Advanced Leasing Concepts
ACCTG 305
LEARNING OBJECTIVES
1.
2.
3.
4.
5.
6.
7.
Understand the key terms in lease accounting guidance
Understand the accounting issues faced by the asset owner (lessor) and the asset
user (lessee) in recording a lease transaction.
Outline the types of contractual provisions typically included in lease agreements.
Apply the lease classification criteria in order to distinguish between capital and
operating leases.
Properly account for both capital and operating leases from the standpoint
of the lessee (asset user).
Properly account for both capital and operating leases from the standpoint
of the lessor (asset owner).
Prepare and interpret the lease disclosures required of both lessors and
lessees.
15-2
Introduction
• A lease is a contract specifying the terms
under which the owner of property, the
lessor, transfers the right to use the property
to a lessee.
• A major challenge for the accounting
profession has been to establish standards
that prevent companies from using the legal
form of a lease to avoid recognizing future
payment obligations as a liability.
15-3
Economic Advantages to
Leasing Over Purchasing
For the Lessee
1. No down payment
2. Avoid risks of ownership
3. Flexibility
For the Lessor
1. Increased sales
2. Ongoing business relationship with lessee
3. Residual value retained
15-4
Simple Example
•
•
•
Owner Company owns a piece of equipment
with a market value of $10,000 and an
estimated useful life of five years.
User Company wishes to acquire the
equipment.
User Company can borrow $10,000 from the
bank at 10% interest. Payments for principal
and interest would be five equal annual
installments of $2,638.
(continued)
15-5
Simple Example
•
Alternatively, User Company can lease the
equipment from Owner Company for five years
and make five annual “rental” payments of
$2,638.
•
User will still use the equipment for five years
and will still make payments of $2,638 per
year.
•
The primary difference is that now Owner is
not just selling the equipment but is also
substituting for the bank in providing financing.
(continued)
15-6
Simple Example
On the date the lease is signed, should Owner
Company recognize an equipment sale?
The key accounting issues for the lessor are:
•
Has effective ownership of the equipment
been passed from Owner to User?
•
Is the transaction complete, meaning does
Owner have any significant responsibilities
remaining in regard to the equipment?
•
Is Owner Company reasonably certain the five
annual payments can be collected from User
Company?
(continued)
15-7
Simple Example
•
•
Question: On the date the lease is signed,
should User recognize the lease equipment
as an asset and the obligation to make the
lease payment as a liability?
Answer: The answer hinges on whether
effective ownership, as opposed to legal
ownership, of the equipment changes
hands when Owner and User sign the lease
agreement.
(continued)
15-8
Simple Example
• The economic substance of the lease is
that the lease signing is equivalent to
the transfer of effective ownership, and
the fact that Owner retains legal title of
the equipment during the lease period
is a mere technicality.
15-9
Capital vs. Operating Lease
•
•
Capital leases are accounted for as if the
lease agreement transfers ownership of
the asset from the lessor to lessee.
Operating leases are accounted for as
rental agreements, with no transfer of
effective ownership associated with the
lease.
15-10
Why Leasing Over Purchasing?
•
Keeping the asset off the balance sheet
improves financial ratio measures of
efficiency.
•
Keeping the liability off the balance sheet
improves measures of leverage.
•
For companies that lease a large portion of
the assets they use, the accounting
standards associated with leasing are the
most critical standards that they apply.
15-11
Key Lease Provisions
Cancellation Provisions
• Some leases are noncancelable, meaning
that these lease contracts are cancelable only
on the outcome of some remote contingency
or that the cancellation provisions and
penalties of these leases are so costly to the
lessee that cancellation will not occur.
• All cancelable leases are accounting for as
operating leases.
• Some, but not all noncancelable leases are
accounted for as capital leases.
15-13
Bargain Purchase Option
•
•
•
If the specified purchase option price is
expected to be considerably less than the
fair value at the date the purchase option
may be exercised, the option is called a
bargain purchase option.
By definition, a bargain purchase option is
one that is expected to be exercised.
Noncancelable leases with BPO are
accounted for as capital leases.
15-14
Lease Term
•
•
•
The lease term is the time period from the
beginning to the end of the lease.
The beginning of the lease term occurs
when the leased property is transferred to
the lessee.
The end of the lease term is more flexible
because many leases include provisions
allowing the lessee to extend the lease
period.
(continued)
15-15
Lease Term
•
•
The end of the lease term is at the end of the
fixed noncancelable lease period plus all
renewal option periods that are likely to be
exercised.
A bargain renewal option is one with such
an attractive lease rate, or other favorable
provision, that at the inception of the lease, it
is likely that the lease will be renewed
beyond the fixed lease period.
15-16
Residual Value
•
•
The market value of the leased property at
the end of the lease term is referred to as
its residual value.
Some lease contracts require the lessee to
guarantee a minimum residual value. If the
market value falls below the guaranteed
residual value, the lessee must pay the
difference.
(continued)
15-17
Residual Value
•
•
If there is no bargain purchase option or
guarantee of the residual value, the lessor
reacquires the property.
If the actual amount of the residual value is
unknown until the end of the lease term, it
must be estimated at the inception of the
lease. The residual value under these
circumstances is referred to as an
unguaranteed residual value.
15-18
Minimum Lease Payments
• The rental payments required over the lease
term plus any amount to be paid for the
residual value are referred to as the
minimum lease payments.
• Lease payments sometimes include charges
for items such as insurance, maintenance,
and taxes on the leased property. These are
referred to as executory costs and they are
not included as part of the minimum lease
payment.
(continued)
15-19
Minimum Lease Paymentsexample
Dorney Leasing Co. owns and leases road
equipment for three years at $3,000 per
month. Included in the lease payment is $500
per month for executory costs to insure and
maintain the equipment. At the end of the
3-year period, Dorney is guaranteed a
residual value of $10,000 by the lessee.
Question What are the total lease
payments
15-20
Minimum Lease Paymentsexample (cont)
Minimum lease payments:
Rental payments exclusive of executory
costs ($2,500 × 36)
Guaranteed residual value
Total minimum lease payments
$ 90,000
10,000
$100,000
How did Dorney decide that a $2,500 monthly lease
payment would be sufficient if 12% is the interest rate?
15-21
Implicit Interest Rate
• The implicit interest rate is the rate used
by the lessor in calculating the desired
lease payment.
• For purposes of computing the present
value of the minimum lease payments, the
lessee uses the lower of (i) the implicit
interest rate used by the lessor and (ii) the
lessee’s own incremental borrowing
(continued)
rate.
15-22
15-23
15-23
General Classification Criteria—
Lessee and Lessor
The four general criteria that apply to all leases
for both the lessee and lessor relate to transfer of
ownership, bargain purchase option, economic
life, and fair value.
1. The lease transfers ownership of the
leased asset to the lessee by the end of the
lease term.
2. The lease contains a bargain purchase
option making it reasonably assured that the
property will be purchased by the lessee at a
future date.
(continued)
15-24
General Classification Criteria—
Lessee and Lessor
3. The lease term is equal to 75% or more of the
estimated economic life of the leased property.
4. The present value of the minimum lease
payments at the beginning of the lease equals or
exceeds 90% or more of the fair market value of
the leased asset.
15-25
Revenue Recognition
Criteria—Lessor
In addition to meeting one of the four general criteria, a
lease must meet two additional revenue recognition
criteria to be classified by the lessor as a capital lease:
1. Collection of the minimum lease payments
must be reasonably predictable.
2. Any unreimbursable costs yet to be incurred
by the lessor under the terms of the lease
are known or can be reasonably estimated
at the lease inception date.
15-26
15-27
15-27
Accounting for Leases—Lessee
• All leases as viewed by the lessee may
be divided into two types: operating
leases and capital leases.
• If the lease meets any one of the four
criteria, it is treated as a capital lease.
Otherwise, it is an operating lease.
(continued)
15-28
Accounting for Leases—Lessee
•
•
Accounting for operating leases involves the
recognition of rent expense over the term of
the lease.
Accounting for a capital lease essentially
requires the lessee to report on the balance
sheet the present value of the future lease
payments, both as an asset and a liability.
• The asset is amortized as though it had
been purchased by the lessee.
• The liability is reduced by payments, and
accreted to present value
15-29
Accounting for Operating
Lease—Lessee
The lease terms for manufacturing
equipment are $40,000 a year on a
year-to-year basis. The entry to record the
lease payment for the year would be as
follows:
Rent Expense
Cash
40,000
40,000
15-30
Operating Leases with
Varying Lease Payments
•
•
The terms of the lease for an aircraft by
International Airlines provide for payments
of $150,000 a year for the first two years of
the lease and $250,000 for each of the
next three years.
The total lease payments would be
$1,050,000, or $210,000 a year on a
straight-line basis.
(continued)
15-31
Operating Leases with
Varying Lease Payments
The required entries in the first two years
would be as follows:
Rent Expense
Cash
Rent Payable
210,000
current liability
150,000
60,000
The entries for each of the last three years
are as follows:
Rent Expense
Rent Payable
Cash
210,000
40,000
250,000
15-32
Accounting for Capital
Leases—Lessee
Marshall Corporation—Lessee
• Lease period: 5 years, beginning January 1,
2013. Noncancelable.
• Rental amount: $65,000 per year payable
annually in advance; includes $5,000 to cover
executory costs.
• Estimated economic life of equipment: 5 years.
• Expected residual value of equipment at end of
lease period: None.
(continued)
15-33
Accounting for Capital
Leases—Lessee
Marshall Corp. Entries on January 1, 2013
Leased Equipment
Obligations under Capital Leases
To record the lease.
Lease Expense
Obligations under Capital Leases
Cash
To record the first lease
payment (including executory
costs of $5,000).
250,192
250,192
PMT = $60,000; N
5,000
= 5; I = 10%
60,000
65,000
(continued)
15-34
Accounting for Capital
Leases—Lessee
• The term lease expense is used to record
the executory costs related to the leased
equipment, such as insurance and taxes.
• When a lease is capitalized, the asset is
included on the balance sheet and written
off over time. The word amortization,
instead of depreciation, is typically used
when describing the systematic expensing
of the cost of a leased asset.
(continued)
15-35
Accounting for Capital
Leases—Lessee
Marshall Corp. Entries on December 31, 2013
If normal company depreciation policy for this
type of equipment is used, the amortization entry
for 2013 is shown below:
Amortization Expense on Leased
Equipment
Accumulated Amortization on
Leased Equipment
50,038
$250,192/5 50,038
(continued)
15-36
(continued)
15-37
15-37
Accounting for Capital
Leases—Lessee
Entries on December 31, 2013
Prepaid Executory Costs
Obligations under Capital
Leases
Interest Expense
Cash
5,000
40,981
19,019
65,000
($250,192 –
$60,000) ×
0.10
(continued)
15-38
Accounting for Capital
Leases—Lessee
The December 31, 2013, balance sheet of
Marshall Corporation would include information
concerning the leased equipment and related
obligations.
(continued)
15-39
Accounting for Capital Leases—
Lessee
•
•
As the amount of interest expense declines
each period, the total expense will be
reduced and, for the last two years, will be
less than the $65,000 payments (See Slide
15-52).
The total amount debited to expense over
the life of the lease will be the same
regardless of whether the lease is
accounted for as an operating lease or a
capital lease.
(continued)
15-40
15-41
15-41
Accounting for Leases with a
Bargain Purchase Option
•
•
Frequently, the lessee is given the option of
purchasing the property in the future at what
appears to be a bargain price.
The present value of the bargain purchase
option is part of the minimum lease
payments and should be included in the
capitalized value of the lease.
15-42
Accounting for Leases with a
Bargain Purchase Option
Lessee
• Lease period: 5 years, beginning January 1,
2013, noncancelable.
• Rental amount: $65,000 per year payable
annually in advance; includes $5,000 to cover
executory costs.
• Estimated economic life of equipment: 10 years.
• Expected residual value of equipment at end of
lease period: None.
(continued)
15-43
Accounting for Leases with a Bargain
Purchase Option
•
•
These are the same facts as the previous
illustration. However, we’ve added a
bargain purchase option of $75,000
exercisable after five years. The economic
life of the equipment is expected to be ten
years.
Notice that the present value of the bargain
purchase amount of $75,000, or $46,569,
increases the present value of the minimum
lease payments.
(continued)
15-44
Accounting for Leases with a Bargain
Purchase Option
Minimum Lease Payments
Present value of five payments at the
beginning of each year for five years:
PMT = $60,000, N = 5, I = 10%
$250,192
Present value of the bargain purchase
option of $75,000 at the end of 5 years:
46,569
Present value of minimum lease payments $296,761
FV = $75,000, N = 5, I = 10%
(continued)
15-45
(continued)
15-46
15-46
Accounting for Leases with a Bargain
Purchase Option
Entries on December 31, 2017
Obligations under Capital Leases
Interest Expense
Cash
To record exercise of bargain
purchase option.
Equipment
Accumulated Amortization on
($296,761/10) × 5
Leased Equipment
Leased Equipment years
68,182
6,818
75,000
$68,182 ×
10%
148,381
148,380
296,761
To transfer remaining balance in
leased asset account to equipment.
(continued)
15-47
Accounting for Leases with a Bargain
Purchase Option
If the equipment is not purchased and the lease
is permitted to lapse, the following entry is
required on December 31, 2017:
Loss from Failure to Exercise
Bargain Purchase Option
Obligation under Capital Leases
Interest Expense
Accumulated Amortization on
Leased Equipment
Leased Equipment
73,381
68,182
6,818
148,380
296,761
15-48
Accounting for Purchase of
Asset During Lease Term
•
•
On December 31, 2015, rather than making
the lease payment due, the lessee purchased
the leased property in the Marshall
Corporation example for $120,000.
At that date, the remaining liability recorded
on the lessee’s books is $114,545 and the
net book value of the recorded leased asset
is $100,078 [capitalized value of $250,192
less $150,114 amortization ($50,038 × 3)].
Question What would be the entries to
record this sale
15-49
Accounting for Purchase of
Asset During Lease Term
Given the facts the entry to record the
purchase on the lessee’s books would be as
follows:
Interest Expense
Obligation under Capital Leases
Equipment
Accumulated Amortization on
Leased Equipment
Leased Equipment
Cash
10,413
104,132
105,533
150,114
250,192
20,000
[$100,078 + ($120,000 – $114,545)]
15-50
Treatment of Leases on Lessee’s
Statement of Cash Flows
•
Operating leases present no special problems
to the lessee in preparing a statement of cash
flows.
•
For capital leases by the lessee the
amortization of leased assets would be treated
the same as depreciation.
•
The portion of the cash payment allocated to
interest expense would require no adjustment
under the indirect method and would be
reported as part of the cash payment for interest
expense under the direct method.
(continued)
15-51
Treatment of Leases on Lessee’s
Statement of Cash Flows
•
For capitalized leases, the portion of the cash
payment allocated to the lease liability would
be reported as a financing outflow under either
method.
(continued)
15-52
15-53
15-53
Treatment of Leases on Lessee’s
Statement of Cash Flows
In addition, the supplemental disclosure to the
statement of cash flows would include the
following two lease-related items:
• Significant noncash transaction: During 2013
the company leased equipment under a
capital lease arrangement. The present value
of the minimum future payments under the
lease was $250,192 on the lease-signing
date.
•
Cash paid for interest was $19,019.
15-56
Learning Objective 6
Properly account for
both capital and
operating leases from
the standpoint of the
lessor (asset owner).
15-57
Accounting for Leases—Lessor
•
•
Direct financing leases involve a lessor
who is primarily engaged in financing
activities, such as a bank or finance
company. The lessor views the lease as an
investment.
Sales-type leases involve manufacturers or
dealers who use leases as a means of
facilitating the marketing of their products.
(continued)
15-58
Accounting for Leases—Lessor
A sales-type lease generates two different
types of revenue:
1) An immediate profit or loss, which is the
difference between the cost of the property
being leased and its sales price, or fair
value, at the inception of the lease.
2) Interest revenue earned over time as the
lessee makes the lease payments that pay
off the lease obligation plus interest.
15-59
Initial Direct Costs
•
For either an operating, direct financing, or
sales-type lease, a lessor may incur
certain costs, referred to as initial direct
costs, in connection with obtaining the
lease.
• These costs include the costs to negotiate
the lease, perform the credit check on the
lessee, and prepare the lease documents.
Question What is the accounting for
these costs?
(continued)
15-60
15-61
15-61
Accounting for
Operating Leases—Lessor
Universal Leasing Co. (Lessor)
Minimum payment (in advance) including
$5,000 executory cost
Lease period (beginning Jan. 1, 2013)
Economic life of asset
Estimated residual value at end of lease
Implicit rate
Incremental borrowing rate
Cost to lessor
Initial direct costs
$65,000/year
5 years
10 years
$0
10%
10%
$400,000
$15,000
Question What is the journal entry to record the
initiation of this lease (lessor)
15-62
Accounting for
Operating Leases—Lessor
Universal Leasing Co. (Lessor)
The entries to record the payment of the initial
direct costs and the receipt of the lease payment
on January 1, 2013 would be as follows:
Deferred Initial Direct Costs
Cash
15,000
Cash
Rent Revenue
Executory Costs
65,000
15,000
60,000
5,000
(continued)
15-63
Accounting for
Operating Leases—Lessor
Universal Leasing Co. (Lessor)
To record the amortization of direct costs over five
years and the depreciation of equipment over ten
years using the straight-line basis:
Amortization of Initial Direct Costs
Deferred Initial Direct Costs
Depreciation Expense on Leased
Equipment
Accumulated Depreciation on
Leased Equipment
3,000
3,000
40,000
40,000
15-64
Accounting for
Direct Financing Leases
Refer to Slides for details concerning Marshall
Corporation’s leasing arrangement with
Universal Leasing Company. The cost of the
equipment to Universal was the same as the fair
value, $250,192 and Equipment Purchased for
Lease was charged when the equipment was
acquired.
Question What is the journal entry to
record the initiation of this lease
(lessor)
15-65
Accounting for
Direct Financing Leases
Receivable Recorded at Gross Amount
To record initial lease on January 1, 2013:
Lease Payments Receivable
Equipment Purchased for Lease
Unearned Interest Revenue
300,000
250,192
49,808
To record first payment on January 1, 2013:
Cash
Lease Payment Receivable
Executory Costs
65,000
60,000
5,000
(continued)
15-66
(continued)
15-67
15-67
Accounting for
Direct Financing Leases
To record receipt of the second payment:
Cash
Lease Payment Receivable
Deferred Executory Costs (a liability)
Unearned Interest Revenue
Interest Revenue
(continued)
65,000
60,000
5,000
19,019
19,019
15-68
Accounting for
Direct Financing Leases
The asset portion of the balance sheet of the
lessor at December 31, 2013, will report the
lease receivable as follows:
15-69
Lessor Accounting for Direct
Financing Leases with Residual Value
•
Assuming the same facts as the last
illustration, except that the asset has a residual
value at the end of the 5-year lease of $75,000.
The cost to Universal Leasing Company was
again the same as its fair value, $296,761.
•
The fair value in this example is different from
the fair value in the previous example because,
in the previous example, the asset was
assumed to be worthless at the end of the
lease term.
Question What is the journal entry to record the
initiation of this lease (lessor)
15-70
Lessor Accounting for Direct
Financing Leases with Residual Value
Receivable Recorded at Net Amount
To record initial lease on January 1, 2013:
Lease Payments Receivable
Equipment Purchased for Lease
296,761
296,761
To record first payment on January 1, 2013:
Cash
Lease Payment Receivable
Executory Costs
65,000
60,000
5,000
(continued)
15-71
Lessor Accounting for Direct
Financing Leases with Residual Value
To record payment on December 31, 2013:
Cash
Lease Payments Receivable
Deferred Executory Cost
Interest Revenue
65,000
36,324
5,000
23,676
To record recovery of the leased asset at the end
of the lease term on December 31, 2015:
Equipment
Lease Payment Receivable
Interest Revenue
75,000
68,182
6,818
15-72
Accounting for Sales-Type Leases—
Lessor
•
•
In a sales-type lease, an immediate profit
or loss arises from the difference between
the sales price of the leased property and
the lessor’s cost to manufacture or
purchase the asset.
If there is. no difference between the sales
price and the lessor’s cost, the lease is
not a sales-type lease
(continued)
15-73
Accounting for Sales-Type Leases—
Lessor
•
The lessor will also recognize interest
revenue over the lease term for the
difference between the sales price and the
gross amount of the minimum lease
payments.
(continued)
15-74
Accounting for Sales-Type Leases—
Lessor
(1) Minimum lease payments
Financial
Revenue
(Interest)
(2) Fair value of leased asset
(3) Cost or carrying value of
leased asset to lessor
Manufacturer’s
or Dealer’s
Profit (Loss)
(continued)
15-75
Accounting for Sales-Type Leases—
Lessor
American Manufacturing Co. (Lessor)
Fair value of equipment
Lease period (beginning Jan. 1, 2013)
Economic life of asset
Estimated residual value at end of lease
Implicit rate
PV of future lease payments
Cost to lessor
Direct costs incurred
$250,192
5 years
10 years
$0
10%
$250,192
$160,000
$15,000
Question How much revenue is recorded at the initiation of the
lease? How much interest income over the life of the lease?
15-76
Accounting for Sales-Type Leases—
Lessor
(1) Minimum lease payments:
($65,000 – $5,000) × 5
$300,000
(2) Fair value of equipment
$250,192
(3) Cost of leased equipment
to lessor, plus initial direct
costs
$175,000
$49,808
(Interest
Revenue)
$75,192
(Mfr.’s
Profit)
(continued)
15-77
Accounting for Sales-Type Leases—
Lessor
American Manufacturing Co. (Lessor)
To record entries on January 1, 2013:
Lease Payments Receivable
Sales
250,192
Cost of Goods Sold
Finished Goods Inventory
Deferred Initial Direct Costs
175,000
Cash
Lease Payments Receivable
Executory Costs
65,000
250,192
160,000
15,000
60,000
5,000
15-78
Accounting for Sales-Type Leases—
BPO or Guaranteed R/V
• The minimum lease payments will include
the following if they are part of the
agreement:
 a lump sum (from a bargain purchase
option) at the end of the lease term OR
 a guaranteed residual value.
• The receivable is increased by the
present value of the future payment, and
sales are increased by the present value
of the additional amount.
(continued)
15-79
Accounting for Sales-Type Leases—
BPO or Guaranteed R/V
Using the data from Exhibit 15-5, American
Manufacturing offers a bargain purchase option
of $75,000 at the end of five years.
(continued)
15-80
Accounting for Sales-Type Leases—
BPO or Guaranteed R/V
American Manufacturing Co. (Lessor)
To record entries on January 1, 2013:
Lease Payments Receivable
Sales
296,761
Cost of Goods Sold
Finished Goods Inventory
Deferred Initial Direct Costs
175,000
Cash
Lease Payments Receivable
Executory Costs
65,000
296,761
160,000
15,000
60,000
5,000
15-81
Accounting for Sales-Type Leases—
Unguaranteed Residual Value
When a sales-type lease does not contain
a bargain purchase option or a guaranteed
residual value, but the economic life of the
leased asset exceeds the lease term, the
residual value will remain with the lessor.
This is called an unguaranteed residual
value.
(continued)
15-82
Accounting for Sales-Type Leases—
Unguaranteed Residual Value
To record entries on January 1, 2013:
Lease Payments Receivable
Sales
Cost of Goods Sold ($175,000 –
$46,569)
Finished Goods Inventory
($160,000 – $46,569)
Deferred Initial Direct Costs
Lease Payments Receivable
Finished Goods Inventory
250,192
250,192
128,431
113,431
15,000
46,569
46,569
(continued)
15-83
Accounting for Sales-Type Leases—
Unguaranteed Residual Value
Gross profit on the transaction is the same
regardless of whether the residual value is
guaranteed or unguaranteed.
15-84
Third-Party Guarantees
of Residual Value
• When a lease is used to increase sales, the
seller wants to account for the lease as a
sales-type lease.
• On the other hand, the buyer would prefer to
account for the lease as an operating lease to
keep the obligation off the balance sheet.
• A third-party guarantee of residual value is a
clever trick that companies have devised to
get around accounting rules.
How do they do it?
(continued)
15-85
Third-Party Guarantees of
Residual Value
• The lessor includes a guaranteed residual value with
•
the calculation so that present value of the minimum
lease payments meet the 90% of fair value criterion.
This allows the lessor to treat the lease as a salestype lease.
The lessee pays an insurance company or investment
firm to guarantee the residual value. This allows the
lessee to remove the guaranteed residual value from
the calculation, dropping the amount below 90%.
This allows the lessee to account for the lease as an
operating lease.
15-86
SALE OF ASSET DURING LEASE
TERM
Sale of Asset During Lease
Term
If the leased asset in Exhibit 15-8 below is sold on
December 31, 2015, for $140,000 before the
$60,000 rental payment is made (the Lease
Payments Receivable balance is $104,132)…
(continued)
15-88
Sale of Asset During Lease
Term
…a gain of $25,455 would be reported. The
following journal entry would be recorded on
December 31, 2015, to record the sale:
Cash
Interest Revenue
Lease Payments Receivable
Gain on Sale of Leased Asset
140,000
10,413
104,132
25,455
15-89
15-90
15-90
₵
Expanded
Material
$
15-101
15-101
Learning Objective 9
Record a
sales-leaseback
transaction for both a
seller-lessee and a
purchaser-lessor.
15-102
Sale and leaseback transactions
• Transactions involving real estate (meeting specific
criteria) and assets other than real estate
– Record the sale
– Remove the asset and related liabilities from the balance
sheet
– Account for the leaseback
– Recognition/deferral of any profit/loss on the sale is based on
the significance of the leaseback to the sold asset
– Any deferred profit or loss on sale is subsequently amortized
• Transactions involving real estate not meeting specific
criteria
– Account for under either the financing or the deposit method
Sale-Leaseback
Transactions (Sale at a Gain)
On January 1, 2013, Hopkins Inc. sells
equipment having a carrying value of $750,000
to Ashcroft Co. for $950,000 and immediately
leases back the equipment. Terms of the lease
are:
1. The term of the lease is 10 years,
noncancelable. A down payment of $200,000
is required plus equal lease payments of
$107,107 at the beginning of each year. The
implicit rate is 10%.
(continued)
15-104
Sale-Leaseback Transactions (Sale
at a Gain)
2. The equipment has a fair value of $950,000
and an expected life of 20 years. Straightline depreciation is used.
3. Hopkins has an option to renew the lease
for $10,000 per year for 10 years, the rest
of its economic life. Title passes at the end
of the lease.
Question What are the journal entries to record this
transaction at the beginning and end of 2013:
Lessee & Lessor
15-105
(continued)
15-106
15-106
Sale-Leaseback Transactions (Sale
at a Gain)
15-107
Advanced Lease Topics
15-108
Ongoing monitoring of leases
Ongoing monitoring of leases
• Ongoing monitoring includes consideration of
accounting consequences of:
– Contractual changes to or renewal/extension of a
lease which could:
• Change whether a contract is or contains a lease
• Be considered a lease modification
• Be considered a lease termination
– Entering into a sublease
– Ceasing to use an asset under an operating lease
– Impairment indicators for a capital lease asset (or
related asset group)
– A change in estimate
Lease modification steps
1. Determine the type of lease modification
• Renewal/extension beyond the original lease term
• Changes in provisions (other than renewal/extension)
2. Determine whether the revised agreement is a new lease
• Renewal/extension of lease term — All deemed to be “new leases”
• Other changes — Perform classification test as of original lease
inception date assuming new contractual terms were in effect
– Change in classification — “new lease”
– No change in classification — not a new lease
3. If new lease, perform classification test as of the lease
modification date
• Accounting for the revised lease is based on the classification of
both the original lease and the new lease
Lease modification scenario
• Company A has a 10-year operating lease with a 5year renewal option
– Accounting lease term at inception — 10 years (exercise of
renewal option not reasonably assured at inception)
• At the beginning of year 8, Company A exercises
renewal option (new remaining lease term is 7 years)
• Company A has an accrued rent balance of $100,000
at the beginning of year 8
• Let’s walk through the steps to assess this lease
modification
Lease modification scenario —
steps
• Is the change a lease modification? If so, what type of
modification?
– Lease modification due to a renewal or extension of the lease term
• Does the change result in a new lease?
– Yes, because the exercised renewal option extends lease term beyond
term of original lease
• Perform classification test at modification date
– Use the minimum lease payments for the remaining 7-year lease term
(years 8-15) and other factors determined as of the modification date
(i.e., beginning of year 8)
• If new lease is an operating lease, what is accounting
treatment?
Lease modification scenario —
answer
• No income statement or balance sheet effect
as of the lease modification date
• Company A updates the straight-line rental
calculation as of the beginning of year 8
– Accrued rent balance of $100,000 should be
amortized over the term of the new lease (years 8
through 15)
Lease termination costs related to
exit or disposal activities
• Costs to terminate an operating lease before the end of
the lease term
– Determine appropriate accounting for a change — form of
the contract is not determinative
• Termination of lease and simultaneously entering into similar lease
may be accounted for similar to a lease modification
• A change that increases lease payments while shortening the lease
term may be considered to include a termination payment
– Liability recognized at the termination date
– Measured at fair value
• Reference: Leases FRD Sections 4.3.8, 4.3.10
Lease termination costs related to
exit or disposal activities (cont.)
• Costs that will continue to be incurred by a lessee
under an operating lease without economic benefit
– Recognized at “cease-use date”
– Initially measured at fair value and based on:
• Remaining lease payments
• +/- the effects of any prepaid or deferred items recognized
• Less estimated sublease rentals that could be reasonably obtained
– Subsequently:
• Accrete the liability and recognize expense (e.g., accretion
expense)
• Adjust liability for any change in cash flows using initial discount
rate
• Reference: Leases FRD Section 4.3.10
Overview of lessee involvement in
asset construction
• Lessee involvement in projects where a long-lived
asset is constructed may result in sale and leaseback
transactions
– Could occur in build-to-suit transactions or other arrangements
• ASC 840-40 contains specific rules, including a
detailed “maximum guarantee test” and special
provisions that can result in the lessee being deemed
to have substantially all of the construction period
risk
– Lessee considered the accounting owner of the asset during
construction
– Deemed sale and leaseback occurs upon completion of construction
Overview of lessee involvement in
asset construction (cont.)
• Applicable to real estate projects and projects
involving assets other than real estate
– Could apply to projects related to existing assets
(e.g., redevelopment of a building)
– Could apply to equipment (e.g., construction of a
specialized marine asset)
• Accounting can be very complex and therefore
should be analyzed closely
• Guidance does not apply to lessors
• Reference: Leases FRD Section 10