Chapter 18 Exam 1

what are the group 2 crtieria

1. The present value of the sum of the lease payments and any residual value the lessee or a third party guarantees to pay (that is not otherwise included in the lease payments) is = to substantially all of the asset's fair value 2. It is probable that the lessor will collect the lease payment plus any amount necessary to satisfy a residual value guarantee

there is a disconnect for both the lessee and the lessor under both GAAP and IFRS

-under both standards the lessee always recognizes the leased asset and the lease liability -in the operating lease the lessor continues to reognize the asset on its balance sheet

what are the advantages of leasing

1. COMPLETE FINANCING -leases may allow the lessee to enter into a lease agreement with little or no money down and with no security deposit -the lessee maintains its cash and other assets, resulting in 100% financing for the leased asset 2. LESSOR BEARS THE RISK OF OBSOLESCENCE 3. BUSINESS AND FINANCIAL FLEXIBILITY -leases can offer many businesses options for the lessee like asset upgrades/returns, modified lease terms or purchase option -the lease may also provide financial flexibility by permitting the lessee to obtain an additional source of financing without affecting existing lines of credit 3. TAX BENEFITS -if the company leases the equipment the entire lease payment may be tax deductible -if a company leases a building the total lease payment may be fully tax deductible as rent expense

what are the disadvantages of leasing?

1. OVERALL COST OF THE ASSET -lessee often pays more for the asset over the life of the lease compared to if they had purchased it from the beginning -(lease payments must compensate the lessor for the use of the asset, financing costs, and the risk of ownership) 2. LACK OF OWNERSHIP -unless the lease agreement includes a transfer of ownership or purchase option, asset doesnt belong to the lessee at the end

if both of the following criteria are met the right to use an asset is considered a separate lease component:

1. lessee can benefit from the ROU of the asset either on its own or together with other resources 2. right of use is neither highly dependent on nor highly interrelated with other rights to use the assets in the contract

the net investment in lease - sales-type lease reflects the assets related to the lease transaction and is composed of

1. the lease receivable 2. the PV of any unguaranteed residual asset

COGS calculation

CV leased aset <PV unguaranteed residual value> +Initial direct costs paid by the lessor

parties involved in a lease contraction consider 2 groups of criteria to classify the lease

Group I: apply to both lessees and lessors provide guidance on which party to the lease effectively owns and controls the asset Group II: apply to only the lessor, determine extent to which the lessor will absorb the credit risk related to the lease contract

started as a convergence project between FASB and IASB but...

IASB adopted a single lessee model (finacing lease only) whereas FASB adopted operating and financing lease models for leases

calculation for Right-Of-Use asset

Initial measurement of lease liability (PV of lease payments) Add: initial direct costs incurred by lessee Deduct: lease incentives received from lessor Add: Payments made to lessor prior to lease commencement date

--- is always considered a separate lease component (unless the impact on the financial statements of NOT separating the land from other assets is insignificant)

LAND

implicit rate calculation

PV of lease payments + PV of guaranteed and unguaranteed residual asset = fair value of leased asset + deferred initial direct costs of lessor

calculation for lease liability

PV of the lease payments + the PV of the guaranteed residual value if the lessee guarantees it (if any)

COGS for a sales-type lease is = to the...

carrying value of the leased asset less the PV of any unguaranteed residual asset plus any deferred initial costs paid by the lessor

if none of the group I criteria are met, and you are the lessor, moves on to

check Group II criteria which will result in a direct-financing or operating lease

lease gives the lessee the right to --- and use the property plant or equipment legally owned by the lessor for a specified period of time in return for periodic payments made by the lessee

control

FASB included the short-term policy election exemption because of

cost restraint -the costs of measuring and rpoting the lease liability and the right of use asset outweight the benefits of reporting these amounts on the balance sheet for a lease with a term of 1 year or less

step 1 identify a lease contract involves...

determining whether there are separate lease components and/or non-lease components within a lease contract

if both of the group II criteria are met, the lessor classifies the lease as a

direct-financing lease

IFRS only has --- leases

financing while GAAP has operating, direct-financing, sales-type

a ----- is a guarantee or assurance made to the lessor that he will receive a fixed dollar amount for the leased asset at the end of the lease

guaranteed residual value.

What is the calculation for lease epxense

interest expense + amortization expense **FOR OPERATING LEASE THESE ARE COMBINED ON THE INCOME STATEMENT. FOR FINANCING, THEY ARE SEPARATELY RECORDED**

in simplest terms, what is the Group I criteria testing for

is this lease effectively the purchase of an asset over time?

date on which the lessee is allowed to begin using the leased asset

lease commencement

payments the lessor makes to the lessee to provide an incentive to enter into a lease agreement

lease incentives

date lease agreement is signed

lease inception

user of the asset

lessee

financing lease Lessee (only) :

lessee: IM: lessee records a right of use asset and lease liability under PV of lease payments SM: lessee reduces the right of use asset by recording amortization expense on a straight-line basis. allocate payments to lease liability and interest using effective interest method

operating lease Lessee: Lessor:

lessee: initial measurement: measures lease liability and right-of-use asset at PV lease payments subsequent measurement: lessee adjusts balances of lease liability and right-of-use asset while recognizing lease expense lessor: continues to report leased asset on their balance sheet and reports rent revenue. may also report depreciation expense related to the asset on the income statement

owner of the asset

lessor

direct financing lease lessor only

lessor can classify a lease as direct-financing only when there is a third-party residual value guarantee. deferred recognition of profit, but immediate recognition of loss

sales-type lease Lessor: (only)

lessor: IM: recognizes revenue on the sale and records the new lease receiveable called "net investment in lease - sales-type lease". remove leased asset from its accounts and records COGS. sales-type leases can have profit or no profit

when a lease term is 12 months or less, the lessee can make a policy election to ----- record the lease liability and the ROU asset

not -instead it records rent expense based on the rent payments

what are the 5 key steps in a lease transaction

o 1. Identify a lease contract o 2. Identify lease and nonlease components and allocate costs to each component o 3. Classify the lease o 4. Recognize and initially measure the lease transaction o 5. Determine subsequent measurement of the lease transaction

what is the Group I criteria made up of?

o To meet the group I conditions, transaction only needs to meet 1 of the 5 criteria: 1. Lease transfers ownership of the leased asset to the lessee at the end of the lease term. If the lease transfers ownership the lessee firm has in essence purchased the asset. 2. The lessee is given an option to purchase the asset that the lessee is reasonably certain to use. For example it might be reasonably certain that the lessee would exercise a purchase option if the purchase price is a bargain, or well under the expected value of the leased asset at the completion of the term of the lease 3. The lease term is for a major part of the economic life of the asset (greater than 75%). 4. The present value of the sum of the lease payments and any residual value the lessee guarantees to pay (that is not otherwise included in the lease payments) is equal to substantially all of the assets fair value (greater than 90%) 5. The leased asset is of specialized nature. An asset with a specialized nature has no alternative use to the lessor at the end of the lease term. Because the asset has no alternative use to the lessor, its specialized nature implies that the lessor transferred control of the asset to the lessee.

lessee classifications are either

operating (meets none of group I) or financing (meets at least 1 of the 5 group I criteria)

if 1 of the 2 or none of the group II criteria are met it is an

operating lease

lessor classifcations are..

operating, sales type with or without profit, and financing

lease receivable calculation

payments to be received + PV of any guaranteed residual value

what is the monthly JEs when a lessee makes the short-term lease policy election

records rent expense based on the rent payments Rent expense xx Cash xx

lessors: if any of the Group I criteria are met, lessor should treat the lease as a

sales-type

what is the revenue for a sales-type lease?

the lower of 1) fair value of the leased asset or 2) sum of lease receivable and any lease payments paid before the lease commencement date

what is the objective of lease disclosures

to enable users of financial statements to assess the amount, timing and uncertainty of cash flows arising from lease agreements

amount the lessor expects to derive from the leased asset at the end of the lease term

unguaranteed residual value