Leases

Under IFRS what is the interest rate used by lessees to capitalize a finance lease when the implicit rate cannot be determined? 1. The prime rate. 2. The lessor's published rate 3. The lessee's average borrowing rate. 4. The lessee's incremental borrowing rate.

4. The lessee's incremental borrowing rate.

When lease payments are made under a finance lease, each payment is allocated first to interest on the basis of the interest rate and the carrying value of the lease obligation.

Any remaining portion of the lease payment is recorded as amortization to reduce the lease obligation.

If a lease is a finance lease because there is a transfer of title, the asset will be removed from the lessor's books and a receivable will be recognized.

As a result, the lessor will record interest revenue but not depreciation expense.

Payments made on a finance lease are first applied to interest with the remainder reducing the lease obligation. As the lease obligation declines each year, the amount recognized as interest expense also decreases. When lease payments are equal, as the interest portion declines, the principal reduction increases.

As a result, the principal reduction in the fifth year would be greater than the fourth year and smaller than the reduction in the sixth year.

sale-leaseback transaction

Does it meet the criteria for a finance lease? (Special PO-T 75/90? If yes, treat as a loan, not a sale. In this case the accounting is simple: -The asset remains on the seller-lessee's books -No sale or gain is recorded -No lease accounting is applied -the transaction is accounted for as a note payable.

When a finance lease is recorded, the initial balance of the liability will be equal to the present value of the lease payments, which includes a purchase option likely to be exercised.

If properly recorded, when the lease expires, the unamortized amount of the liability will be equal to the purchase option.

A finance lease is classified as such if it meets one of five criteria: specialized nature of the leased property, a purchase option that is likely to be exercised, a title that is transferred to the lessee at the end of lease, a lease term representing 75% or more of the asset's life, or lease payments with a present value of more than 90% of the asset's FVM.

If the lease meets none of those criteria, it's an operating lease.

The lessee recognizes a right-of-use (ROU) asset and a lease obligation at the present value (PV) of the lease payments, even if this amount is greater than the leased asset's fair value.

If there are maintenance service agreements in a lease contract, they are separated from the balance sheet lease components and expensed as incurred.

The general rule for finance leases is that the right-of-use asset, which is measured at the present value (PV) of lease payments, will be amortized on a straight-line basis (ie, evenly) over the shorter of the lease term or useful life

If there is a purchase option, use the useful life. Note that the PV of lease payments should include any amount expected to be owed as a result of the guaranteed residual value (GRV)

When the present value (PV) of lease payments is substantially all of the leased item's fair value, it is a finance lease. The lease obligation is recorded at the PV of the lease payments.

Leases can also include nonlease components (eg, maintenance service obligations) that are separated from the lease components and expensed as incurred.

What are the five criteria for a financing lease?

Special POT 75/90 -Specialized Nature -contains a bargain Purchase Option reasonably certain to be exercised -lease Transfers Title to the lesee at the end of the term -Lease term is for the "major part" (75%) of the remaining economic life -PV of lease payments and any residual value is equal to 'substantially all' (90%) of the fair market value of the property.

Finance lease accounting steps

Step 1 Record right-of-use asset and lease liability. Present value of lease payments Step 2 Amortize right-of-use asset each lease period. Straight-line method over shorter of lease term or useful life (used for purchase option or title transfer) Step 3 Record payment, interest expense, and reduction in lease liability. -Credit cash for lease payment -Debit interest expense (Interest rate × Liability balance) -Debit lease liability for the difference

The equal annual payments may include tax and insurance costs, if so...

Tax and insurance costs are considered part of the lease payment even though the tax + insurance portion of the payment is itemized separately. Executory costs included in annual payments however are recognized as expense in the period incurred

Miriam Corporation commonly enters into leases as the lessee of equipment. In Miriam's disclosures, it must report

The aggregate amount of future minimum lease payments and the amount for each of the succeeding five years for finance and operating leases

A purchase option on a lease meets one of the criteria necessary for a finance lease (Special-PO-T-75-90). The lessee records a right-of-use asset and liability equal to the present value of lease payments.

The asset is amortized over the shorter of its useful life or lease term unless there is a purchase option or title transfer requiring amortization over its useful life.

The existence of a purchase option that is reasonably certain to be exercised on a lease makes it a finance lease. The lessee records a right-of-use asset and liability equal to the present value of lease payments.

The asset is amortized over the shorter of its useful life or the lease term unless there is a purchase option or title transfer that requires amortization over its useful life.

Operating lease expense must be recognized evenly over the lease term. Dividing the total lease payments by the total number of payment periods gives the uniform yearly lease expense

The liability for deferred lease payments is calculated by comparing lease expense recognized with actual rent paid as of a given date

A lease that meets the criteria of a finance lease is recorded by the lessor as a sales-type lease. The lessor derecognizes the leased asset and recognizes a lease receivable.

The profit on a sales-type lease equals the lease receivable less the leased asset's carrying value.

A lease includes variable lease payments. The lessee knows the amount of the variable lease payments at the inception of the lease. How should the lessee account for the payments?

The variable lease payments should be included at their present value in the lease liability

The Right of Use asset is the present value of lease payments amortized over its useful life. True or false, the annual ROU amortization excludes the fair value (salvage value) at the end of its useful life.

True The fair value (similar to salvage value) at the end of the lease is not included in the straight line calculation for Right of Use amortization

True or False. If title passes from Lessor to Lessee at the expiration of the lease, the leased asset is amortized over the useful life of the asset which may be longer than the terms of the lease.

True, if title is passed at the end of the lease, the lessee uses the useful life for amortization.

In a Right of Use Asset accounted for as a finance lease, the amortization is straight line over the useful life if there is an option to purchase at the end of the lease.

\The amount to amortize will be the capitalized amount minus the salvage value

The present value of the minimum lease payments is calculated

by multiplying the periodic payment amount by a present value factor of an annuity or annuity due, and then adding the present value of any purchase option likely to be exercised or guaranteed residual value amount likely to be paid.

Very important when calculating the carrying value of the lease liability, when the payment is 'annuity due',

deduct the first payment from the carrying value, which on the first payment is the PV of annuity due payments (you've missed this question several times during reviews)

Executory costs are

expensed as incurred with all leases, including direct-financing leases.

Amounts likely to be owed under a residual value guarantee is considered one component of minimum lease payments. As a result, it is

included in calculating the capitalized amount of the asset and obligation under the lease. The amount will be the present value of the payment to be made in a lump sum at the end of the lease term.

If a lease contains a purchase option which is expected to exercise, the equipment will be amortized over its useful life

not the life of the lease

In a sale-leaseback transaction that qualifies as a true sale + operating lease, the gain is

recognized immediately on the income statement. Note: normal revenue recognition conditions must be met ant the lease portion meets none of the financing lease criteria. If the lease portion meets at least one of the 5 criteria, there is not a genuine sale and no gain is recorded.

When a lease term is a major part (ie, ≥ 75%) of the leased asset's useful life, it is a finance lease. The asset is amortized over the

shorter of its useful life or the lease term unless there is a purchase option or title transfer requiring amortization over its useful life.

A nonrefundable lease bonus paid by a lessee is treated as part of the lease payments and is recognized over the

term of the lease.

If a lease contains a purchase option which is expected to exercise, the equipment will be amortized over its useful life. The amount to amortize will be

the capitalized amount minus the salvage value amortized over the useful life.

The lessee in an operating lease records a right-of-use asset and a corresponding lease liability. The lease payments are expensed uniformly over the lease term on a straight-line basis. Rent expense begins when

the lessee has control of the property at the commencement of the lease.

In a finance lease, the lease payments are composed of interest expense and a reduction of the lease liability. The year-end outstanding lease liability is composed of a current liability portion (ie, due within the next year) and a long-term liability portion.

The current liability portion equals the reduction of the lease liability based on the next year's lease payment.

In a finance lease, the lease payments are composed of interest expense and a reduction of the lease liability. The year-end outstanding lease liability is composed of a current portion (ie, due within the next year) and a long-term portion.

The current portion equals the reduction of the lease liability based on the next year's lease payment. (in the amortization table it's the value in the column on the far right, amortization of lease liability).

Residual value in a finance lease is added to the liability value recorded at present value

The finance lease will be recorded as a right-of-use asset and an obligation equal to the present value of the lease payments. The lease payments represent an annuity due for X periods, since the first payment is at the inception of the lease. The guaranteed residual value amount expected to be paid is owed and represents a lump sum payment to be made at the end of 5 periods.

Profits or losses are recognized immediately in a sales-leaseback transaction. True or Fale?

True (assuming it's "A Sale + An Operating Lease") A sale-leaseback where one of the five criteria for a finance lease are met is treated like a loan to raise cash. If the transaction qualifies as a finance lease, no genuine sale occurred: the asset remains on the seller-lessee's books, no sale and no gain or loss is recorded, no lease accounting is applied and the transaction is accounted for as a note payable. To record the transaction: DR: Cash CR: Note Payable To record cash payments: DR: Interest Expense DR: Note Payable CR: Cash

Wilburn Corp. signs an agreement to lease land and a building for 20 years. At the end of the lease, the property will not transfer to Wilburn. The life of the building is estimated to be 20 years. Wilburn prepares its financial statements in accordance with IFRS. How should Wilburn account for the lease?

the lease should be separated into two components. The land should be recorded as an operating lease and the building should be recorded as a finance lease.

A lessee records a finance lease at

the lower of either fair market value of the leased property or the present value of the minimum lease payments.

The amount will be equal to the present value of the lease payments, excluding the tax insurance costs because

they are billed separately by the lessor as incurred, provided it does not exceed the fair market value of the leased asset.

When calculating the lease receivable for a direct-financing lease, the lessor will include the minimum lease payments and the asset's residual value,

which is added to, not subtracted from, the minimum lease payments