AC 311: CH 15

3. What are the advantages of leasing assets rather than purchasing them?

-Can offer tax saving advantages over purchases. -Can facilitate asset acquisition. -Lease to obtain "off-balance-sheet financing."

Guaranteed Residual: 1) Direct financing Lease a) Include in 90% test. (Recovery of investment test) b) Include in lease receivable as part of MLP. 2) Sales type lease a) Include in 90% test. (Recovery of investment test) b)Include in lease receivable as part of MLP. c) Include PV in Sales Revenue. Unguaranteed residual: 1) Direct Financing Lease a) Do not include in 90% test. (Recovery of investment test) b)Include in lease receivable. 2) Sales type lease a) Do not include in 90% test. (Recovery of investment test) b) Include in lease receivable. c) Exclude PV of residual from Sales Revenue and reduce COGS by PV of residual (This portion of the asset has not been sold.)

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FINANCE LEASES: 1. (Lessee or Lessor?) records the asset on the books and then depreciates (amortizes) it. 2. (Lessee or Lessor?) records liability on books and uses the effective interest method to recognize interest. 3. At inception of the lease, the asset and liability are recorded at the _____ _____of lease payments

1) Lessee 2) Lessee 3) present value

4. List the five classification criteria used to distinguish finance leases from operating leases. How many of the criteria must a lease meet to be a finance lease?

1) The agreement specifies that ownership of the asset transfers to the lessee. 2) The agreement contains a bargain purchase option. 3) The noncancelable lease term is = to 75% or more of the expected economic life of the asset. 4) The PV of the "minimum lease pmts" is = to or greater than 90% of the FV of the asset. 5) 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. At least one of the five criteria needs to be met.

7. What amounts are included in minimum lease payments (as part of criterion 4)? (page 864)

1) The total of periodic rental pmts 2) Any guaranteed residual value 3) Any bargain purchase option price

Guaranteed Residual Value: 1. This is an additional payment (in form of asset worth this amount or cash to make up the difference) and is (excluded or included?) in the minimum lease payments by both lessee and lessor. 2. The or lessee depreciates the asset over the lease term and uses the guaranteed residual value as the _____ value. If the asset is worth less than this amount, the lessee must pay cash and will record a ____. If the asset is worth more, the lessee (does or does not?) record a gain.

1) included 2) salvage, loss 3) does NOT

DISCOUNT RATE USED BY LESSEE: 1. ______ borrowing rate unless 2. the _____ rate used by lessor is ____ to lessee and is (greater or less?) than incremental borrowing rate.

1) incremental 2) implicit, known, less

EXECUTORY COSTS: 1) Includes the cost of (3 different things). If the lessor makes these payments, a portion of the lease payments will be to cover executory costs. In this case, the executory costs are deducted from the periodic payments to determine the minimum lease payments.

1) insurance, maintenance and taxes related to the leased asset

LESSEE - the entity leasing (using) the asset For lessees, all leases are either 1. _____ leases or 2. ____ leases To be a capital (nonoperating) lease, the lease must contain a ________ lease term, and one of four criteria must be met. 1. 2. 3. 4. (Note: Tests 3 & 4 are not applied if the asset is leased within the last __% of the EUL.)

1) operating 2) capital noncancelable 1) Transfer of ownership 2) Bargain purchase option 3) Economic life test - lease term is at least 75% of economic life of asset 4) Recoverability of investment test - PV of MLP is at least 90% of fair value of asset 25%

Bargain Purchase Option: 1. Not all purchase options are bargain purchase options. 2. By definition, a BPO results in a _____ lease for the lessee and for the lessor (if the additional criteria are met). 3. The lessee will purchase the asset because this is too good to pass up. Therefore, the BPO is an additional payment and is (included or exlcuded?) in the minimum lease payments by both lessee and lessor. 4. The (lessor or lessee?) will depreciate the asset over its estimated useful life and use the salvage value expected at the end of its (term lease or useful life?).

2) capital 3) included 4) lessee, useful life

Unguaranteed Residual Value: 1. An unguaranteed residual is the amount the lessor expects the asset to be worth when returned. This amount is used by the lessor when setting the payments. 2. The lessee ignores an unguaranteed residual (may not be aware of it). Computations and entries for the lessee are the same as when no residual is expected. 3. The lessor always includes the residual (whether BPO, GRV or UGRV) in the lease receivable but does not include UGRV in the minimum lease payments. 4. Adjustments must be made to the _____ _____ and _____ for an UGRV. We reduce both amounts by the _____ _____ of the UGRV.

4) Sales Revenue, COGS, present value

1. What is a lease?

A contractual arrangement by which a lessor (owner) provides a lessee (user) the right to use an asset for a specified period of time. In return for this right, the lessee agrees to make stipulated, periodic cash payments during the term of the lease.

5. What is a bargain purchase option?

A provision in the lease contract that gives the lessee the option of purchasing the leased property at a bargain price.

4. What are initial direct costs? (page 886)

Costs incurred by the lessor that are associated directly with originating a lease and are essential to acquire the lease. (EX: legal fees, commissions)

OPERATING LEASES- (lessor or lessee?) retains rights and responsibilities of ownership: 1. Payments are recorded as Rent ____ (lessee) or Rent _____ (lessor). 2. When payments are not equal, must use _____-_____ method for recording rent expense. That is, total the rent payments to be made and divide by number of ______ to find rent expense per period. If lessee has paid more than amount recognized as rent expense, will have ______ _____ (lessor will have Unearned Rent). If lessee has paid less than the amount recognized as Rent Expense, will have _____ ______ (lessor will have Rent Receivable). 3. The leased asset is not recorded on the books of the (lessee or lessor?). 4. The present value of the lease liability is not recorded on the books of the (lessee or lessor?) but must be _____ in the _____.

Lessor 1) Expense, Revenue 2) straight-line, periods, Prepaid Rent, Rent Payable 3) lessee 4) lessee, disclosed, notes

1. What are executory costs? (page 883)

Maintenance, insurance, taxes, and any other costs usually associated with ownership.

2. What is the difference between an operating lease and a finance lease?

Operating lease: Fundamental rights and responsibilities of ownership are retained by the lessor and that the lessee merely is using the asset temporarily. Finance Lease (sales type): Installment purchases/sales that are formulated outwardly as leases.

13. How does a sale-type lease differ from a direct-financing lease for the lessor? (page 873- 874)

The lessor receives a manufacturer's or dealer's profit on the "sale" of the asset in a sales-type lease. A direct-financing lease is a lease in which the lessor finances the asset for the lessee and earns interest revenue over the lease term. Accounting for a sales-type lease is the same as for a direct financing lease except for recognizing the profit at the inception of the lease.

12. A lessee must depreciate an asset acquired with a capital lease. What period should be used as the as the useful life of the asset? (page 871)

The period used would be the term of the lease, unless the lease provides for transfer of title of a BPO.

9. Explain how the lessor and lessee account for rental payments under an operating lease. (page 866)

The periodic rental pmts are accounted for merely as rent by both parties to the transaction. -Rent revenue: the lessor -Rent expense: the lessee

LESSOR - the entity that owns the asset and lets lessee use it. For lessors, a lease is one of the following: 1. operating lease 2. capital lease: a. _______ lease b. _______ lease To be a capital lease for the lessor, the contract must meet one of the four criteria listed for the lessee AND it must meet both of the following criteria: 1. The _______ of the ______ ______ must be ______ _______. 2. If any ______ to the lessor have yet to be _______, they are _____ ______.

a) direct-financing b) sales type 1) collectibility, lease payments, reasonably predictable 2) costs, incurred, reasonably predictable

MINIMUM LEASE PAYMENTS include: a. b. c. d.

a) minimum rental payments excluding executory costs b) any guaranteed residual value c penalty for failure to renew or extend the lease d) Bargain purchase option (BPO) (this is too good to pass up so lessee will pay it to get the asset)

DIRECT FINANCING LEASE: The lessor is simply _____ the asset and earns only ______ ______.

financing, interest revenue

SALES TYPE LEASE: The lessor not only finances the asset and earns interest revenue; the lessor also earns a _____ _____ on the sale. A ______ ______ is earned when there is a difference between the cost (book value) and the fair value of the asset when leased.

gross profit gross profit