Chapter 8 (Unit 7) Accounting for Leases Flashcards
For Short-Term Leases:
a) What is the Lessee’s journal entry to record lease expense?
b) What is the Lessor’s journal entry to record lease revenue?
a)
D: Lease Expense
C: Cash or Payable
b)
D: Cash or Receivalbe
C: Lease Revenue
Define an Operating Lease.
A lease that is greater than 12 months but does not meet any of the five finance lease criteria.
On January 1, 20x8, Jake Co. (lessee) leased equipment from Paul Co. (lessor) for a five year lease term.
Equipment has a cost and fair value of $80,000 and a useful life of 7 years with no salvage value.
No renewal option or purchase option, equipment will revert back to Paul Co. at the end of the lease term, equipment has alternative use.
Unguaranteed residual value = $15,000
Implicit rate, of which Jake is aware, is 7%.
Paul uses the straight-line method of depreciation.
Payments are due at the beginning of the year (annuity due).
a) Calculate the lease payment
b) What is the Lessor’s journal entry to record the 01/01/x8 lease payment at the beginning of the year?
c) What is the Lessor’s AJE for the lease payment on 12/31/x8?
d) What is the Lessor’s AJE for the depreciation of the asset on 12/31/x8?
e) What is the Lessee’s first journal entry at the beginning of the lease period?
f) What is the Lessee’s journal entry for their first lease payment and when is the payment made?
g) What is Lessee’s journal entry to record lease expense for 20x8?
h) What is the Lessee’s journal entry to record the second lease payment (x9)
I) What is the Lessee’s journal entry to record lease expense for 20x9?
Fair Value of the Equipment = $80,000
Less: PV of the Unguaranteed Residual Value = 10,694.85 (15,000 x 0.71299)
On Calculator:
FV = 15,000
N= 5
I/Y = 7
PV = 10,694.85
Amount to be recovered through Lease Payments = 80,000 -10,694.85 = 69,305.15
Divide by the Present Value Factor of an Annuity Due for 5 years at 7% = 4.38721
Annual lease payment to charge the lessee = 69,305.15 / 4.38721 = 15,797.09
On Calculator:
BGN Mode
PV = 69,305.15
N = 5
I/y = 7
a) PMT = 15797.09
b)
D: Cash 15,797.09
C: Unearned Lease Revenue 15,797.09
c) Now that the year has passed, the lessor can recognize the lease revenue earned.
D: Unearned Lease Revenue 15,797.09
C: Lease Revenue 15,797.09
d)
D: Depreciation Expense 11,428.57 (80,000 / 7 years)
C: Accumulated Depreciation 11,428.57
e) Lessee capitalizes the present value of the lease payments
D: Right-of-Use Asset 69,305.15
C: Lease Liability 69,305.15
f) Because the lease is an annuity due, the payment is made at the beginning of the month, 01/01/x8
D: Lease Liability 15,797.09
C: Cash 15,797.09
g)
D: Lease Expense 15,797.09
C: Right-of-Use Asset 12,051.53 (amortization)
C: Lease Liability 3,745.56 (recording the interest into the lease liability
h)
D: Lease Liability 15,797.09
C: Cash 15,797.09
i)
D: Lease Expense 15,797.09
C: Right-of-Use Asset 12,895.13
C: Lease Liability 2,901.96
Finance (lessee) or Sales-Type (Lessor) leases must meet one of five criteria.
What are that criteria?
Lease is noncancelable (in an exam, you can assume a lease is noncancelable until explicitly stated otherwise)
1) Transfer of ownership at the end of the lease term
2) Purchase Option / Bargain Purchase Option
3) Lease Term is 75% or greater than the Economic Life
4) Present Value of the Lease is 90% or more of the Fair Value of the Asset
5) The Asset does not have alternative uses to the Lessor once the lease term ends
When is a Lease considered an Operating Lease (lessee)? (Lessor perspective would be operating or direct financing)
Lease term is longer than one year (otherwise it would be a short-term lease)
Meets none of the Finance/Sales lease criteria.
What are the steps to determine if the present value of your lease is 90% or more than the fair value of the asset?
You need to know which interest rate to use.
Implicit Rate - the rate the lessor uses to calculate their rate of return on the lease
Incremental Rate - the borrowing rate the lessee would have to pay if they went through a bank or a lending institution to finance this lease
If, as the lessee, you know the lessor’s implicit rate and that rate is less than your incremental borrowing rate, then you will use the implicit rate
If, as the lessee, you do not know the lessor’s implicit rate, then you will use the incremental borrowing rate.
The Lessor will always use the implicit interest rate - the rate earned by the lessor on the lease. Effectively, the rate equating the PV of the minimum lease payments and unguaranteed residual value to the asset’s fair value. This rate may also be referred to as the rate of return.
A leased asset has a fair value of $45,000 and a 7-year useful life.
Annual lease payments of $11,000 are due at the end of each year (ordinary annuity) over a 5-year lease term.
Expected value at the end of the lease term is $10,000, unguranteed.
The lessor’s implicit interest rate is 10%. The ordinary annuity PV factor is 3.79.
The lessee’s incremental borrowing rate is 9.0%. The ordinary annuity PV factor is 3.89.
The lessee knows the lessor’s implicit rate.
Does this lease meet any of the five criteria to be considered a financing/sales-type lease?
- Title Transfer? - NO
- BPO? - NO
- Lease > 75% useful life? (5 / 7 = 71%) - NO
- PV of minimum lease payments > 90% of FV? (42,790 / 45,000 = 95%) YES
Use the lower rate: 9% incremental rate
$11,000 x 3.89 = $42,790 - No Alternative Use? Assume no when no information is explicitly stated. - NO
a) What is the Lessee’s journal entry at the inception of a Finance Lease?
b) What is the Lessee’s journal entry to record the first lease payment (ordinary annuity)?
c)What is the Lessee’s journal entry to record the first lease payment (annuity due)?
d) What is the Lessee’s journal entry at the end of the first period (annuity due)?
a)
D: Right-of-Use Asset
C: Lease Liability
b)
D: Interest Expense
D: Lease Liability
C: Cash
c) Because the payment comes at the beginning of the period, no interest to recognize
D: Lease Liability
C: Cash
d) Now that time has passed, the Lessee must accrue interest
D: Interest Expense
C: Lease Liability
a) What is the Lesse’s journal entry at the end of the year to record amortization expense on a Finance Lease?
b) How is the Amortization Expense calculated?
a)
D: Amortization Expense
C: Right-Of-Use Asset
b)
Right-of-Use Asset / Shorter of Lease Term or Asset’s Useful LIfe
a) What is the Lesse’s journal entry at the end of the year to record amortization expense on a Finance Lease?
b) How is the Amortization Expense calculated?
a)
D: Amortization Expense
C: Right-Of-Use Asset
b)
Right-of-Use Asset / Shorter of Lease Term or Asset’s Useful Life
How does a Lessor calculate the lease payment they will charge the lessee?
(Fair value of the asset - PV of Unguaranteed Residual Value) / PV factor of the annuity with the N and I/Y
OR
Use PMT function on calculator if PV factor is not given with PV being the amount to be recovered by lease payments (Fair Value of the Asset - PV of any Unguaranteed Residual Value)
On 1/1/yr1 the parties sign a lease with the following data:
Equipment fair value = 25,771
Lease payments due each Dec 31, end of lease term 12/31/yr3
Interest rate for both parties = 8%
Useful life of asset = 3 years
Guaranteed Residual value of 3,000, expected residual value of 2,000
a) What is the lease payment the Lessor calculates?
b) What will the Lessee capitalize as the Lease Liability?
c) What would the Lessee capitalize as the Lease Liability if the Guaranteed Residual value was actually not guaranteed?
a) 9,076
b) 24,184 (23,390 + 794)
(PV of the Annual Lease Payment - PV of the difference between guaranteed and expected residual value)
PV of the Annual Lease Payment
PMT = 9,076
N = 3
I/Y = 8
PV = 23,390
PV of the difference between Guaranteed and Expected Residual Value
FV = 3,000 - 2,000 = 1,000
N = 3
I/Y = 8
PV = 794
c) 23,390
Just the PV of the annual lease payment.
How is the Lessor’s calculation of lease payment affected if there is a GRV vs a UGRV.
Trick question. It does not change the calculation. It only affects the Lessee’s calculation of the amount to capitalize as the lease liability.
How does the reported present value of the leased asset differ between Lessee and Lessor?
How will this difference in present value reporting affect the Lessee and Lessor’s amortization schedules?
The Lessee reduces the fair value of the leased asset by the PV of UGV or GRV to determine the amount of the asset to capitalize.
The Lessor uses the fair value of the leased asset (including UGV or GRV)
On the Lessee’s amortization schedule, the Lease Payable will end at 0.00. The Lessor’s amortization schedule will have just the UGV/GRV remaining at the end of the lease as the final year lease payment which will reduce the lease receivable down to 0 after interest is calculated.
What is the Lessor’s journal entry at the beginning of a Sales-type lease?
D: Lease Receivable (Fair Value of the Leased Asset)
D: Cost of Goods Sold (plug or PV of UGV)
C: Sales Revenue (the amount to be collected from pmts - fair value - PV of residual value)
C: Inventory (removed from Inventory at cost)
