Gleim FAR Unit 13
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
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 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.
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. - Under IFRS, a lessee may elect not to recognize the right-of-use asset and lease liability for low-value leases for leases of assets with a value of $5,000 or less.
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 Criterion 1 - Transfer of ownership Criterion 2 - Exercise of purchase option Criterion 3 - Major part of the remaining economic life Criterion 4 - Substantially all of the fair value Criterion 5 - No alternative use to the lessor Amortization Period of the ROU Asset Criterion 1 - Useful life of the leased asset Criterion 2 - Useful life of the leased asset Criterion 3 - Shorter of ROU asset's useful life or lease term Criterion 4 - Shorter of ROU asset's useful life or lease term Criterion 5 - Shorter of ROU asset's useful life or lease term
How can a lessor classify a lease under IFRS?
A lessor classifies a lease as either a finance lease (similar to a sales-type lease under U.S. GAAP) or an operating lease. IFRS does not distinguish between sales-type and direct financing leases.
When are contingent losses accrued?
A material contingent loss is accrued when the following two criteria are met: - It is probable that, at the balance sheet date, an asset has been impaired or a liability has been incurred. - 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 - Finance lease or sales-type lease - Operating lease Classification of the initial transfer of assets - Not a sale - 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 - Interest expense - Interest expense = Lease liability at the beginning of the period × Discount rate - 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.
Give the calculation for the selling profit or loss recognized by a lessor in a sales-type lease.
Fair value of the leased asset or lease receivable, if lower + PV of unguaranteed residual value - Carrying amount of the leased asset = Selling profit or loss
T or F A criterion for a lease to be classified as a finance lease by the lessee is that the lease term is 90% or more of the estimated economic life of the leased property.
False A criterion for a lease to be classified as a finance lease by the lessee is that the lease term is 75% or more of the estimated economic life of the leased property. This criterion is not applicable if the beginning of the lease term falls within the last 25% of the property's total estimated economic life.
T or F A criterion for a lease to be classified as a sales-type lease by the lessor is that the present value of the lease payments is at least 80% of the carrying amount of the leased property to the lessor at the inception of the lease.
False A criterion for a lease to be classified as a sales-type lease by the lessor is that the present value of the lease payments is at least 90% of the fair value of the leased property to the lessor at the lease commencement date.
T or F At lease commencement date, a right-of-use asset is measured at the amount at which the lease liability was recognized minus initial direct costs incurred by the lessee.
False At the lease commencement date, a right-of-use asset is measured at the amount at which the lease liability was recognized plus initial direct costs incurred by the lessee.
T or F All contingencies should be recognized when the gain or loss is probable.
False Gain contingencies are not recognized until they are realized. A gain contingency must be adequately disclosed, but misleading implications about realization must be avoided. Loss contingencies should be accrued if the loss is probable, can be reasonably estimated, and the amount is material.
T or F If it is probable that a liability has been incurred and the amount of loss is reasonably estimated within a range, and no amount within that range appears to be a better estimate than any other, the middle of the range must be accrued.
False If the estimate of a probable loss is stated within a range, and no amount within that range appears to be a better estimate than any other, the minimum (not the middle) of the range should be accrued.
T or F In a sale and leaseback transaction in which the leaseback is classified as an operating lease, the seller-lessee will continue to report the transferred asset and depreciate it.
False If the leaseback is classified as an operating lease, the initial transfer of the asset to the buyer-lessor can be accounted for as a sale of an asset if all criteria for revenue recognition were met. Thus, the seller-lessee should derecognize the carrying amount of the asset. The transferred asset will be depreciated by the buyer-lessor.
T or F Once a lessee has determined that a lease must be recognized as a finance lease, the lessee must report the present value of the lease payments as a noncurrent liability.
False In a classified balance sheet, the lease liability must be allocated between current and noncurrent portions. The current portion at a balance sheet date is the reduction of the lease liability in the forthcoming year.
T or F In a sales-type lease, cost-of-goods sold recognized at the lease commencement date equals the carrying amount of the leased asset plus the present value of the residual value guaranteed by the lessee or any other third party.
False In a sales-type lease, cost-of-goods sold recognized equals the carrying amount of the leased asset minus the present value of any unguaranteed residual value. Thus, when no residual value is unguaranteed, cost-of-goods sold is the carrying amount of the leased asset.
T or F In a sales-type lease, the lessor must depreciate the leased asset using a straight-line depreciation method over the lease term.
False In a sales-type lease, the lessor derecognizes the leased asset on the lease commencement date. Thus, no depreciation expense on the leased asset is recognized by the lessor.
T or F In a sales-type lease, initial direct costs (IDCs) of the lease are expensed as incurred when the fair value of the leased asset equals its carrying amount.
False In a sales-type lease, when the fair value of the leased asset equals its carrying amount, IDCs are deferred. The deferred IDCs are included in the calculation of the rate implicit in the lease. Thus, they are automatically included in calculation of net investment in the lease. They need not be added separately. IDCs are expensed when the fair value of the leased asset differs from its carrying amount.
T or F In the balance sheet, all lease liabilities from finance and operating leases must be presented together in the same line item but separately from other liabilities.
False In the balance sheet, finance lease liabilities and operating lease liabilities must not be presented together in the same line item. They are presented in the balance sheet, or disclosed in the notes, separately from each other and separately from other liabilities.
T or F In an operating lease, interest expense for a lease liability and amortization expense for a right-of-use asset must be recognized and separately reported.
False In the income statement, a single amount for the total lease expense for the period is reported in income from continuing operations. Thus, interest expense for a lease liability and amortization expense for a right-of-use asset are not reported separately.
T or F The discount rate used by the lessee in calculating the present value of the minimum lease payments is the greater of the lessor's implicit rate if it is known to the lessee and the lessee's incremental borrowing rate.
False The discount rate for the lease is the rate implicit in the lease. If the lessee cannot determine the rate implicit in the lease, the lessee uses its incremental borrowing rate.
T or F When it is not probable that a guarantor will have to make payments, no liability is recognized at the inception of the guarantee.
False The essence of a guarantee is a noncontingent obligation to be ready to perform after the occurrence of a triggering event or condition. It is coupled with a contingent obligation to make payments if such an event or condition occurs. Thus, recognition of a liability at the inception of a guarantee is required even when it is not probable that payments will be made.
T or F The lessor must expense initial direct costs for an operating lease immediately.
False The lessor must defer and amortize the initial direct costs of an operating lease. Amortization is over the lease term on a straight-line basis.
T or F In a sales-type lease, the initial measurement of the net investment in the lease excludes the unguaranteed residual value of the leased property.
False The net investment in the lease is the total of cash and other assets that the lessor expects to receive over the lease term. It equals (1) the present value of the lease payments and (2) the present value of an amount that a lessor expects to derive from the leased asset following the end of the lease term. This amount includes the guaranteed residual value and the unguaranteed residual value of the leased asset.
T or F Under a direct financing lease, no selling profit or loss is recognized by the lessor on the lease commencement date.
False Under a direct financing lease, no selling profit is recognized on the lease commencement date. Any selling profit is deferred and reduces the initial amount of the net investment in the lease. But any selling loss is recognized in the income statement on the lease commencement date.
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.
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 - Interest expense = Lease liability at the beginning of the period × Discount rate Amortization of the ROU asset - Amortization of the ROU asset = Single periodic lease expense - Interest expense NOTE: 1. 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. 2. 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 divided by Lease term
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 ($) divided by 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 NOTE: Net investment in the lease = Fair value of the leased asset
How are payments for operating leases presented in a lessee's statement of cash flows?
Payment - Repayment of lease liability (principal) - Interest expense on lease liability Cash flow classification - Cash outflows from operating activities
How are finance lease payments presented in a lessee's statement of cash flows?
Payment - Repayment of the principal portion - Payment of interest Cash flow classification - Cash outflow from financing activities - Cash outflow from operating activities
How should a remote loss contingency be accounted for?
Remote loss contingencies are not disclosed except for a guarantee of others.
What do lease payments at the lease commencement date consist of?
Rental payments Purchase option Penalties for terminating the lease (nonrenewal penalties) Guaranteed residual value
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.
How are leases classified by the lessee under IFRS?
The lessee accounts for all leases, except for short-term leases and low-value leases, similar to a finance lease under U.S. GAAP. An operating lease is not a classification option for the lessee under IFRS.
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 - The lessee is reasonably certain to exercise that option or - The option is controlled by the lessor.
Teal Properties, Inc., is a defendant in a lawsuit that could result in a large payment to the plaintiff. Teal's attorney believes that Teal has a 90% chance of losing the suit and estimates that the loss will be between $750,000 and $1,200,000. None of the estimates is better than the others. What is the journal entry to record Teal's loss contingency?
To record loss contingency: Contingent loss $750,000 Contingent liability $750,000
On January 1, Year 1, Tatum Co. sold a machine with a remaining useful life of 10 years to Irving Co. for $600,000. The carrying amount of the machine was $400,000, and its fair value was $510,000. At the same time, Tatum (seller-lessee) entered into a contract with Irving (buyer-lessor) for the right to use the machine (leaseback) for 2 years, with annual rental payments of $170,000 payable at the end of each year. A discount rate for the lease of 10% is used by both Tatum and Irving. The present value factor for an ordinary annuity at 10% for 2 periods is 1.73554. What entry does Tatum make to record the sale? January 1, Year 1
To record the sale: Cash $600,000 Machine $400,000 Gain on sale 110,000 ($510,000 fair value - $400,000 carrying amount) Financial liability 90,000 ($600,000 sale price - $510,000 fair value) Right-of-use (ROU) asset $205,042 Lease liability $205,042 ($118,143 × 1.73554) Because no criterion to classify the leaseback as a sales-type lease or finance lease was met, the leaseback is classified as an operating lease. Thus, a gain on sale of the machine can be recognized by Tatum. The transaction is not at fair value because the sale price of the machine is greater than its fair value. Tatum essentially received additional financing from Irving of $90,000 ($600,000 - $510,000). This financing should be accounted for separately from the lease liability by recognizing the following two components of each annual lease payment of $170,000: - Annual payment for the additional financing of $51,857 ($90,000 ÷ 1.73554). - Annual rental payment for the right to use the machine of $118,143 ($170,000 - $51,857). Because the lease is classified as an operating lease, $118,143 is the rental expense (revenue) recognized each period by Tatum (Irving).
On January 1, Year 1, Meyer, Inc., entered into a 3-year lease of a machine from Noble, LLC. Meyer must pay Noble three annual payments of $150,000 starting on December 31, Year 1. The machine's useful life from the lease commencement date is 5 years. The lease allows Meyer the option to purchase the machine at the end of the lease term for $20,000. Meyer is reasonably certain to exercise this purchase option. Meyer's incremental borrowing rate is 15%, but the rate implicit in the lease is 10%, which is known to Meyer. - The present value factor for an ordinary annuity at 10% for 3 periods is 2.48685, and the present value of $1 at 10% for 3 periods is 0.7513. - The present value factor for an ordinary annuity at 15% for 3 periods is 2.28323, and the present value of $1 at 15% for 3 periods is 0.65752. What is Meyer's journal entry to record this transaction?
To record this transaction: Right-of-use asset $388,054 Lease liability $388,054 The lease is a finance lease because it meets the lease classification criterion of including a purchase option that the lessee is reasonably certain to exercise. The rate implicit in the lease of 10% is used to calculate the present value of the lease payments because Meyer knows this rate. PV of rental payments ($150,000 × 2.48685) = $373,028 PV of purchase option ($20,000 × 0.7513) = 15,026 PV of lease payments = $388,054
Brady Co. sells and leases unspecialized machines. On January 1, Year 1, Brady leased a machine to Wayne Co. for 3 annual payments of $125,000 starting on December 31, Year 1. The machine's remaining useful life is 5 years. The expected residual value of the machine at the end of Year 3 is $40,000, and Wayne guarantees this amount. At the inception of the lease, the fair value of the machine was $340,908 and the carrying amount was $300,000. The rate implicit in the lease is 10%. The present value factor for an ordinary annuity at 10% for 3 periods is 2.48685, and the present value of $1 at 10% for 3 periods is 0.7513. What is Brady's journal entry to record this transaction?
To record this transaction: Net investment in the lease $340,908 (fair value of the machine) Cost of goods sold 300,000 (machine's carrying amount) Revenue $340,908 (lease receivable) Machine 300,000 (machine's carrying amount) PV of rental payments ($125,000 × 2.48685) $310,856 PV of residual value guaranteed by the lessee ($40,000 × 0.7513) 30,052 Total $340,908 Brady classifies the lease as a sales-type lease because the "substantially all of the fair value of the leased asset" classification criterion was met. The sum of the present value of the lease payments and the present value of the residual value guaranteed by the lessee ($340,908) equals or exceeds substantially all of the fair value of the leased machine ($340,908). This classification criterion is the only one that was satisfied.
On January 1, Year 1, Salazar, Inc., entered into a 3-year lease of a machine from Murphy, LLC. Assume that (1) Salazar concludes that the contract is an operating lease, (2) the lease does not include a purchase option, (3) the rental payments are $150,000 at the end of Years 1 and 2 and $210,000 at the end of Year 3, and (4) the rate implicit in the lease is not known to Salazar. The machine's useful life from the lease commencement date is 5 years. Salazar's incremental borrowing rate is 15%. The present value factor for an ordinary annuity at 15% for 3 periods is 2.28323, and the present value of $1 at 15% for 3 periods is 0.65752. What is Salazar's journal entry to record this transaction?
To record this transaction: Right-of-use asset $381,936 Lease liability $381,936 Because Salazar does not know the rate implicit in the lease, it uses its incremental borrowing rate of 15% to calculate the present value of lease payments. The PV of the rental payments is $381,936 [($150,000 × 2.28323) + ($60,000 × 0.65752)].
T or F A contingent loss must be accrued when (1) it is probable that, at a balance sheet date, an asset has been impaired or a liability has been incurred, and (2) the amount of the loss can be reasonably estimated.
True A contingent loss must be accrued (debit loss, credit liability or asset valuation allowance) when, based on information available prior to the issuance of the financial statements, two conditions are met. It must be probable that, at a balance sheet date, an asset has been impaired or a liability has been incurred, and the amount of the loss can be reasonably estimated.
T or F If a lease does not contain a purchase option, any nonrenewal penalty is a component of the lease payments owed by a lessee.
True A nonrenewal penalty is a required payment by the lessee upon failure to renew or extend the lease at the end of the lease term. If the lease contains no purchase option, the nonrenewal penalty is among the items included in the lease payments.
T or F In a sale and leaseback transaction, no sales revenue is recognized on the initial transfer of an asset to the buyer-lessor if the leaseback is classified as a sales-type lease.
True A sale and leaseback transaction involves the sale of property by the owner (seller-lessee) and a lease of the property back from the buyer-lessor. The initial transfer of the asset to the buyer-lessor is not a sale of the asset if the leaseback is classified as a finance lease or a sales-type lease.
T or F For short-term leases, a lessee may elect not to recognize the right-of-use asset and lease liability.
True A short-term lease is a lease that, at the commencement date, has a lease term of 12 months or less and does not include a purchase option that the lessee is reasonably certain to exercise. As an accounting policy for short-term leases, a lessee may elect not to recognize the right-of-use asset and lease liability.
T or F An estimate is not a contingency.
True An estimate is not a contingency. A contingency is "an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (a gain contingency) or loss (a loss contingency) to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur." Thus, the estimated depreciation for the period is not consistent with the definition of a contingency. It is certain that the utility of a depreciable asset will expire.
T or F The amount of guaranteed residual value to be included in measuring the lease liability is the amount probable of being owed by the lessee under residual value guarantees.
True At the lease commencement date, a lease liability is measured at the present value of the lease payments to be made over the lease term. The lease payments include amounts probable of being owed by the lessee under residual value guarantees.
T or F Each periodic lease payment made by the lessee has two components: interest and the reduction of the lease obligation.
True Each periodic lease payment made by the lessee has two components: interest and the reduction of the lease obligation. GAAP mandates the effective-interest method, which requires that the appropriate interest rate be applied to the carrying amount of the lease obligation at the beginning of each period to calculate interest expense. The portion of the lease payment in excess of interest expense reduces the lease liability.
T or F In a sales-type lease, interest income recognized is calculated as the carrying amount of the net investment in the lease at the beginning of the period times the discount rate implicit in the lease.
True In a sales-type lease, each periodic lease payment received has two components: interest income and the reduction of the net investment in the lease. Interest income is calculated using the effective interest method. It equals carrying amount of the net investment in the lease at the beginning of the period times the discount rate implicit in the lease.
T or F In a sales-type lease, the lease receivable recognized by the lessor at the lease commencement date equals the present value of the lease payments plus the present value of the residual value guaranteed by the lessee or any other third party.
True In a sales-type lease, the lease receivable is (1) the present value of the lease payments plus (2) the present value of the residual value guaranteed by the lessee or any other third party. The lease receivable is the revenue recognized at the lease commencement date.
T or F In an operating lease, a single lease expense is recognized by the lessee in each period.
True In an operating lease, a single (equal) lease expense is recognized by the lessee in each period. It is calculated so that the total undiscounted lease payments are allocated over the lease term on a straight-line basis.
T or F Under IFRS, a contingent liability is not recognized.
True Under IFRS, a contingent liability is a possible obligation resulting from past events. It must not be recognized but should be disclosed unless the possibility is remote.
T or F Under an operating lease, an equal amount of rental income is recognized by the lessor each period over the lease term.
True Under an operating lease, lease payments are recognized as lease (rental) income by the lessor. If rental payments vary from a straight-line basis (e.g., if the first month is free), rental income should be recognized over the full lease term on the straight-line basis. Thus, an equal amount of rental income is recognized each period over the lease term. The equal amount of rental income equals total lease payments to be received over the lease term divided by the lease term.
T or F The lessee records a finance lease as an asset and a liability at an amount equal to the present value of the lease payments.
True Under both finance and operating leases, at the lease commencement date, a lessee must recognize a lease liability and a right-of-use asset. A lease liability is measured at the present value of the lease payments to be made over the lease term. Assuming no direct costs were incurred, a right-of-use asset is measured at the amount at which the lease liability was recognized.
What lease payments are included in the calculation of lease liability?
With purchases options (reasonably certain to exercise) - Rental payments - Exercise price of the purchase option No purchase option - Rental payments - Any penalties for terminating the lease (nonrenewal penalties) - Amount probably of being owed by the lessee under residual value guarantees
