ACCT 302 Test 2 Additional Points
Journal Entry for lessor for beginning of sales type lease with selling profit
Lease receivable (PV of payments) 479,079 Cost of goods sold (lessor's cost) 300,000 Sales revenue (PV of payments) 479,079 Equipment (lessor's cost) 300,000
How does the lessor record the beginning of an operating lease?
[No entry to record a receivable or to derecognize asset]
How does the lessee record the first pmt in an operating lease?
dr. lease payable cr. cash
Harry Potter Barn (HPB) leased equipment from Sorcerer's Leasing Co. on July 1, 2018, in a sales-type lease. The present value of the lease payments discounted at 10% was $80,000. Ten annual lease payments of $12,000 are due each July 1, beginning July 1, 2018. The total decrease in earnings (pretax) inHPB's Dec. 31, 2018, income statement would be:
$3,400 Interest expense: ([10% x ½] x [$80,000 - 12,000]) + 4,000 Amortization expense: ($80/10) x ½ = $7,400.
How to account with regards to uncertainty of lease payments
-the amounts of future lease payments are uncertain and often avoidable, we don't consider them as part of the lease payments used to calculate the lessee's lease liability and the lessor's lease receivable. -If and when lease payments increase, the change in the lease payments has no effect on balance sheet accounts and simply is reported as a separate lease expense (lessee) and lease revenue (lessor).
What is required in order to classify a lease as short-term?
1) Has a lease term (including any options to renew or extend) of twelve months or less; and 2) Does not contain a purchase option that the lessee is reasonably certain to exercise, which would extend the term beyond twelve months.
What are the five criteria of a finance/sales type lease?
1. The agreement specifies that ownership of the asset transfers to the lessee. 2. The agreement contains a purchase option that the lessee is reasonably certain to exercise (bargain purchase option). 3. The lease term is for the "major part" of the remaining economic life of the underlying asset. 4. The present value of the lease payments equals or exceeds "substantially all" of the fair value of the underlying 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.
What is the journal entry to record the the beginning pmt for the lessee for a short-term lease?
No entry to record a right-of-use asset and liability (lease term ≤ one year)
what will the lessor report on its income statement with regards to an operating lease?
The lessor has only a single lease revenue account in an operating lease and reports that straight-line amount, $100,000, each year in its income statement.
Key point with short-term leases
This is also the approach (how lessee records short-term lease) used by the lessor for lease revenue on the flip side of the transaction.
What is the difference for the lessor when there exists a selling profit?
When there is a selling profit, all lessor entries, other than the entry at the beginning of the lease to include the selling profit, are precisely the same as the entries for a sales-type lease without a selling profit.
What does the Lessee record at the beginning of a finance lease?
An asset and liability are recorded by the lessee at the present value of the lease payments.
Lessee can elect what in a short-term lease?
not to recognize a right-of-use asset or a lease liability. to recognize lease payments as expense over the lease term.
What amount uses straight line depreciation in an operating lease?
In an operating lease, it's the total lease expense, not the amortization component, that's a straight-line amount.
How does the lessee record amortization expense (at what cost) in an operating lease?
In an operating lease, the lessee records interest the normal way and then "plugs" the right-of-use asset amortization at whatever amount is needed for interest plus amortization to equal the straight-line lease payment, $100,000.
When should a lessor adjust the lease term for an option that the lessee might take?
A company should only adjust the lease term for an option if it is reasonably certain that the lessee will exercise the option after considering the relevant economic factors.
How to classify short-term lease?
A lease that has a maximum possible lease term (including any options to renew) of 12 months or less is a "short-term lease." Lease-by-lease option to choose a short-cut approach.
Amortization for a finance lease
Amortization reflects the right to use the asset and the financing of the right (interest expense).
Who records the depreciation in an operating lease?
Because the lessor does not take the asset off its books, it must depreciate that asset (over its useful life).
First pmt of sales type lease with selling profit
Cash 100,000 Lease receivable 100,000
What causes a reassessment of the lease term?
Circumstances can change that require reassessment of a lease term. Reassessment requires a "triggering event" such that the lessee now has an economic incentive to exercise an option that extends or terminates the lease.
What are the journal entries to record the Lease Payments (January 1, April 1, July 1, October 1, 2018) for lessee?
Dr. lease expense cr. cash
What happens if the lessee gets an additional right of use?
If the lessee gets an additional right of use, the original lease is terminated and a new lease is created based on the modified arrangement.
What will a lessee report on its income statement with regards to a finance lease?
In a finance lease, the lessee will report interest expense and amortization expense separately in the income statement.
LeaseCo Industries leased equipment to UserCorp. on July 1, 2018. LeaseCo recorded the lease as a sales-type lease at $810,000, the present value of lease payments discounted at 10%. The lease called for ten annual lease payments of $120,000 due each July 1. The first payment was received on July 1, 2018. LeaseCo had manufactured the equipment at a cost of $750,000. The total increase in earnings (pretax) on LeaseCo's December 31, 2018, income statement would be:
Interest revenue is [10% x ($810,000 - 120,000) x 6/12] = $34,500 Selling profit is ($810,000 - 750,000) = 60,000 Increase in earnings (pretax) $94,500
On January 1, 2018, Super Sports Supply recorded a right-of-use asset of $135,180 in an operating lease. The lease calls for ten annual payments of $20,000 at the beginning of each year. The interest rate charged by the lessor was 10%. The balance in the right-of-use asset at December 31, 2018, will be:
Interest the first year is 10% x ($135,180 - 20,000) = $11,518. So, amortization will be $20,000 - 11,518 = $8,482. The year-end balance is $135,180 - 8,482 = $126,698.
Why would a lease include a contingent payment provision?
It's a way for lessees and lessors to share the risk associated with the asset's productivity. For example, let's assume a store owner, like at Gap, who pays for a premium mall location is doing so anticipating higher revenue. If the mall attracts a sufficiently higher number of shoppers, the lessee pays the lessor part of the resulting higher profits, but if not, the lessee makes only the normal lease payments. This arrangement also provides the lessor an incentive to attract shoppers to the mall, which is in the lessee's best interest.
What does a lessee record on its income statement with regards to an operating lease?
Lease expense equal to the 2018 lease payments. the lessee amortizes the asset in the amount needed for the total lease expense (interest plus amortization) to be equal to the periodic lease payment and reports the lease payment as lease expense in its income statement.
If the residual value of a leased asset turns out to be more than the amount guaranteed by the lessee, the:
Lessor is not obligated to compensate the lessee for the excess.
When does lessor recognize selling profit and interest revenue of a finance lease with sales profit?
Lessor recognizes a selling profit at the beginning of the lease term. [as sales revenue and cost of goods sold] Lessor also recognizes interest revenue over the lease term
Mill's Tread Industries leased exercise equipment to Jim's Gyms on July 1, 2018. The lease does not meet the criteria for classification as a finance lease. The lease agreement specifies four annual payments of $80,000 beginning on July 1, 2018. The present value of those payments at a discount rate of 10% is $278,948. Which of the following is true regarding the entries made on July 1, 2018?
On July 1, 2018, the lessee records a debit to Right-of-use asset for $278,948 and a credit to lease payable for $278,948. The lessee also records a debit to lease payable and credit to cash for $80,000. The lessor records a debit to cash and credit to deferred lease revenue for $80,000.
Key reason for leasing before new GAAP Rules
Prior to recent accounting guidance, ASU 2016-02, one of the primary advantages associated with operating leases was "off balance sheet financing." However, GAAP now requires lessees to record assets and liabilities for all but very short-term leases.
How does the lessee record the beginning of an operating lease?
Right-of-use asset (PV of lease payments) 348,685 Lease payable (PV of lease payments) 348,685
Reassessment Example: Assuming the present value of the remaining five lease payments totaled $400,000, while the current balance of the lease liability before re-measurement is $250,000, the lessee would make the following adjustment:
Right-of-use asset 150,000 Lease payable (increase in balance*) 150,000 *PV of remaining 5 payments, discounted at the current rate $400,000 Liability balance after 3 years based on initial lease terms $250,000 Increase in balance $150,000
How to calculate selling profit in sales type lease?
Sales revenue $479,079 Less: Cost of goods sold 300,000 Selling Profit $179,079
How do you calculate selling profit?
Selling profit is the difference between sales revenue and cost of goods sold.
What rate to use?
The implicit rate is used to consider the time value of money while calculating the present value. This is the desired rate of return that the lessor has in mind when deciding the size of the lease payments. When the lessor's implicit rate is unknown, the lessee should use its own incremental borrowing rate.
Who records the amortization expense in a finance lease?
The lessee incurs an expense as it uses the asset. This is similar to the recording of depreciation expense associated with purchased assets.
What is the difference for the lessee when there exists a selling profit?
The lessee's accounting is not impacted by whether or not the lessor recognizes a profit. The journal entries made by the lessee are precisely the same with or without a selling profit for the lessor.
Differences between GAAP and IFRS with regards to short-term leases
U.S. GAAP defines a short-term lease as a lease that has a lease term of 12 months or less and does not include a purchase option that the lessee is reasonably certain to exercise. IFRS precludes a lease from being considered short-term if the lease includes a purchase option regardless of whether the lessee is reasonably certain to exercise it. In addition, though, unlike U.S. GAAP, IFRS allows "small ticket leases," also to apply this short-cut method. Small ticket leases are defined as those having a value of $5,000 or less.
How are leases classified under IFRS?
Under IFRS No. 17, all leases are accounted for as finance leases by the lessee (one-model approach). Only lessors apply the classification criteria to distinguish between finance and operating leases.
When should a lessee remeasure variable lease payments that depend on an index or a rate?
Under IFRS, a lessee will remeasure the variable lease payments that depend on an index or a rate not just when the lessee remeasures the right-of-use asset and lease liability for other reasons, but also whenever there is a change in the cash flows resulting from a change in the reference index or rate.
What is required to be done when a lease term changes?
When there is a change in the lease term, lessees are required to reassess the classification of the lease. Lessees must apply the five criteria presented in Illustration 15-3 to determine whether the lease now meets the criteria for classification as a finance lease. If the classification has changed, then the lessee must account for the lease as a finance lease for the remainder of the lease term. Lessors are not permitted to reassess the initial determination of the lease term or discount rate.
Journal Entry to record amortization expense in a finance lease
dr. Amortization expense (PV / years or periods) cr. Right-of-use asset
What is the first payment journal entry for the lessor of a sales type lease?
dr. Cash (lease payment) cr. Lease receivable
first pmt with interest journal entry for sales type lease
dr. Cash (lease payment) cr. Lease receivable (difference) cr. Interest revenue (effective interest)
First pmt with interest journal entry for finance lease
dr. Interest expense (effective interest) dr. Lease payable (difference) cr. Cash (lease payment)
What is the first payment journal entry for the lessee of a finance lease?
dr. Lease Payable cr. Cash (lease payment)
What is the journal entry for the lessor at the beginning of a sales type lease?
dr. Lease receivable (present value of lease payments) cr. Equipment (lessor's cost: carrying amount) *Notice that the lessor's entries are the flip side or mirror image of the lessee's entries.
What is the second pmt journal entry for the lessee in an operating lease?
dr. lease payable dr. interest expense cr. cash dr. amortization exp. cr. right of use asset
What are two exceptions to not including variable payments in the calculation of the lease liability recorded at the beginning of the lease?
they are "in-substance fixed payments" or if payments vary solely when an index (like CPI) or rate (like market interest rate)