Gleim FAR Study Unit 12

How are selling profits or losses from a direct financing lease accounted for by the lessor at the lease commencement date?

- Selling profits are deferred and reduce the initial amount of net investment in the lease. - Selling losses are recognized in the income statement on the lease commencement date.

What do lease payments at the lease commencement date consist of?

1) Rental payments 2) Purchase option 3) Penalties for terminating the lease (nonrenewal penalties) 4) Guaranteed residual value

What are the five criteria to classify a lease as a finance lease by the lessee and a sales-type lease by the lessor?

A lease is classified as a finance lease by the lessee or a sales-type lease by the lessor if at least one of the following five criteria is met. 1) The lease transfers ownership of the leased asset to the lessee by the end of the lease term. 2) The lease includes an option to purchase the leased asset that the lessee is reasonably certain to exercise. 3) The lease term is for the major part (75%) of the remaining economic life of the leased asset. 4) The present value of the sum of (a) the lease payments and (b) any residual value guaranteed by the lessee equals or exceeds substantially all (90%) of the fair value of the leased asset. 5) The leased asset is so specialized that it is expected to have no alternative use to the lessor at the end of the lease term.

How should a leased asset be accounted for by a lessor in an operating lease?

A leased asset continues to be reported on the lessor's balance sheet and the lessor depreciates the leased asset. No net investment in the lease is recognized.

How is a right-of-use (ROU) asset amortized by a lessee in a finance lease?

A lessee amortizes a ROU asset on the straight-line basis. The amortization period is based on the classification criterion that was satisfied. Lease Classification Criterion Satisfied Amortization Period of the ROU Asset Criterion 1 - Transfer of ownership Useful life of the leased asset Criterion 2 - Exercise of purchase option Useful life of the leased asset Criterion 3 - Major part of the remaining economic life Shorter of ROU asset's useful life or lease term Criterion 4 - Substantially all of the fair value Shorter of ROU asset's useful life or lease term Criterion 5 - No alternative use to the lessor Shorter of ROU asset's useful life or lease term

When are contingent losses accrued?

A material contingent loss is accrued when the following two criteria are met: 1) It is probable that, at the balance sheet date, an asset has been impaired or a liability has been incurred. 2) The amount of the loss can be reasonably estimated.

How are cash receipts from leases presented in a lessor's statement of cash flows?

Cash receipts from all leases (sales-type, direct financing, and operating leases) are classified as cash inflows from operating activities.

How does one determine if the initial transfer of an asset under a sale and leaseback transaction is a sale or not?

Classification of the leaseback by buyer-lessor (Classification of the initial transfer of assets) Finance lease or sales-type lease (Not a sale) Operating lease (A sale (if all revenue recognition criteria are met))

What are the two components of the periodic lease payment recognized by the lessee in a finance lease?

Each periodic lease payment made by the lessee consists of 1) Interest expense Interest expense = Lease liability at the beginning of the period × Discount rate 2) Reduction of the lease liability Reduction of the lease liability = Periodic lease payment - Interest expense NOTE: If the first payment is received at the lease commencement date, its only component is the reduction of the lease liability. No interest expense is recognized.

What is recognized by the lessee at the lease commencement date?

For both finance and operating leases, a lessee must recognize a lease liability and a right-of-use (ROU) asset at the lease commencement date.

Within a range of contingent losses that are both probable and reasonably estimated, what amount is accrued?

With an amount that appears to be a better estimate > The better estimate Without an amount that appears to be a better estimate > The minimum of the range of loss

How is the gain (loss) on sale in a sale and leaseback transaction calculated if the transaction is a sale at fair value?

Gain (loss) on sale = Selling price of the asset - Carrying amount of the asset

How should gain contingencies be accounted for?

Gain contingencies are recognized when realized and adequately disclosed in the notes to the financial statements.

What are the two components of a single periodic lease expense by the lessee in an operating lease?

Interest expense 1) Interest expense = Lease liability at the beginning of the period × Discount rate Amortization of the ROU asset 2) Amortization of the ROU asset = Single periodic lease expense - Interest expense NOTE: The two components are not reported separately in the income statement. The single amount for the total lease expense for the period is reported in income from continuing operations. If the first payment is received at the lease commencement date, its only component is the amortization of the ROU asset. No interest expense is recognized.

What are the two components of periodic lease payments received by a lessor in a sales-type lease?

Interest income Interest income = Beginning net investment in the lease × Discount rate Reduction of net investment in the lease Reduction of net investment in the lease = Periodic lease payment - Interest income NOTE: If the first payment is received at the lease commencement date, its only component is the reduction of the net investment in the lease. No interest income is recognized.

How does a lessor account for lease payments under an operating lease?

Lease payments are recognized as lease (rental) income by the lessor in an equal amount over the lease term. Rental payment recognized each period = Total payments to be received Lease term

Give the calculation for the selling profit or loss recognized by a lessor in a sales-type lease.

Lease receivable + PV of unguaranteed residual value - Carrying amount of the leased asset = Selling profit or loss

Give the calculation for a lease receivable recognized by a lessor in a sales-type lease.

Lease receivable = PV of lease payments + PV of guaranteed residual value

How is the single periodic operating lease expense calculated?

Single periodic lease expense = Total undiscounted lease payments ($) / Lease term (years)

Give the calculation for the net investment in a lease recognized by a lessor in a sales-type lease.

PV of lease payments + PV of guaranteed residual value + PV of unguaranteed residual value = Net investment in the lease OR Lease receivable + PV of unguaranteed residual value = Net investment in the lease

How are payments for operating leases presented in a lessee's statement of cash flows?

Payment (Cash flow classification) Repayment of lease liability (principal) Interest expense on lease liability (Cash outflows from operating activities)

How are finance lease payments presented in a lessee's statement of cash flows?

Payment (Cash flow classification) Repayment of the principal portion (Cash outflow from financing activities) Payment of interest (Cash outflow from operating activities)

How is a right-of-use (ROU) asset measured at the lease commencement date?

ROU asset = Lease liability + Initial direct cost incurred by the lessee

How should a remote loss contingency be accounted for?

Remote loss contingencies are not disclosed except for a guarantee of others.

What is the discount rate used by a lessee to discount lease payments?

The discount rate for a lease is the rate implicit in the lease. If the lessee cannot determine the implicit rate, the lessee's incremental borrowing rate is used.

When should a lessor classify a lease as a direct financing lease?

The lessor classifies a lease as a direct financing lease only when The lease is not a sales-type lease (none of the five criteria is met), The present value of the sum of (1) the lease payments and (2) any residual value guaranteed by the lessee or any other third party equals or exceeds substantially all of the fair value of the leased asset, and It is probable that the lease payments and any residual value guarantee will be collected.

If a loss contingency is neither probable nor reasonably estimated, but the probability of loss is at least reasonably possible, how should it be accounted for?

The nature of the contingency must be described, and an estimate of the amount of possible loss (or the range of loss) must be disclosed.

When are periods covered by an option to extend a lease included in the lease term?

They are included in the lease term when 1) The lessee is reasonably certain to exercise that option or 2) The option is controlled by the lessor.

For which type of lease is a lessee not required to recognize the right-of-use asset and lease liability?

Under U.S. GAAP, a lessee may elect not to recognize the right-of-use asset and lease liability for short-term leases having a lease term of 12 months or less.

What lease payments are included in the calculation of lease liability?

With purchases options (reasonably certain to exercise) No purchase options Rental payments Rental payments Exercise price of the purchase option Any penalties for terminating the lease (nonrenewal penalties) Amount probable of being owed by the lessee under residual value guarantees