (Finance) Lease Accounting - Term to Use in Computing Depreciation of the Asset - Period of Benefit (Depreciable Life) [U.S. GAAP] |
1. Ownership Transfer & Written Bargain Estimated economic life of the asset is used if the lessee takes ownership of the leased asset by the end of the lease or if there is a bargain purchase option as part of the agreement. 2. Ninety % FV and Seventy-five % Life Lessee uses lease term if lessee does not take ownership of the asset by the end of the lease or if there is not a bargain purchase option. |
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Lessee Capital (Finance) Lease Accounting - Term to Use in Computing Depreciation of the Asset - Period of Benefit (Depreciable Life) [U.S. GAAP] - Depreciation Rules |
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Lessee Capital (Finance) Lease Accounting - Term to Use in Computing Depreciation of the Asset - Period Of Benefit (Depreciable Life) [IFRS] |
The depreciation period is the shorter of the lease term and the useful life of the asset. If there is a reasonable certainty that the lessee will own the leased asset after the lease term, then the leased asset should be depreciated over its useful life. |
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Lessee Capital (Finance) Lease Accounting - Lease Amortization-Liability & Asset on Lessee's Books |
The obligation under Capital (Finance) Lease account and the related Leased Asset account are recorded initially at the same amount. However, subsequent amortization of each account takes place independently and results in different account balances by the end of the first year. The lease liability is amortized using the effective interest method. |
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Lessee Capital (Finance) Lease Accounting - Lessee's Financial Statement Required Disclosures of Leases - Capital Lease |
1. Assets, acc. amortization, & liabilities from capital leases are reported separately in the B/S & classified as current or noncurrent in the same manner as other assets & liabilities. 2. Current amortization charges to income must be clearly disclosed, along w/ add'l information: (a) Gross amt of assets recorded as of each B/S date presented by major property categories. This info may be combined w/ info for comparable owned assets. (b) Future minimum lease payments in aggregrate & for each of the next 5 yrs, showing deductions for executory costs, incl. any profit, & the amt of imputed interest to reduce net minimum lease payments to PV. (c) Total minimum sublease rentals received in the future under noncancelable subleases. (d) Total contingent rentals actually incurred for each period an I/S is presented. |
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Lessee Capital (Finance) Lease Accounting - Lessee's Financial Statement Required Disclosures of Leases - Operating Leases |
1. Required for operating leases of lessees having noncancelable lease terms > 1 year: (a) Minimum future rental payments in total, and for each of the next five years. (b) Minimum sublease income due in future periods under noncancelable subleases. 2. Required for all operating leases: (a) Schedule of total rental expense showing composition by minimum rentals, contingent rentals, & sublease income (excluding leases w/ terms of 1 month or less that were renewed). |
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Lessee Capital (Finance) Lease Accounting - Lessee's Financial Statement Required Disclosures of Leases - General Disclosures |
General disclosures of lessee's leasing arrangements: 1. Basis of contingent rental payments. 2. Terms of renewals, purchase options, and escalation clauses. 3. Restrictions imposed by lease agreements, such as additional debt, dividends, and leasing limitations. |
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Summary of Lessee Capitalization Rules (U.S. GAAP) |
Capitalize as PP&E the leased asset at lesser of: 1. Cost = PV of future lease payments (a) Include: (1) Guaranteed residual value by lessee. (2) Bargain purchase option (if applicable). (b) Exclude: Executory costs (insurance, taxes, & repair & maintenance). (c) Discount Rate - Lesser of: (1) Rate implicit in the lease (if known). (2) Incremental borrowing rate. 2. Fair Value = Given
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Summary of Lessee Capitalization Rules (U.S. GAAP) |
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Lessor Accounting - Recording a Sales-Type (Finance) Lease |
Under IFRS, sales-type lease is referred to as a finance lease of an asset by a manufacturer or dealer lessor. Terms that are important to know for sales-type (finance) leases included: 1. Gross investment (lease receivable) 2. Net Investment 3. Unearned Interest Revenue (contra-lease receivable) 4. Cost of Goods Sold 5. Sales Revenue |
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Lessor Accounting - Recording a Sales-Type (Finance) Lease - Gross Investment (lease receivable) |
Gross Investment (lease receivable) The minimum lease payments + any unguaranteed residual value accruing to the benefit of the lessor. This is recorded as Lease Payments Receivable on the lessor's books.
Lease payment + unguaranteed residual value = gross investment |
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Lessor Accounting - Recording a Sales-Type (Finance) Lease - Net investment |
Computed as sum of PV of the minimum lease payments (incl. periodic lease payments, bargain purchase option, or guaranteed residual value) & PV of unguaranteed residual value accruing to lessor's benefit, using the implicit interest rate. Lease payment + unguaranteed residual value = gross investment x PV = Net investment |
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Lessor Accounting - Recording a Sales-Type (Finance) Lease - Unearned Interest Revenue (contra-lease receivable) |
Gross investment less net investment = unearned interest revenue. Unearned interest revenue is recognized over life of lease using effective interest method & is included in B/S as a deduction from the gross investment (Lease receivable - Unearned interest revenue = Net investment reported) Gross investment - Net investment = Unearned interest revenue |
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Lessor Accounting - Recording a Sales-Type (Finance) Lease - Cost of Goods Sold |
Cost of leased asset + initial direct costs, such as legal fees or commissions to the lessor, minus PV of unguaranteed residual value accruing to lessor's benefit. This is charged against income in period in which corresponding sale is recorded.
Cost of asset - PV unguaranteed residual value = Cost of Goods Sold |
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Lessor Accounting - Recording a Sales-Type (Finance) Lease - Sales Revenue |
Present value of minimum lease payments is recorded as sales revenue. This does include the PV of guaranteed residual value but not the PV of any unguaranteed residual value. |
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Pass Key: Lessor Accounting - Rule for Sales-Type Lease |
Cost + Profit = Present value = Selling price = Fair Value |
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Recording a Direct Financing (Finance) Lease: |
Under IFRS, direct financing lease is referred to as a finance lease. Under both IFRS & GAAP, no manufacturer's or dealer's profit is realized in a direct financing lease cuz FV of leased property = cost or carrying value @ inception of the lease. The info necessary to record this type of lease is: 1. Gross Investment (lease receivable) 2. Net investment 3. Unearned interest revenue |
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Pass Key: Rule for Direct Financing Lease |
Present value = Carrying amount of receivable = Cost of asset sold |
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Recording a Direct Financing (Finance) Lease - Gross Investment (Lease receivable) |
Gross investment = minimum lease payments + unguaranteed residual value. Recorded as lease payment receivable. |
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Recording a Direct Financing (Finance) Lease - Net Investment |
Net investment equals gross investment plus any unamortized initial direct costs less the unearned income. The initial direct costs are amortized over the lease term by the effective interest method.
Net investment = Gross investment x PV |
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Recording a Direct Financing (Finance) Lease - Unearned Interest Revenue |
Gross investment less the cost of the leased property plus any initial direct costs. It is amortized over the lease term by the effective interest method.
Gross investment - net investment = unearned interest revenue |
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Sale-Leaseback: Introduction |
In this transaction, owner of property (seller-lessee) sells property & simultaneously leases it back from purchaser-lessor. Usually there is no interruption property use. Sale-leaseback transactions are treated as single financing transactions w/ profit deferred & amortized.
Under GAAP, 2 questions are involved in determining the treatment of any profits: 1. Is lease a capital or operating lease? And 2. What portion of rights to leaseback property is retained? Under IFRS, the treatment of any profits is determined by whether the lease is an operating lease or a finance lease. |
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Sale-Leaseback: Terminology - Selling Price |
Selling price is the negotiated price in the sale-leaseback agreement. It may be less than, equal to, or greater than the market value of the property, depending on the negotiated terms of the sale-leaseback. |
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Sale-Leaseback: Terminology - Profit or Loss on Sale: |
Profit or loss on the sale is the amount that would have been recognized by the seller-lessee assuming there was no leaseback. It is calculated by subtracting book value from fair value (sale price). |
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Sale-Leaseback: Terminology - Excess Profit on Sale-leaseback (U.S. GAAP only) |
a. Operating Lease Excess Profit The amount of profit on the sale that exceeds the PV of the minimum lease payments. Sale price - Asset NBV = Tentative gain - PV min. lease payment = Excess Gain
b. Capital Lease Excess Profit The amount of profit on sale hat exceeds the recorded amount of the asset. This amount will be the same as in an operating lease unless asset is recorded @ lower FV.
Leaseback asset amount is lesser of: 1. FV of the leased property, or 2. PV of the minimum lease payments. Sale price - Asset NBV = Tentative gain - Leaseback asset = Excess gain |
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Sale-Leaseback - Accounting by Seller/Lessee (U.S. GAAP) - Amount of Deferred Gain |
Under GAAP, amount of deferred gain is determined by the retained rights to remaining use of "leaseback" property. The rights to the remaining use of the property are determined by the PV of rent payments paid by seller-lessee. Seller-lessee's rights are categorized as follows: 1. "Substantially All" Rights Retained (>90%) 2. Rights Retained < "Substantially All", but > "Minor" (between 90%-10%) 3. Minor portion of rights retained by seller-lessee (<10%) 4. Real economic loss/recognize immediately |
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Sale-Leaseback - Accounting by Seller/Lessee (U.S. GAAP) - Amount of Deferred Gain - "Substantially All" Rights Retained (>90%) |
The present value of the rent payments is equal to or greater than 90% of the fair value of the property. These leases are usually accounted for as capital leases.
Pass key: Defer all gain & amortize w/ the leased asset. |
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Sale-Leaseback - Accounting by Seller/Lessee (U.S. GAAP) - Amount of Deferred Gain - Rights Retained < "Substantially All", but > "Minor" (between 90%-10%) |
The present value of the rent payments is less than 90% of the fair value, but greater than 10% of the fair value of property at the lease inception. These leases are accounted for as either capital or operating leases, depending on the criteria.
Pass key: Defer gain up to PV of the minimum leaseback payments (operating lease) or capitalized asset (capital lease). Gain in excess of this amount is recognized immediately. |
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Sale-Leaseback - Accounting by Seller/Lessee (U.S. GAAP) - Amount of Deferred Gain - Minor Portion of Rights Retained by Seller-lessee (Less than 10%) |
The present value of the rent payments is 10% or less of the fair value of the property at lease inception. These leases are usually accounted for as operating leases.
Pass Key: Recognize gain or loss at the time of the sale-leaseback transaction. Gains are not deferred. |
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Sale-Leaseback - Accounting by Seller/Lessee (U.S. GAAP) - Amount of Deferred Gain - Real Economic Loss/Recognize Immediately |
1. Real Economic Loss - a loss that must be recognized immediately is when FV of property at time of sale-leaseback < book value, in which case the excess of BV over FV is the loss.
2. Artificial Loss - When the sales price is below the FV, the loss is deferred & amortized over the leaseback period. |
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Sale-Leaseback - Accounting by Seller/Lessee (U.S. GAAP) - Amortization of Deferred Gain - Capital Leaseback |
In capital leaseback, deferred gain or loss is amortized in proportion to amortization of leased asset. 1. Deferred gain (or loss) is recognized as an "unearned profit (or loss) on sale-leaseback." 2. The "unearned profit (or loss) on sale-leaseback" would be treated as a valuation account of the leased (back) asset. |
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Sale-Leaseback - Accounting by Seller/Lessee (U.S. GAAP) - Amortization of Deferred Gain - Operating Leaseback |
In operating leaseback, deferred gain or loss is amortized in proportion to gross rental expense over life of lease. 1. Deferred gain (or loss) is recognized as an "unearned profit (or loss) on sale-leaseback." 2. "Unearned profit (or loss) on sale-leaseback" is reported as a deferred credit (or debit) in B/S. |
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Sale-Leaseback: Summary |
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Accounting by Seller/Lessee (IFRS) |
Under IFRS, accounting for profit on the sale-leaseback depends on classification of the lease:
1. Finance Lease 2. Operating Lease
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Accounting by Seller/Lessee (IFRS) - Finance Lease |
If a sale-leaseback transaction results in a finance lease, any profit from the sale-leaseback transaction is deferred & amortized over the lease term. |
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Accounting by Seller/Lessee (IFRS) - Operating Lease |
If a sale-leaseback transaction results in an operating lease, profit or loss from the sale-leaseback transaction is recognized based on the leased asset's carrying amount, FV & selling price. a. Sales Price = FV (general rule): profit or loss is recognized immediately b. Sales Price Above FV: Profit is deferred & amortized over asset's expected usage period. c. Sales Price Below FV: Profit/loss recognized immediately except that if loss is compensated for by future lease payments at below market price, the loss is deferred & amortized over the asset's expected usage period. |
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Sale-leaseback - Accounting by Purchaser-lessor |
The acquisition of the asset is accounted for as a purchase. If the lease is an operating lease, it is accounted for as such. If the lease is a capital lease, it is accounted for as a direct financing lease. |
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Subleases - Accounting by Original Lessor |
If the original lessee enters into a sublease, the original lessor's accounting for the lease will not change. |
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Subleases - Sublease Classification by Original Lessee and Sublessee |
When a lessee sublets property to another, the newly created sublease must be classified as either an operating lease or capital lease. 1. Original Lease = Operating Lease If original lease was an operating lease, sublease is also an operating lease. 2. Original Lease = Capital Lease a. If original lease was a capital lease due to: (1) Ownership transfer (2) Written bargain purchase option Then sublease is also a capital lease. b. If original lease as a capital lease cuz it met either of the other requirements: (1) Ninety percent FV (2) Seventy-five percent of life Then sublease will be an operating lease unless it meets one of the capital lease requirements. |
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Douglas Co. leased machinery with an economic useful life of six years. For tax purposes, the depreciable life is seven years. The lease is for five years, and Douglas can purchase the machinery at fair value at the end of the lease. What is the depreciable life of the leased machinery for financial reporting? |
5 years. The purchase option is for " fair value." It is not a "bargain purchase option" therefore the assumption cannot be made that Douglas Co. will acquire the machine at the end of the lease period. As a result, the machinery should be depreciated over the five-year lease term under both IFRS & U.S. GAAP. |
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Jan 2, Yr 1, Marx as lessee signed a 5-yr noncancelable equipment lease w/ annual payments of $200,000 beg. Dec 31, Yr 1. Marx treated this transaction as a capital (finance) lease. The 5 lease payments have a present value of $758,000 at Jan 2, Yr 1, based on 10% interest. What should Marx report as interest expense for the year ended Dec 31, Year 1? |
$75,800. The lease term began January 2, Year 1 on a lease valued at $758,000. The first payment of $200,000 was made on December 31, Year 1. Since the interest rate is 10% and one year has expired, Marx Co.'s interest expense is computed as 10% of $758,000 or $75,800. The remainder of the $200,000 payment reduces the obligation under the lease. |
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In sale-leaseback transaction, gain resulting from sale is deferred at the time of sale-leaseback & amortized under U.S. GAAP when? I. The seller-lessee has transferred substantially all the risks of ownership. II. The seller-lessee retains the right to substantially all of the remaining use of the property. |
II only. Recognition of a gain resulting from the sale in a sale-leaseback should be deferred when the seller-lessee retains the right to substantially all of the remaining use of the property (as in a capital lease). |
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6-year capital lease entered into on Dec 31, Yr 1, specified equal minimum annual lease payments due Dec 31 each year. The first annual lease payment, paid Dec 31, Year 1, consists of which of the following? Interest expense Lease liability a. No Yes b. Yes No c. Yes Yes d. No No
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Choice "a" is correct. The debt was incurred on December 31, Year 1. The initial payment was made on December 31, Year 1. No interest expense is recognized since no time has passed between when the debt was incurred and the payment was made. Thus, the full amount of the payment reduces the lease liability. |
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Glade leases computer equipment to customers under GAAP direct-financing leases. Equipment has no residual value & the leases do not contain bargain purchase options. Glade wishes to earn 8% interest on a 5-yr lease of equipment w/ $323,400 FV. PV of an annuity due of $1 @ 8% for 5 yrs is 4.312. What is the total amount of interest revenue that Glade will earn over the life of the lease? |
$51,600. The FV of the equipment = the PV of the future cash flows. $323,400 = annual rents x 4.312 Thus, annual rents = $75,000 Total cash flows = 5 x $75,000 = $375,000 and total interest revenue equals $51,600 [$375,000 total cash flows less $323,400 present value of cash flows]. |
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When should a lessor recognize in income a nonrefundable lease bonus paid by a lessee on signing an operating lease? a. At the expiration of the lease. b. Over the life of the lease. c. When received. d. At the inception of the lease. |
Since the lease bonus is nonrefundable, it represents income attributable to the lease term. Therefore, recognition is deferred and recognized equally over the life of the lease. |
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At the inception of a capital (finance) lease, the guaranteed residual value should be: a. Included as part of minimum lease payments only to the extent that guaranteed residual value is expected to exceed est. residual value. b. Included as part of minimum lease payments at present value. c. Excluded from minimum lease payments. d. Included as part of minimum lease payments at future value. |
Included as part of minimum lease payments at present value. |
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Graf, a lessor, granted Zep, a lessee, 12 months free rent under a 5-yr operating lease. The lease was effective Jan 1, Yr 1, & provides for monthly rental payments to begin Jan 1, Year 2. Zep made the 1st rental payment Dec 30, Yr 1. How much revenue should Graf report in Yr 1? a. Zero. b. 1/4 of total cash received over the lease life c. Cash received during Year 1. d. 1/5 of total cash received over the lease life
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Choice "d" is correct. Annual rental revenue equals the total rental revenue from the lease allocated over the full life of the lease. In this case, revenue equals total cash divided by five years. |
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Under GAAP, 1 criterion for a capital lease is the term of the lease must equal a minimum % of leased property's estimated economic life at inception of lease. What is this minimum %? a. 51% b. 90% c. 75% d. 80% |
The U.S. GAAP lease term criterion is that the lease term be greater than or equal to 75% of the economic life of the leased asset. |
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Neal entered 9-yr capital (finance) lease on Dec 31, Yr 1. Lease payments of $52,000, incl. real estate taxes of $2,000, & are due annually, beg. Dec. 31, Yr 2, & every Dec 31 after. Neal does not know the interest rate implicit in the lease; incremental borrowing rate is 9%. The PV of an ordinary annuity for 9 yrs @ 9% is 5.6. What is the capitalized lease liability @ Dec. 31, Yr 1? |
Capital (finance) leases should be recorded at the present value of the minimum lease payment (fair market value of property is not stated). The lease payment is used. Taxes should be expensed when paid. $50,000 x 5.6 = $280,000 |
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Howe leased equipment to Kew on Jan 2, Yr 1, for 8-yr period expiring Dec 31, Yr 8. Equal payments under the lease are $600,000 due on Jan 2 each year. 1st payment was made Jan 2, Yr 1. The list selling price of the equipment is $3,520,000 & carrying cost is $2,800,000. The lease is accounted for as a sales-type lease. The PV of lease payments at imputed interest rate of 12% (Howe's incremental borrowing rate) is $3,300,000. What profit on the sale should Howe report for the year ended Dec 31, Yr 1? |
The excess of the present value of the selling price over its cost is recorded as profit.
Present value of payments $ 3,300,000 Carrying cost (2,800,000) Profit on sale $ 500,000 |
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Wall leased office premises to Fox, for a 5-yr term beg. Jan 2, Yr 1. Under terms of operating lease, rent for 1st yr is $8,000 & rent for yrs 2-5 is $12,500 per annum. As, an inducement to enter the lease, Wall granted Fox the first six months of the lease rent-free. In its December 31, Year 1 income statement, what amount should Wall report as rental income? |
Rent in Year 1 (1/2 of $8,000) = $ 4,000 Rent in Years 2-5 ($12,500 x 4) = 50,000 Total rent = $54,000 Year 1 Rent (1/5 x $54,000) = $ 10,800 |
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Jan 2, Yr 1, Nori (lessee) entered a 5-yr lease. Nori accounted for the acquisition as a capital lease for $240,000, including a $10,000 bargain purchase option. At end of lease, Nori expects to exercise the bargain purchase option. Nori estimates the equipment's FV is $20,000 at end of its 8-yr life. Nori uses SL depreciation. For the yr ended Dec 31, Yr 1, what should Nori recognize as depreciation expense? |
When a lease is capitalized because of transfer of title or bargain purchase, depreciation is based on the life of the asset, not the lease. The cost includes the bargain purchase price. Depreciation cannot be taken below the salvage value. Depreciation is: ($240,000 - 20,000) / 8 years = $27,500 |
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Star leases a building. The 10-yr nonrenewable lease expires Dec 31, Yr 10. In Jan Yr 5, Star redecorated its showroom & made leasehold improvements of $48,000. Estimated useful life of improvements is 8 yrs. Star uses SL method of amortization. What amount of leasehold improvements, net of amortization, should Star report in its June 30, Year 5, balance sheet? |
Leasehold improvements should be amortized over the lesser of the remaining life of the lease (6 years), the life of the improvement (8 years). $48,000 ÷ 6 = $8,000 amortization for a year or $4,000 for January Year 5 through June 30, Year 5. $48,000 - $4,000 = $44,000. |
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Robbins leased a machine from Ready. The lease qualifies as a capital lease & requires 10 annual payments of $10,000 beg. immediately. Lease specifies 12% interest rate & $10,000 purchase option at end of 10th yr. Robbins' incremental borrowing rate is 14%. PV of an annuity due of 1 at: 12% for 10 yrs is 6.328 & 14% for 10 yrs is 5.946. PV of 1 at: 12% for 10 yrs is .322 & 14% for 10 years is .270. What is the lease liability at beg. of lease term? |
The bargain purchase option must also be capitalized. The amount capitalized is:
Annual payments, $10,000 x 6.328 = $ 63,280
Bargain purchase option, $10,000 x .322 = 3,220
Total = $ 66,500 |
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Lease A does not contain a bargain purchase option, but lease term is 90% of estimated economic life of leased property. Lease B does not transfer ownership of property, but lease term is 75 percent of estimated economic life of the leased property. How should the lessee classify these leases under U.S. GAAP? Capital or Operating? |
Both leases have terms equal to or more than 75% of their estimated economic life; so both are capital leases. Rule: if any of these conditions are met, a lease is a capital lease & is treated as if owned by the lessee: Lease transfers ownership to lessee by the end of the lease term. The lease contains a bargain purchase option. PV at beg. of lease term of the "minimum lease payments" equals or exceeds 90% of the fair value of the leased property. Lease term is 75% or more of estimated economic life of the leased property. |
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Jan 1, Yr 1, Park signed a 10-yr operating lease at $96,000/yr. Lease includes a provision for additional rent of 5% of annual company sales in excess of $500,000. Park's sales for the year ended December 31, Year 1 were $600,000. Upon execution of the lease, Park paid $24,000 as a bonus for the lease. Park's rent expense for the year ended December 31, Year 1 is: |
Base rent (operating lease)$ 96,000 Additional rent ($600,000 − $500,000 = $100,000 x 5%) = 5,000 Amortization of lease bonus ($24,000 ÷ 10 yrs.) = 2,400
Rent expense, Year 1$ 103,400 |
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Jan 1, Yr 1, Tell Co. leased equipment from Swill under 9-yr sales-type lease. Equipment had a cost of $400,000 & estimated useful life of 15 yrs. Semiannual lease payments of $44,000 are due Jan 1 and July 1. PV of lease payments at 12% was $505,000, which = sales price of the equipment. Using SL method, what is the depreciation expense in the current year? |
Present value of minimum lease payments = $ 505,000
÷ 9 (Lease term) = Straight-line depreciation expense $ 56,111 |
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Koby entered into capital lease w/ a vendor for equipment on Jan 2 for 7 yrs. Equipment has no guaranteed residual value. Lease required Koby to pay $500,000 annually on Jan 2, beg. w/ the current year. The present value of an annuity due for seven years was 5.35 at the inception of the lease. What amount should Koby capitalize as leased equipment? |
The amount to be capitalized for a capital lease is the present value of the minimum lease payments. In this question, the minimum lease payments are $500,000 and the present value factor is 5.35. The present value of the minimum lease payments is thus $500,000 x.5.35, or $2,675,000. |
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Which is a criterion for a lease to be classified as a capital lease under GAAP? a. The present value of the minimum lease payments is 70% or more of the fair market value of the leased property. b. The lease contains a bargain purchase option. c. The lease term is equal to 65% or more of the estimated useful life of the leased property. d. The lease does not transfer ownership of the property to the lessee. |
The lease contains a bargain purchase option. |
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Steam acquired equipment under a capital lease for 6 yrs. Minimum lease payments were $60,000 payable annually at yr-end. Interest rate was 5% w/ annuity factor for 6 yrs of 5.0757. PV of the payments was equal to the FV of the equipment. What amount should Steam report as interest expense at the end of the first year of the lease? |
he capital (finance) lease will be recorded by debiting leased asset and crediting capital lease obligation for $304,542 ($60,000 minimum lease payment x 5.0757 annuity factor). The interest expense in the first year will be calculated by multiplying the 5% interest rate times the capital (finance) lease obligation: $304,542 x 5% = $15,227. |
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Oak leased equipment for its entire 9-yr useful life, agreeing to pay $50,000 at start of lease term on Dec 31, Yr 1, & $50,000 annually on Dec 31. Oak paid $3,000 in initial direct costs at lease inception. PV on Dec 31, Yr 1, of the 9 lease payments, using implicit rate of 10% was $316,500. Dec 31, Yr 1, PV of lease payments using Oak's incremental borrowing rate of 12% was $298,500. Oak accounts for the finance lease under IFRS and uses SL depreciation. What should Oak report as finance lease asset on Dec 31, Yr 2 B/S? |
$284,000. Under IFRS, initial direct costs must be added to the finance lease asset at lease inception |
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Able Co. leased equipment to Baker under a noncancellable lease with a transfer of title. Will Able record depreciation expense on the leased asset and interest revenue related to the lease? |
No-Yes. Able Co. leased equipment to Baker under a noncancellable lease with a transfer of title. Will Able record depreciation expense on the leased asset and interest revenue related to the lease? |
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What are the components of the lease receivable for a lessor involved in a direct-financing lease? a. Minimum lease payments + executory costs. b. Minimum lease payments + residual value. c. Minimum lease payments less initial direct costs. d. Minimum lease payments less residual value.
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Lessors recording a lease receivable for a direct-financing lease should include the minimum lease payments PLUS any residual value. The reason for this is because the lessor can also expect to collect this residual value from the lessee at the culmination of the lease. |
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A company enters into a three-year operating lease agreement effective January 1, year 1. The amounts due on the first day of each year are $25,000 in year 1, $30,000 in year 2, and $35,000 in year 3. What amount, if any, is the related liability on the first day of year 2? |
$5,000. Operating lease expense must be recorded equally over the life of the lease. The average annual lease amount is $30,000 per year, or $2,500 per month. |
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Peg leased equipment from Howe July 1, Yr 1 for 8-yr period ending June 30, Yr 9. Equal payments under the lease are $600,000 due July 1 each year. 1st payment was made July 1, Yr 1. The rate of interest is 10%. Cash selling price of equipment is $3,520,000, & cost of equipment on Howe's accounting records is $2,800,000. The lease is appropriately recorded as a sales-type (finance) lease. What profit on the sale & interest revenue should Howe record for the year ended Dec 31, Year 1? |
$720,000 sale profit $146,000 interest revenue Cash selling price of equipment $ 3,520,000 Less cost of equipment (2,800,000) Profit recognized on sale $ 720,000
PV of the lease at 7/1/Year1 $ 3,520,000 Less initial payment 7/1/Year 1(600,000) Balance during first year 2,920,000 2,920,000 x 10% x 0.5 = $ 146,000 |
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Jan 1, Yr 1, Hooks sold equipment w/ a carrying amount of $100,000 & remaining useful life of 10 yrs to Maco for $150,000. Hooks leased the equipment back under a 10-year (finance) lease w/ PV of $150,000 & will depreciate the equipment using SL method. Hooks made the 1st lease payment of $24,412 in Dec Yr 1. In Hooks' Dec 31, Yr 1, B/S, unearned gain on equipment sale under IFRS should be: |
Rule: Any profit on a sale-leaseback classified as a capital (finance) lease should be deferred & amortized in proportion to depreciation taken on the leased-back asset. Selling price $ 150,000 Carrying value (100,000) Deferred Gain 1/1/Yr1 50,000 50,000÷ 10 years = (5000) Deferred gain 12/31/Year 1 $ 45,000 |
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In an IFRS sale-leaseback transaction, a gain resulting from the sale is deferred and subsequently amortized when: I. The seller-lessee accounts for the lease as a finance lease. II. Seller-lessee accounts for lease as operating lease and the sales price equals fair value. III. The seller-lessee accounts for the lease as an operating lease & sales price is above FV. IV. The seller-lessee accounts for the lease as an operating lease & sales price is below FV. |
I and III. |
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Finance Here provides leased-based financing for commercial generators. Sales of the generators are properly accounted for as operating sales-type (finance) leases. Terms of the leases include return of the generators to Finance Here for resale in secondary markets. Company estimates the non-guaranteed residual values on generators = an avg. of 10% of the historical cost of the generators. Finance Here Sales & Service can expect that: |
a. COGS will be less than the historical cost of the generators sold. b.COGS will be equal to the historical cost of the generators sold. c. The relationship of COGS & the historical cost of the generators cannot be determined. d. COGS will be greater than the historical cost of the generators sold. In a sales-type lease, COGS = historical cost of asset sold - PV Of the non-guaranteed residual value discounted over the life of the lease. |
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June 1, Yr 1, a company entered a lease agreement. The lease is an operating lease and is fully executed on that day. Payments of $28,900 per month are scheduled to begin Oct 1 of the current year & continue each month thereafter for 56 months. Lease term spans 5 yrs. What amount is the company's lease expense for the current calendar year? |
If free or reduced rent is part of the lease package, the lessee must take the total rent expense to be paid for the entire term of the lease and divide it evenly over each period. Rent to be paid per month $ 28,900× 56 = $1,618,400 $1,618,400 ÷ 60 = $26,973 26,973 × 7 = $ 188,813 |
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Jan 1, a company enters into an operating lease & receives control of the property to make leasehold improvements. Company begins alterations on March 1 & the staff moves in on May 1. Monthly rental payments begin July 1. The recognition of rental expense for the new offices should begin in which month? |
The lessee should begin the recognition of rental expenses for the new office in January as rent expense is recorded over the lease term. |
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Spring entered a 5-yr operating lease agreement w/ Fall Corp. Spring, the lessee, paid an additional $5,000 nonrefundable lease bonus to Fall upon signing the agreement. When would Fall recognize in income the nonrefundable lease bonus paid by Spring?
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Over the life of the lease. The appropriate accounting treatment for a lease bonus to the lessor in an operating lease is that the bonus is originally recorded as deferred revenue and then amortized into income over the life of the lease. |
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A lease is classified as a capital lease because it contains a bargain purchase option. Over what period of time should the lessee amortize the leased property? a. The lease term or the economic life of the asset, whichever is shorter. b. The economic life of the asset. c. The economic life of the asset, not to exceed 40 years. d. The term of the lease. |
With a capital lease, the lessee should amortize the leased property over the economic life of the asset when there is a bargain purchase option or when the lessee takes ownership of the asset at the end of the lease term. |
