Flashcards in Section 12 - Accounting for Leases Deck (25):
What is the goal for accounting for leases?
To recognize the true SUBSTANCE OVER THE FORM.
Maybe a true rental (Operating Lease) or it could be a purchase of sale, which transfers all the rights and risks of ownership (Capital Lease/Non-operating Lease)
How are Operating Lease costs under the Lessor (owner) treated?
-Direct lease costs (commissions, legal fees) amortized S/L over the lease term
-Executory costs recognized as incurred
-Lease bonus is deferred (unearned revenue) and amortized over the life of the lease
-Rent received in advance is considered unearned (deferred revenue)
-Nonrefundable - unearned revenue until earned
-Refundable - liability until returned (db cash, cr Liab)
-Uneven rental payments are recognized uniformly over the lease term
JE - Lease payments
Cash or Rent receivable
How are Operating Lease costs under the Lessee (renter) treated?
-Risk of ownership does not pass
-No asset or liability recorded on F/S
-Lease rent is recognized uniformly (evenly)
-Lease bonus considered an asset and amortized S/L over the lease term
-Leasehold improvements are reported with PPE and amortized over the shorter of LEASE TERM or USEFUL LIFE
-Refundable security deposits are assets (receivable)
JE - Lease payments
Cash or Rent Payable
What are executory costs?
What is a Capital Lease?
A lease where the RIGHTS and RISKS of ownership have transferred from the lessor to the lessee.
In substance its a purchase, although in form it's a lease.
What are the 4 criteria a lease must meet to qualify as a Capital Lease?
Must meet one of these criteria:
1) TT - Title Transfer
2) BPO - Bargain purchase option
3) 75 - lease term is greater than or equal to 75% of the useful life
4) 90 - PV of Minimum Lease Payment (MLP) is greater than or equal to 90% of the FMV
What is included in the Lessee's Minimum Lease Payments (MLP)?
1) Base rent
4) Residual Value
What are not included in the MLP?
1) Contingent rents
2) Executory costs
These are recorded as income by Lessor and expense by Lessee.
What amount of the lease does the Lessee record?
Lower of FMV or PV of MLP
FMV (A new implicit interest rate must be calculated)
PV of MLP
-Periodic payments (annual payment)
-BPO (lump sum)
-Guaranteed Residual Value (only if guaranteed by Lessee, always recorded in Lessor's book)
-Penalty for failure to renew (if any)
-DO NOT include executory costs. They are expense as incurred.
Which interest rate is used by the Lessee to PV the payments?
Lesser of Incremental Rate (from the bank) OR Lessor's Implicit Rate (if it is known)
**Lessor will always use their implicit rate
What method is used to amortize the lease payments?
Effective Interest Method
Lease Liability X Interest Rate (incremental or implicit rate) = Interest expense/income - Lease payment = Amortization of lease liability
What are the J/Es for lease payments under Capital Lease for the Lessee?
First Payment (Day 1)
Second Payment (one year later)
Interest Expense (plug)
What term/year does Lessee use to depreciates asset under a Capital Lease?
TT and BPO
-depreciate over USEFUL LIFE
-take out salvage value
-ownership has transferred
-depreciates over shorter of useful life or lease term
-ignore salvage value
What are the Disclosures requirement for Capital Lease?
-description of entity's leasing activities
-gross amount of assets recorded under capital lease
-MLP for each of the next 5 years
-all remaining years (after the 5 years) as a total group (aggregate)
What are the 2 Non-Operating Leases for Lessor?
1) Sales Type Lease
2) Direct Financing Lease
In addition to the criteria for Capital Lease for Lessee, what are the two other criteria for Non-Operating Lease for Lessor?
1) COLLECTABILITY of the lease payments is reasonably assured
2) NO SIGNIFICANT UNCERTAINTIES re: unreimburseable costs to be incurred by the lessor (MEASURABILITY)
What is a Sales Type Lease and how do you treat the costs/gains?
FV of the cost usually differs from the cost. Which creates a profit/loss on sale and interest revenue to be earned over the lease term using the Effective Interest Method.
Lessor always use the implicit rate (their rate)
What are the J/Es for Sales Type Lease (Non Operating) for Lessor?
Gross investment in lease (MLP + residual value)
Unearned interest (contra account, amortize)
*Sales Revenue = PV of MLP + PV of residual value
COGS (cost of asset - initial indirect costs - PV of unguaranteed residual value
Inventory (cost of asset)
Gross investment in lease (receivable)
Interest is recognized at first anniversary of lease term.
Unearned interest rev
What is a Direct Financing Lease and how do you treat the revenue?
Lease where the Lessor is not earning a manufacturer's or dealer's profit. The PV of the MLP will be equal to the FV of the property and the lessor will earn only interest income.
Lease payment receivables (minimum lease payment + residual value)
Unearned interest revenue
-Interest revenue decreases with passage of time
-principal amount increase with each payment
-carrying amount of lease decreases
What is a Sale-Leaseback
Property owner sells the property and the immediately leases all or part of it back. Considered two separate transactions.
How do you determine what portion of rights to the leaseback property for the Lessor?
-If PV of Lease Payments >= 90% of asset's FMV, seller-lessee retains substantially ALL the rights
-accounted as Capital Lease
-defer all gain and offset against depreciation expense
If PV of Lease Payments
What is the difference between Annuity Due and Ordinary Annuity for Lease Payments?
-Payment begins at the START of the lease
- Payment begins after the end of the first year
Under IFRS, what is Capital Lease called?
Under IFRS if the RISKs and REWARDS of ownership has been transferred
What are the 4 criteria for Financing Lease under IFRS?
3) lease term MAJOR PART of the asset's useful life
4) PV MLP is SUBSTANTIALLY EQUAL to the FV of the asset