ch 15
how reassesment of lease term works
- calculate full term of lease total number of years, and number of years remaining - lessee would remeasure the lease liability as the present value of the remaining lease payments. -the discount rate for the new term is the incremental borrowing rate of the lessee using market interest rates at the time of the reassessment.
Lessor Operating Lease
- does not record a lease receivable or derecognize the leased asset - reports lease revenue as an equal amount each period vs a declining amount on a lease receivable as in a sales type lease
lessee operating lease
- does report right of use asset and a lease liability in BS - amortization calculated differently - amortization of ROU asset is combined with interest expense on lease liability and is an equal amount of lease expense reported each period of an operating lease
initial direct costs
- for the lessee, they are added to the right of use asset. -for the lessor: - if in a sales type lease that includes selling profit, they are expensed in the period of "Sale" - at the beginning of the lease. -in a sales type lease with no selling profit, they are deferred and expensed over the lease term -in an operating lease, they are deferred and expensed over the lease term, typically on straight line basis
2 exceptions to not including variable payments in the calculation of the lease liability recorded at the beginning of the lease are:
- if they are "in substance fixed payments" or - if payments vary solely when an index or rate changes
a lease is considered a direct financing lease if
- it doesnt qualify as a sales type lease -the combined pv of the lessees periodic payments, the lessee-guaranteed residual value, and the third party guaranteed residual value will constitute substantially all of the assets fv -its probable that the lessor will collect the lease payments JE lease receivable (PV of lease payments) cr asset (CV)
more on sales type lease w selling profit
- lessee is not affected by whether or not the lessor recognizes a profit - all lessor entries, except for the entry at the beginning of the lease are the same as the entries for sales type leases without a selling profit
discount rate used
- the lessee uses the interest rate implicit in the lease if known; otherwise the lessee uses its own incremental borrowing rate - this is the rate the lessee would expect to pay a bank if funds were borrowed to buy the asset
lessor and lessee are permitted to elect to not separate the nonlease components when:
- the timing and pattern of transfer for the lease and nonlease components are identical - the lease would qualify as an operating lease if thelease payments alone are considered
lessor w residual value sales type lease
-expects to receive residual value in the form of equipment at the end of the lease term
why lease?
-leasing reduces the upfront cash needed to use an asset -lease payments are oftern lower than installment payments - offers flexibility and a lower cost when disposing of the asset -offer protection against the risk of declining asset values -tax advantages
effects of a residual value on lease classification
-payments from the lessee are the periodic lease payments plus any portion of the residual value the lessee has guaranteed - if the pv of the lease payments, including any lessee-guaranteed residual vale, constitutes substantially all of the fair value of the asset, it is a finance lease/sales type lease
Lessee-Guaranteed Residual Value
-pv of excess residual value is added to the cash paid to lessor in periodic payments and is used to record the right of use asset and lease liability at the beginning of the lease -lessor also considers excess residual value in payments and lease receivable
is it a lease?
-there must be an identified asset -must be ppe -the lessee must have the right to control the use of the identified asset
if a lessee remeasures the liability for reasons other than change in index or rate it is recalculated by:
-using the new lease payments as adjusted for changes in the index or rate and -the discount rate that applies as of the date of the reassessment *** the lessor never reassesses its lease receivable for variable lease payments
classification criteria, any of the following must be met to be a finance lease/sales type lease:
1. the agreement specifies that ownership of the asset transfers to the lesse 2. the agreement contains a purchase option that the lessee is resonably 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 lease term.
first lease payment vs second lease payment (lessee)
1st: dr lease payable cr cash 2nd: dr interest expense (initial recording minus 1st pmt times interest rate) dr lease payable cr cash
BS classification of an operating lease liability is
a non debt liability
criterion 2: a purchase option
a provision in the lease contract that gives the lessee the option to purchase the leased property at a specified price. criterion is met if the price is sufficiently lower than the expected fair value of the property when the option becomes exercisable that the exercise of the option appears reasonably certain at the beginning of the lease.
when the substance of the lease is
a temporary rental agreement: we classify those as operating leases whent he lease contract essentially represents the sale of an asset: the lessee has a finance lease, and the lessor has a sales type lease.
if and when the lessee remeasures the lease liability for reasons other than a change in the index or rate should the lessee
adjust the right of use asset and lease liability for changes in the amount of payment (for ex, reassesment of lease term or modification of the lease).
the residual, whether guaranteed or unguaranteed
affects the size of the lease payments
amortization expense with purchase option
amortized over useful life of the asset, not the usual lease term amount of years
residual value - guarantee of the residual value
amount to be recovered (fair value) less: PV of residual value =amount to be recovered through periodic rental payments div by pv factor = lease payments at beg of each year
in-substance fixed payments
are included in lease payments used in present value calculations ex: if monthly lease payments by the higher of $250 or .5% of monthly store revenue, lease payments will increase by at least 250, so those payments are deemed to be insubstance fized payments.
uncertain lease payments
because the amounts are uncertain and often avoidable, we dont consider them as part of the lease payments used to calculate the lessees lease liability and the lessors lease receivable. if and when lease payments increasem the change in the lease payments has no effect on balance sheet accounts and simply is reported as a separate lease expense/revenue
selling price - cost of asset = selling profit sales revenue - cogs = selling profit JE for sales type lease with a selling profit
beginning of lease JE dr lease receivable (PV of lease pmts) dr cogs (lessors cost) cr sales revenue (PV of lease pmts) equipment (lessors cost) first lease pmt cash - 1st pmt amount lease -receivable
short term leases
considered short term if: - has a lease term (including options to renew or extend) of 12 months or less AND - does not contain a purchase option that the lessee is reasonably certain to exercise, which would extend the term beyond 12 months
leasehold improvements
cost is allocated as amortization or depreciation expene ovr its useful life to the lessee, which will be the shorter of the leae term or the physical life of the asset.
amortization othe right of use asset for operating lease
different from amortization of a finance lease - ddetermine amortization as the amount needed to cause the total lease expense (interest plus amortization) to be an equal straight line amount over the lease term
JE for reassessment of the lease term
dr ROU asset cr Lease payable PV of remaining pmts discounted at the current rate less liability balance after 3 years based on initial lease terms = increase in balance if lease term is shortened, dr lease payable cr rou asset lessees are required to reassess the classification of a lease lessors are not permitted to reassess its initial determination of a lease term or disc. rate
recording amortization of the right of use asset for a lessee
dr amortization expense cr right of use asset ( price/num of yrs) lessee should amortize over the lease term unless the lease provides for transfer of title or a BPO.
end of lease term - actual residual value equals the estimated amount : lessor
dr equipment (residual value) cr lease receivable cr interest revenue (%*outstanding balance) - if actual residual value is less or more the lessor would record a loss or gain -lessor includes in its amortization schedule the residual value interest revenue is higher -a greater total amount of lease receipts is collected (gross investment in the lease)
lessor beginning of the lease JE
dr lease receivable (PV of lease pmts) cr equipment (lessors cost; carrying amt)
gross vs net investment in the lease
gross: total amount of lease receipts collected (higher when there is a residual value) net: the amount recorded as the receivable in the journal entry at the beginning of the lease
termination penalites
if it is reasonably certian, the penalty is included and the lease term is from beg of lease to the expected termination date
criterion 1- transfer of ownnership
if legal title passes to the lessee during, or at the end of the lease term, obviously ownership attributes are trasnferred.
the costs that are associated directly with consummating a lease, are essential to acquire the lease, and would not have been incurred had the lease agreement not occurred are reffered to as
initial direct costs -includes legal fees, commissions, and preparing and processing lease documents
each payment includes both interest and a reduction of principal
installment note: dr interest exp dr note payable cr cash finance lease: dr interest expense dr lease payable cr cash
lease expense for operating lease
interest calculated plus amortization = lease expense lease expense = annual payment upon agreement
eoy adjusting entries for beginning of period leases
interest expense (%*last CV) interest payable (its paid next day) dr amort expense (price/tot. yrs) cr ROU asset lessor: dr int rec. cr int rev
the excercise price of a purchase option
is considered to be an additional cash payment if exercise of the option is reasonably certain -we assume the lease term ends on the date that the option is expected to be exercised -both the additional cash payment and the shortened lease term impact the calculation of the lessees ROU asset and the lease liability/receivable
a finance lease
is economically similar to the purchase of the asset becuase the terms of a finance lease 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 asset and created obligations for the lessee that are similar to those that financing the purchase of an asset would impose.
criterion 4- present value of payments is substantially all of fair value
it is logical to identify the lease contract as equivalent to a sale- the lessee has paid enough to have purchased the asset payments with a PV of 90% or more of the FV represent substantially all of the FV.
calculation of sales type lease with selling profit and residual value - lessor
lease receivable ( PV of lease payments plus PV of residual value COGS (equip CV less PV of residual value) cr. sales revenue (lease receivable less residual value) cr equipment (lessors cost)
sale type lease with residual value : lessor
lease receivable (PV of lease payments plus PV of residual value cr equipment (lessors cost carrying amt) - lessor includes residual value in amort. schedule along with lease payments
reassessment of the lease term
lease term is reassessed only when a significant event or change in circumstances indicates a change in economic incentive for extension or termination of the lease.
lease classifications
lessee- finance lease lessor- sales-type lease -without selling profit -with selling profit lessee- operating lease lessor-operating lease
JE on first payment operating lease
lessee: ROU asset (PV) Cr lease payable Lease payable cr cash (payment lessor: no entry for receivable or removing an asset cash -lease payment def rev
JE for operating lease on second lease payment date
lessee: int expense (&*price-1stpmt) lease payable -difference cr cash amort. expense (pmt-int exp) ROU asset lessor: deff rev cr revenue cash -2nd pmt cr deff revenue
lease payments that include nonlease components paid by the lessor
lessee: maintenance expense lease payable cr cash lessor: cash cr lease receivable cr maintenance fee payable *** lessee is given the option to elect to not separate the nonlease components and account for the entire arrangement as a lease
bargain purchase option calculation
lessors calculation: amount to be recovered (FV) less : pv of excercise price amount to be recovered through periodic rental payments div by pvad factor = lease payments at the beginning of each of the six years
criterion 3- whether the asset is leased for the major part of its useful life.
most of the risks and rewards of ownership are deemed to have been transferred to the lessee, as if the asset had been purchased. 75% or more constitutes a major part of the remaining economic life. if the lease includes provisions such as renewable periods or cancelable after a designated noncancelable period, these must be considered whether a change in terms is reasonably certain to occur.
variable leases
most variable lease payments are recognized when incurred rather than being estimated at lease commencment and included in the lessee's right of use asset and lease liability.
lessor beginning of the lease JE operating
no JE
shortcut approach for short term leases permits the lessee tp
not record an asset and related liability associated with the lease at the beginnign of the term. instead, the lessee can simply record the lease payments as rent expense over the lease term. monthly lease pmt ex: lease expense cr cash
comparison of a note and finance lease
note: dr machinery cr NP finance lease dr right of use asset cr lease payable
criterion 5- leased asset is so specialized that it cannot be reasonably repurposed
only the lessee can dervice the usual risks and rewards of ownership of the asset. the lessor will achieve its desired ROI only through the lease payments from that lease, indicating that the lessor intends a sale of ownership rights.
statement of cash flows
operating leases - both lessee and lessor report cash payments for operating leases as operating activities finance lease (lessee)- interest portion is operating activity, and principal portion is a financing activity sales type lease for the lessor: operating activities
lease components
property taxes hazard insurance
lessees calculation of pv of lease payments with bargain purchase option:
pv of periodic leae payments (annual pmt * pvad) plus: pv of exercise price = pv of lease payments
a lessee (user) initially accounts for a lease arrangement by
recording a right of use asset and a lease liability subsequent entries depend on the nature of the lease contract
lesee beginning of the lease entry
right of use asset (PV of the lease payments) cr lease payable
for a lessee, if an operating lease now became a finance lease due to reassessment of length of lease (over 75% of economic life),
right of use asset would now be amortized as a straight line allocation over the next years rather than plugging amortization. a lessor is not permitted to reassess its initial determination of the lease term or discount rate.
interest for operating lease
same as for financing lease - no interest on first payment interest for first payment = %* (price-1stpmt)
lessor and lessee both report ______ amounts in their incomes tatements for operating leases
straight line -reflects the fact that we consider an operating lease as a straight line rental of the asset during the lease term
lessor annual JE for operating lease
straight line revenue as a single lease revenue equal to the amount of lease payment which is also equal to the amount the lessee reports as lease expense
if a cash payment under a lessee guarnateed residual value is predicted,
the PV of that payment is added to the PV of the periodic lease payments that the lessee records as both a right of use asset and a lease liability. - a cash payment that's predicted because of a lessee-guaranteed residual value is treated the same as another lease payment.
recording interest exp/rev
the entire first lease payment is applied to the principal because the payment occured at the beginning, so no interest had accrued. each lease payment after the first one includes interest and a reduction of the balance.
sales type lease with selling profit and residual value
the lease provides the lessor with a selling profit if the PV of payments exceeds the assets cost
Reporting lease expense and lease revenue in an operating lease
the lessee combines interest expense and amortization expense to report a single lease expense in the income statement - in a finance lease the lessee reports interest expense and amortization expense separately in the income statement
operating lease revenue amount is the same as
the lessee's lease expense
sales type lease with residual value - lessee
the lessees accounting is unaffected by the residual value other than its causing the payments to be lower
if a modification to a lease term grants the lessee an additional right of use,
the original lease is terminated and a new lease is created based on the modified arrangement
if a modification alters the lessees right to use an asset rather than grant an additional right of use,
this would mean adjusting, adding to, or deleting what has been recorded in order to conform to the new terms of the contract and perhaps reclassifying the lease from one type to another
if lease term is uncertain
we consider the lease term to be the contractual lease term adjusted for any periods covered by the options to extend or terminate the lease for which there is a significant economic incentive to exercise the option. only if it is "reasonably certain"
when an amount of lease payments depends on an index or a rate
we use the intital lease payment amount based on the current index to discount to present value when determining the right of use asset, lease liability, and lease receivable. when lease payemtns change in the future, we dont remeaseure the lease liabiliy/asset at that time, but simply report the additional amount as a separate lease payment that produces an expense/revenue
selling profit with sales time leases
when the fair value of the asset exceeds the cost or carrying value of the asset sold in addition to interest revenue earned over the lease term, the lessor recognizes a selling profit on the "sale" of the asset profit is recognized at the beginning
