Leases

Finance Lease:

-A lease that transfers control or ownership of the leased asset to the lessee. -Lessee recognizes a right-of-use asset and a lease liability on its books and recognizes interest expense and amortization expense of the lease term. -Lessee "capitalizes" the leased asset. -When a lease is recorded as a finance lease by the lessee, the present value of the future lease payments is debited to the leased asset (right-of-use asset) and credited to the lease liability accounts. -Lessor removes the asset from its books, replaces it with a financial asset (lease receivable), and recognizes interest revenue over the lease term. -When a lease is recorded as a finance lease by the lessor, the present value of future lease payments is debited to the financial asset (receivable) created at the inception of the lease.

There are different views on the capitalization of leases. Which of the following has been adopted by the FASB? A. Capitalize firm leases where the penalty for nonperformance is substantial. B. Capitalize all long-term leases. C. Do not capitalize any leased assets. D. Capitalize leases that a similar to installment purchases.

Capitalize all long-term leases.

In a sale-leaseback arrangement,

a company (the seller-lessee) transfers an asset to another company (the buyer-lessor) and then leases that asset back from the buyer-lessor.

lease

a contractual agreement between a lessor and a lessee conveying the right to use property, plant, or equipment for a specified period of time in exchange for consideration (usually cash payments).

To determine whether the present value of the payments equals or exceeds 90 percent of the fair value of the leased asset,

a lessee should compute the present value of the lease payments using the implicit interest rate In the event that it is impracticable to determine the implicit rate or when the implicit interest rate is higher than the incremental borrowing rate, then the lessee uses its incremental borrowing rate.

A bargain purchase option

a provision allowing the lessee to purchase the leased property for a price that is significantly lower than the property's expected fair value at the date the purchase option becomes exercisable. The lessor expects the option to be taken.

Advantages of Leasing: From the perspective of the lessee, advantages ; From the perspective of the lessor

a. 100% financing at fixed rates b. protection against obsolescence c. flexibility d. less costly financing e. tax advantages a. profitable interest margins b. stimulation of sales c. tax benefits d. return of a high residual value

The guidelines for lessee accounting for a guaranteed residual value are as follows:

a. If it is probable that the expected residual value is equal to or greater than the guaranteed residual value, the lessee should not include the guaranteed residual value in the computation of the lease liability. b. If it is probable that the expected residual value is less than the guaranteed residual value, the difference between the expected and guaranteed residual values should be included in computation of the lease liability.

In a sale, gain or loss recognition is appropriate. The lessor then records the transaction as follows:

a. Increases cash and reduces the carrying value of the asset to zero (referred to as derecognizing the asset). b. Recognizes a gain or loss as appropriate. c. Accounts for the leaseback in accordance with lease accounting guidance.

Lessees and lessors must also provide

additional qualitative and quantitative disclosures to help financial statement users assess the amount, timing, and uncertainty of future cash flows.

For accounting purposes of the lessee,

all leases may be classified as operating leases or finance leases.

The 75% of economic life test

based on the belief that when a lease constitutes a major part of the asset's remaining economic life, control of the asset is transferred to the lessee. A major exception to the 75% rule is when the inception of the lease occurs during the last 25% of the asset's life; when this occurs the 75% test should not be used.

The previous FASB standard on leasing

depended on whether a lease qualified as an operating lease or a finance (referred to as a capital) lease

present value test (90%)

if the present value of the minimum lease payments is reasonably close to the fair value of the asset, the asset is effectively being purchased.

Initial direct costs incurred by the lessee

increase the right-of-use asset.

Lease prepayments made by the lessee

increase the right-of-use asset.

A finance lease

must be non-cancelable and meet one of the following five criteria. In either case, companies capitalize all leased assets and liabilities. a. The lease transfers ownership of the property to the lessee at the end of the lease. b. The lease contains a bargain purchase option. c. The lease term is equal to 75% or more of the estimated economic life of the leased property. d. The present value of the lease payments equals or exceeds 90% of the fair value of the leased property. e. The underlying asset of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

Executory costs

normal expenses associated with owning a leased asset, such as property insurance and property taxes. not capitalized by either party, normally they represent annual expenses associated with owning the asset.

Lease incentive payments made by the lessor to the lessee

reduce the right-of-use asset.

The basic difference between a direct financing lease and a sales-type lease

relates to the profit on the sale. In a sales-type lease, the profit is recognized immediately. In a direct financing lease, the profit is deferred and recognized over the life of the lease.

If the seller-lessee gives up control,

the transaction is a sale.

Operating Lease:

-A lease that does not transfer control or ownership of the leased asset to the lessee. -Not classified as a finance lease by the lessee. -Not classified as a sales-type or direct-financing lease by the lessor. -Lease term is greater than 12 months. -Lessee does capitalize a lease liability and records a right-of-use asset.

Short-Term Lease:

-A lease that is less than 12 months. -Lessee records lease or rent expense as time passes, typically monthly. Debit lease expense and credit cash or accounts payable. -Lessor records lease or rent revenue as earned, also typically monthly. Debit cash or accounts receivable and credit lease revenue.