526 : Leases Chapter 15
If cash payment is received by the lessor, they will record this is would account
-Lease receivable
Qualitative disclosures include what?
-a description of the leasing arrangement including info about variable lease payments, options, nonlease payments, and residual values
if the actual residual value of the equipment is more or less than the residual value then the lessor will record what?
-a gain or loss
Quantitative Disclosures lessee
-finance lease costs, with separate disclosures for interest and amortization -operating lease cost -short term lease cost -variable lease cost -weighted average lease term of operating and finance leases -weighted average discount rate -a reconcilliation of opening and closing balances of the right of use asset -contractual obligations -table of future lease payments
Quantitative disclosures lessor
-info about lease contracts and significant assumptions and judgments -tables of lease revenues received -lease sales disclosed separately from regular sales -table of future lease pauments -info about assets under operating lease -info about risks associated with residual values -info about significant changes in unguaranteed residual value -the gross investment and net investment in leases
In an operating lease the lessee records ________ the normal way and then "plugs" the right of use asset amortization at whatever amount is needed for interest plus amortization to equal the ___________________ lease payment
-interest -straight line
In a direct financing lease, the lessor's main objective is what?
-providing financing of the asset in exchange for interest revenue
Example: 10 day rental of the same computer, with no passage of title to the lessee
-rental -treat this as a operating lease
As lease payments are made over the term of the lease, both the lessee and lessor record interest at what??
-the effective interest rate
How do operating leases affect statement of cash flow
-the lessee and lessor report cash payments for operating leases as operating activities
Journal entry for amortization expense
Debit: Amortization expense Credit: Right-of-use asset
Journal Entry with purchase option: Lessor
Debit: Cash Credit: Interest Revenue Credit: Lease receivable
The amortization period is restricted to the lease term unless what?
The amortization period is restricted to the lease term unless the lease provides for transfer or tile or a BPO
What is a lease?
a contractual arrangement by which a lessor provides a lessee the right to use an asset for a specified time period
A cash payment that's predicted because of a lessee guaranteed residual value is treated the same as what?
a lease payment
What is a purchase option?
a provision of some lease contracts that gives the lessee the option to purchase the lease asset during or at the end of the lease term at a specified exercise price
If a modification grants the lessee an ____________ the original _______ is _____________ and a new lease is created based on the modified arrangement.
additional right of use, lease, terminated
As the expected residual value increases, the size of the lease payments do what?
decrease
In the unlikely event of a profit in a direct financing lease, the revenue (and profit) must be what?
deferred
In an operating lease initial direct costs are recorded where?
deferred and expensed over the lease term generally on a straight line basis
How to determine if costs of owning and operating an asset should be expensed or capitalized?
determining factor is whether the charge represents a transfer of a good or service to the lessee -if so, it qualifies as a nonlease component, separated from lease payments
when control is not transferred to the lessee but the present value of the lease payments constitutes substantially all of the asset's fair value due to a third party guaranteed residual value and its probable that the lessor will collect the lease payments the lease is considered a what?
direct financing lease
What are the purposes of lease disclosures?
enables users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. -info disclosed is both qualitative and quantitative
Most variable lease payments are recognized when ___________ rather than being estimated at lease commencement and included in the lessee's _________________ and lease ___________
incurred, right of use asset, liability
Many contracts are formulated outwardly as leases, but in reality they are what?
installment purchases/sales
In an operating lease, the lessee combines what and what? to report a single lease expense in the income statement
interest expense and amortization expense
In an operating lease, the lessee and lessor records expense and revenues on a _________________ basis?
straight-line
In a BPO the lessor ______ the PV of the exercise price to determine lease payments
subtracts
Criteria five of the financial lease?
-Leased asset is so specialized that it cannot reasonably be repurposed (no further use for the lessor) at the end of the lease
Lease payments include
-fixed payments plus: exercise price for purchase option if exercise is "reasonably certain" plus: termination penalty for termination option if exercise is "reasonably certain" plus: variable lease payments only if a) deemed in substance fixed payments or b) based on index or rate (with any changes in payments included only if and when the lessee remeasures the lease liability for another reason) Plus: excess of guaranteed residual value over expected residual value
Criteria four of the financial lease?
-if the lease payments have a total value that represents "substantially all" of the asset's fair value, it's logical to identify the lease contract as equivalent to sale -90% or more of the fair value of the underlying asset represent "substantially all" of the fair value
Each lease payment includes both an amount that represents __________ and an amount that represents a reduction of __________
-interest, principal
Examples of initial direct costs
-legal fees -commissions -preparing and processing documents
Lease term includes
-noncancelable period plus: periods covered by renewal options if exercise is "reasonably certain" minus: periods following date of purchase option if exercise is "reasonably certain" plus: periods covered by renewal options if under control of lessor plus: periods following date of termination option if its "reasonably certain" the option will not be exercised
Example: A 10 year noncancelable lease of a computer with a 10 year useful life by which title passes to the lessee at the end of the lease term
-represents a purchase rather than a rental agreement -treat this as a finance lease
An asset and liability are recorded by the lessee at what cost?
-the present value of the lease payments
If it is reasonably certain that the lessee will exercise the purchase option, the accounting for the lease is affected in 3 ways?
1) The lease is classified as a finance/sales type lease 2) both the lessee and lessor consider the exercise price of the option to be an additional cash payment 3) we assume the lease term ends on the date that the option is expected to be exercised
A lease is considered a "short-term lease" if what??
1) has a lease term (including any options to renew or extend) of 12 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 motivates a sale-leaseback transaction?
1) if the asset had been financed originally with debt and interest rates have fallen, the sales-leaseback transaction can be used to effectively refinance at a lower rate 2) the most likely motivation for a sale-leaseback transaction is to generate cash
A lease is considered a direct financing lease if???
1) it doesn't qualify as a sales-type lease 2) the combined PV of the lessee's periodic payments, the lessee guaranteed residual value and the third party guaranteed residual value will constitute substantially all of the asset's fair value 3) it's probable that the lessor will collect the lease payments
Terms of a financing lease?
1) normally allow the lessee to direct the use of the asset in a way that the lessee receives substantially all of the remaining benefits from the assets 2) creates obligations for the lessee that similar to those that financing the purchase of an asset would impose -operating leases lack these terms
We classify a finance lease (sales-type lease from lessor perspective) if one or more of the 5 criteria list is met.
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 3) the lease term is for the "major part" of the remaining economic life of the underlying asset 4) the present value of the total 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 term
What 2 things happen in a sale-leaseback transaction?
1) the seller-lessee receives cash from the sale of the asset 2) the seller-lessee pays periodic rent payments to the buyer-lessor to retain the use of the asset
2 exceptions to not including variable payments is when??
1) when variable lease payments are in substance fixed payments 2) when variable lease payments depend on an index or rate
Lessor journal entry when getting equipment back at end of lease with residual value
Debit: Equipment (residual value) Credit: lease receivable Credit:Interest Revenue
Journal Entry with purchase option: Lessee
Debit: Interest Expense Debit: Lease Payable Credit: Cash (exercise price)
Recording interest expense for operating lease
Debit: Interest expense Debit: Lease Payable Credit: Cash Debit: amortization expense Credit: Right of use asset
Finance Lease/Sales-Type Lease: With Selling Profit Journal entry for lessor
Debit: Lease Receivable Debit: Cost of Goods Sold Credit: Sales Revenue Credit: Equipment
Journal entry recording a sales type lease is similar to recording a sale of merchandise on account
Debit: Lease receivable (price) Credit: Sales Revenue (price) Debit: Cost of goods sold (cost) Credit: Equipment (cost)
Accounting for a finance lease (obtain a lease journal entry)
Debit: Leased Machinery Credit: Lease payable
Operating lease acquirement journal entry
Debit: Right of use asset (present value of lease payments Credit: Lease Payable (present value of lease payments)
Lease interest payment / reduction of principal journal entry
Debit: interest Expense Debit: Lease Payable Credit: Cash (payment)
Criteria three of the financial lease?
Lease term is for the major part of the economic life -75% or more of the remaining economic life of the underlying asset constitutes a "major part" of the remaining economic life of that underlying asset.
Journal entries for lessee and lessor for present value of interest payments (payment due at beginning or year)
Lessee Debit: Right of use asset (present value of lease payments) Credit: Lease Payable (present value of lease payments) Lessor: Debit: Lease Receivable Credit: Equipment (lessor's cost carrying amount
Second lease payment (operating lease) journal entry
Lessee: Debit: Interest expense Debit: Lease Payable (difference) Credit: Cash Lessor: Debit: Deferred Lease revenue (january 1st lease payment) Credit: Lease Revenue Debit: Cash (second lease payment) Credit: Deferred lease revenue (lease revenue in 2019 Debit: depreciation expense Credit: Accumulated depreciation Deb
First lease payment (operating lease) Journal Entry
Lessee: Debit: Lease Payable Credit: Cash (lease payment) Lessor Debit: Cash Credit: Deferred lease revenue
Second lease payment journal entry (December 31,2018)
Lessee: Debit:Interest expense Debit: Lease Payable Credit: Cash Lessor: Debit: Cash Credit: Lease Receivable Credit: Interest revenue
First lease payment journal entry (if paying at beginning of year January 1st, 2018)
Lessee: Debit: Lease Payable Credit: Cash Lessor: Debit: Cash Credit:Lease Receivable
When there is a change in the lease term, lessees are required to reassess what?
The classification of the lease
The lessee ___________ the PV of the exercise price to determine its asset and liability
adds
What is residual value?
an estimate of what a leased asset's commercial value will be at the end of the lease term -usually found in operating lease
if none of the 5 criteria are met for a finance lease, it is classified as what?
an operating lease
The gain (or loss) on a sale-leaseback is recognized when?
at the time of the sale
The lessor earns the lease revenue during the year which payment is is received at the _____________ of the year
beginning
Termination penalties are recorded as what?
cash payments
If the purchase option is reasonably certain to be exercised, the lease term _________ for accounting purposes when the option becomes _________
ends, exercisable
What is selling profit?
exists when the fair value of the asset (usually the present value of the lease payments or "selling Price") exceeds the cost or carrying value of the asset sold.
The lessee incurs an _______ as it uses the asset
expense
In a sales type lease that includes selling profit where are initial direct costs expensed?
expensed in the period of the sale at the beginning of the lease
Installment purchases/sales are called what type of leases?
finance leases - by the lessee sales-type leases - by the lessor
A lease is accounted for in 2 ways..
finance/ sales type lease operating lease
The lessor's ____________________________ is the total of periodic lease payments and any residual value
gross investment in the lease
With a purchase option, the lessee amortizes the asset by how many years?
how ever long the equipment will be useful for, not the lease term
Operating Lease
if a lease doesn't meet any of the criteria for a finance/sales-type lease that its considered to be more in the nature of a rental agreement
The cash payment expected when the BPO is exercised represents part ___________ and part ____________ just like the other cash payments
interest, principal
The cost of a leasehold improvement is depreciated over what?
its useful life to the lessee
The lessee uses the interest rate implicit in the lease if it is _______. otherwise the lessee uses its own ___________________
known, incremental borrowing rate
If the present value of the lease payments including and ___________________ constitutes substantially all of the fair value of the asset, it is a finance lease to the lessee and a sales/type lease from the lessor's perspective
lease-guaranteed residual value
for an operating lease, the ______ will report a ________ lease expense
lesee/ single
Fundamental rights and responsibilities of ownership are retained by who?
lessor
The _______ never reassesses its lease receivable for variable lease payments
lessor
How do finance leases (lessor) affect the statement of cash flow?
lessor records cash receipts from a sales type lease as cash inflows from operating activities
When a company sells a product on account, two entries are recorded:
one to record the receivable and sales revenue and another to record the cost of goods sold and corresponding reduction in inventory
When the lessee does not control substantially all of the remaining benefits of the underlying asset, the lease is usually what type?
operating
The sales-leaseback approach is allowed only if the leaseback qualifies as a what?
operating lease
Business leases are referred to as what type of leases?
operating leases
There are none of these types of leases used in international financial reporting standards?
operating leases
Lessor
owner
What are advanced payments
prepaid rent -recorded as deferred rent revenue
What is needed to differentiate between leases that in essence are installment purchases/sales and those that are not?
professional judgment
Because the present value of lease payments is greater than the cost, the lessor has a ________ that is recorded at the beginning of the lease
profit
criteria two of the financial lease?
purchase option the lessee is reasonably certain to exercise -Also known as "Bargain purchase option" -makes a judgment now about whether a future fair value will be sufficiently higher than the exercise price so that exercise is "reasonably certain"
The present value of the residual value of a lease asset is called a what?
residual asset
Costs associated with owning and operating an asset??
service contracts, maintenance, hazard insurance, and property taxes
Initial direct costs?
the costs that 1) are associated directly with consummating a lease 2) are essential to acquire the lease and 3) would not have been incurred had the lease agreement not occurred
How do finance leases (lessee) affect the statement of cash flow?
the interest portion of a finance lease payment is a cash flow from operating activities and the principal portion is a cash flow from financing activities
Reassessment of the lease term
the lease term is reassessed only when a significant event or change in circumstances indicates a change in the economic incentive for extension or termination of the lease
What if a lease term is uncertain?
the lease term is the contractual lease term modified by any renewal or termination options that are reasonably certain to be exercised
Sales type lease with residual value: lessor
the lessor's lease receivable includes the value of the asset expected at the end of the lease term
What is a sale-leaseback transaction?
the owner of an asset sells it and immediately leases it back from the new owner
In a sales type lease with no selling profit where are initial direct costs expenses?
they are deferred and expensed over the lease term -included in lease receivable
In an operating lease, its the ______ lease expense not the amortization component that is a straight line amount
total
Criteria One of the financial lease?
transfer of ownership
lessee
user
