Lease (ASPE 3065)

Question 1

What are the criteria used by a lessee to classify a
lease as operating or capital?

Answer 1

• Reasonable assurance of ownership transfer
  e.g. if there is a bargain purchase option (BPO)
• Lease term is 75% or more of economic life of
  asset
• PV of minimum lease payments (MLP) is 90%
  or more of fair value of property

‒ MLP = minimum rental payments + guaranteed
residual + BPO

‒ Discount rate = lower of incremental borrowing
rate and rate implicit in lease (PV cannot exceed
FV of asset)

Question 2

How are leases accounted for by the lessee (balance sheet and income statement impact)?

Answer 2

Capital lease (At inception)

• Lessee records an asset and obligation at PV of minimum lease payments (discount rate = lower of rate implicit in lease and incremental borrowing rate)
• Any initial direct costs are expensed

Capital Lease (Subsequent)

• Subsequently the lessee records amortization of the asset and interest (accretion) expense on the lease liability
• The asset is amortized over the shorter of the lease term and the assets useful life
• The cash payment are treated like loan payments split between liability reduction and interest expense

Operating lease

• Expense lease payments on straight-line or other rational basis over lease term

Question 3

How are lease inducements e.g., free rent at beginning or end of an operating lease
accounted for by the lessee?

Answer 3

• Inducements are recognized as an offset to rent expense evenly over the lease term i.e., same rental expense recognized each month
  ‒ e.g., If free rent is at beginning the lessee would debit rent expense and credit a liability in months when no rent is paid. In months when rent is paid credit cash and debit rent expense and liability (rent expense will be lower than cash payment so difference reduces liability). Liability will
  be zero by end of lease term.

‒ If free rent is at end, the lessee would debit rent expense and lease inducement asset and credit cash each month that rent is paid. By end of lease term asset will equal free rent and you can debit rent expense and credit the asset in the last month(s) when no rent is paid.

Question 4

What are the criteria used by a lessor to classify a
lease as operating or capital?

Answer 4

• A lease is classified by the lessor as a capital
  lease if:
• It meets any one of the capital lease
  criteria used by the lessee
• The credit risk is normal when compared
  to the risk of collection of similar receivables
• Any Unreimbursable costs can be
  reasonably estimated

Question 5

From the lessor’s perspective, ASPE further subdivides capital leases into sales-type and direct
financing. How is each defined and how are they accounted for?

Answer 5

Sales Type Lease

• Definition
• Usually lessor is a manufacturer or dealer
• At inception FV of property is not equal to
  carrying value
• Accounting treatment
• Record as a sale
• Sales revenue =lesser of fair value of asset and PV of MLP computed using market rate

Direct Financing Lease

• Definition
  Usually financial institution or leasing
  company is the lessor
  At inception FV of property = CV
  (institution buys asset for the purpose of
  leasing it to earn finance income)
• Accounting treatment
• Record a lease receivable = PV of
  lease payments
• Record interest income over the
  lease period