301921 Finance Lease - 3F Flashcards
At the commencement of a finance lease, a guaranteed residual value that is probable should be:
excluded from lease payments.
included as part of lease payments at future value.
included as part of lease payments only to the extent that guaranteed residual value is expected to exceed estimated residual value.
included as part of lease payments at present value.
Question #301921
included as part of lease payments at present value.
Per FASB ASC 842-10-30-5, at the commencement date, lease payments include fixed payments, variable lease payments, reasonably certain option exercise prices, payments for penalties, fees paid by the lessee to owners of a special-purpose entity, and amounts probable of being owed under residual value guarantees.
Note: The lessee includes in the payment only the amount of the guaranteed residual value that is probable of being owed. If the expected residual value will be greater than the guaranteed residual value, then the lessee can ignore it.
FASB ASC 842-10-30-5
Commencement Date
The commencement date is the date on which a lessor makes an underlying asset available for use by a lessee.
FASB ASC Glossary
Finance Lease
A lessee shall classify a lease as a finance lease and a lessor shall classify a lease as a sales-type lease when the lease meets any of the following criteria at lease commencement:
- The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
- The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
- The lease term is for the major part of the remaining economic life of the underlying asset. However, if the commencement date falls at or near the end of the economic life of the underlying asset, this criterion shall not be used for purposes of classifying the lease.
- The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments equals or exceeds substantially all of the fair value of the underlying asset.
- The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.
FASB ASC 842-10-25-2
FASB ASC 842-10-25-2
Lease Payment
At the commencement date, the lease payments shall consist of the following payments relating to the use of the underlying asset during the lease term:
- Fixed payments, including in-substance fixed payments, less any lease incentives paid or payable to the lessee
- Variable lease payments that depend on an index or a rate (such as the Consumer Price Index or a market interest rate), initially measured using the index or rate at the commencement date
- The exercise price of an option to purchase the underlying asset if the lessee is reasonably certain to exercise that option
- Payments for penalties for terminating the lease if the lease term reflects the lessee exercising an option to terminate the lease
- Fees paid by the lessee to the owners of a special-purpose entity for structuring the transaction
- For a lessee only, amounts probable of being owed by the lessee under residual value guarantees
FASB ASC 842-10-30-5
2361.07
The first set of criteria result in a finance lease for a lessee if the lease meets any of the following criteria at commencement:
- Title (ownership) transfers to the lessee by the end of the lease term.
- The lease contains a purchase option that the lessee is reasonably certain to exercise.
- The lease term is for the major part of the remaining economic life of the underlying asset. This criterion shall not be used if the lease commencement date is near the end of the asset’s economic life.
- The present value of the sum of the lease payments and any lessee guaranteed residual value not already in the lease payments equals or exceeds substantially all of the fair value of the underlying asset.
- The underlying asset is specialized and is not expected to have an alternative use to the lessor at the end of the lease term.
2361.09
Lease Classification
- The core principle of the lessee accounting model is that an entity should recognize assets and liabilities arising from leases with a lease term of more than 12 months. In essence, a lease is accounted for as either a rental (operating lease) or a purchase/sale with debt financing (finance lease).
- A lessee will recognize a “right of use” (ROU) asset representing its right to use the leased asset for the lease term and a lease liability to make lease payments.
The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee depends on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset.
2361.10
Finance leases: For most leases of assets other than property (e.g., cars or trucks, construction or manufacturing equipment), a lessee will classify the lease as a “finance” lease if it meets any of the five criteria listed in section 2361.07, and it will recognize the following:
- At commencement: A lease liability and a right-of-use (ROU) asset. The lease liability is initially measured at the present value of lease payments discounted at the rate implicit in the lease if known; otherwise, the lessee uses its incremental borrowing rate. The ROU asset is initially measured as the lease liability plus any lease payments made to the lessor at or before the commencement date minus any lease incentives received plus any initial direct costs.
- Subsequent to commencement: The unwinding of the discount on the lease liability (i.e., interest expense), using the effective interest method, is accounted for separately from the amortization of the ROU asset. (Note: If a finance lease is due to a transfer of ownership or if the lessee is reasonably certain to exercise a purchase option, the lessee shall amortize over the ROU asset life instead of the shorter of the lease term or ROU asset life.) Impairment, if any, is recorded.
2361.10
Example: On January 1, Year 1, a finance lease agreement was entered into that requires annual lease payments of $42,500 over a 4-year lease term, which equals the remaining useful life of the asset. There is no residual value. The first payment is due on January 1, Year 1. The interest rate is 7%, resulting in a present value of $154,000 (rounded). Prepare the journal entries for the first year.
To record lease:
ROU Asset 154,000
Lease Liability 154,000
To record payment at commencement:
Lease Liability 42,500
Cash 42,500
To record financing cost:
Interest Expense 7,805
Lease Liability 7,805
($154,000 − $42,500 = $111,500; $111,500 × 7%)
To record amortization of the ROU asset:
Amortization Expense 38,500
ROU Asset 38,500
