ACCOUNTING FOR LEASES
CHAPTER 15
LEASES
Learning Objectives
1.
2.
3.
4.
Overview : Lease.
Types of Leases
Lease Agreements
Classification criteria in order to distinguish
between the types of leases
5. Accounting for types of leases:
1. Both lessee and lessor
6. Disclosure & Presentation
2
Economic Advantages to Leasing
1.
2.
3.
4.
5.
No down payment.
Avoid risks of ownership.
Flexibility.
Protection against obsolescence
use of an asset without showing the
resources/sources.. Off-balance-sheet
financing
6. …….
3
Accounting by the Lessor/Lessee
A lease is a contractual agreement:
- lessor (Owner of Property) conveys the
right to use property to
- lessee (User/Renter) in return for
periodic cash payments
- For stated period of time
Classification of leases>>>
4
Accounting for Leases and
classifications: FASB 13
• Fundamental Rights and Responsibilities
• Recognize the true Substance over the Form of the
lease
The issue of how to report leases is the case of substance versus
form. Although technically legal title may not pass, the benefits
from the use of the property do.
5
CLASSIFICATION OF LEASE
LEASES
LESSOR
LESSEE
CAPITAL
LEASE
OPERATING
LEASE
transfers
ownership
rental
agreements
OPERATING
LEASE
DIRECT
FINANCING
CAPITAL
LEASE
SALES
TYPE
Classification Criteria:…>
6
CLASSIFICATION OF LEASE
LEASES
PART I
PART II
LESSOR
LESSEE
CAPITAL
LEASE
OPERATING
LEASE
transfers
ownership
rental
agreements
Classification Criteria:…>
7
1. FASB (13) CRITERIA
1. Transfer of Ownership
The lease contract includes a provision that the title to the
leased asset passes to the lessee by the end of the lease term
2. Bargain Purchase Option (BPO)
Makes it reasonably assured that the lessee will acquire asset
allows the lessee to buy the leased asset
at a price significantly lower than the asset’s fair value when the
option is exercisable (BARGAIN PRICE)
3. Term: 75% of economic Life – Lease term is equal to
75% or more of the economic life of the leased asset
4.
Asset Value: Present value of the minimum lease payments is
greater than or equal to 90% of the FMV of the leased asset on
the lease signing - what is included in Lease payments8
CLASSIFICATION OF LEASE:LESSEE
MUST MEET JUST ONE
CRITERIA
Lease Agreement
Non-Cancellable
No
Transfer
of
Ownership
Yes
No
Bargain
Purchase
No
Lease Term
>= 75%
Yes
Yes
PV of
Payments
>= 90%
No
Yes
Capital Lease
Determine if the risks/rewards of ownership transferred to lessee9
O
p
e
r
a
t
i
n
g
L
e
a
s
e
ACCOUNTING FOR CAPITAL LEASE
PURCHASE/OWNERSHIP
LESSEE (books)
•
•
•
•
Determine the criteria:
1. Ownership transfer
2. Bargain purchase option
3. PV of MLP (minimum lease payment) is
equal to 90% of more
• 4. Lease term 75% or more of estimated
economic life
10
Calculation of CAPITAL LEASE
LESSEE (books)
• Determine the criteria: (any one…)
• Lease is classified as: CAPITAL LEASE
LESSEE’S BOOKS
DR. ASSET: LEASE PROPERTY
CR. LEASE OBLIGATION (PAYABLE)
11
CAPIALIZED AMOUNT
Lessee
• The Lessee records the lease an asset/liability:
LESSER OF:
1. FAIR VALUE of the asset at the inception
of lease or
2. PV of MLP (PVMLP)
Question: what should be included in the
PVMLP
12
Residual Value (RV)
Guaranteed or Unguaranteed
• Estimated Value at the end of the lease term!
• GUARANTEED RV is additional payment at the
end of the lease term
•If Bargain Purchase Option:
–GRV
becomes irrelevant
• UNGUARANTEED: not required to make
additional payment at the end of the lease term
13
Accounting by the Lessee
PV OF MINIMUM LEASE PAYMENTS (PVMLP)
Minimum lease payments:

PV rental payment (usually beginning of the period)
Plus: PV Guaranteed residual value
 (unguaranteed : NOT included in PVMLP)
14
CAPITAL Leases - Lessee
The amount recorded (capitalized) is the
PVMLP.
However, the amount recorded cannot exceed
the fair value of the leased asset.
the interest rate used by the lessee is the lower
of:
1. Its incremental borrowing rate, or
2. The implicit interest rate used by the lessor.
ACCOUNTING FOR
CAPITAL LEASE: LESSEE
LESSEE
Asset user
Asset & Liability are recognized
-Amount: PV of Lease payments
-Including any BPO or Guarantee Residual Value (GRV)
Lease payments reduction in Lease Liability &
Increases to interest expense (relates to liability)
Asset is subsequently Depreciated *
Let’s
Illustrate…
16
Depreciation of Asset:
Rules*:
• Transfer of Ownership: Depreciate over
asset life (Legal form)
• Bargain purchase option: Depreciate over
the asset life (legal form)
• Term (75%) : Depreciate lease term
(substance over form)
• Asset Value (90% FV): Depreciate over
lease term (substance over form)
17
Executory Costs
• Ownership of the asset is responsible for
Insurance, maintenance, etc
Capital Lease: Lessee gets the benefit of using the
asset (LESSEE’s expense)
Dr. Maintenance expense (executory costs)
Cr Cash
• (if included in lease payment – deduct to calculate
PV MLP)
• If lessor makes the payment, these costs are
reimbursed by lessee by recording the expense
18
LEASE
PART II
Accounting for Leases- Lessor
• Classification of Lease: LESSOR’S BOOK
19
CLASSIFICATION OF LEASE: LESSOR
LEASES
LESSOR
LESSEE
CAPITAL
LEASE
OPERATING
LEASE
OPERATING
LEASE
DIRECT
FINANCING
CAPITAL
LEASE
SALES
TYPE
Classification Criteria:…>
20
Accounting by the Lessor
Classification of Leases by the Lessor
21
Accounting by the Lessor
Classification of Leases by the Lessor
If any costs to the lessor to be incurred, are reasonably predictable
A lessor may classify a lease as an operating lease but the lessee
may classify the same lease as a capital lease.
22
Nonoperating Leases:
- Lessor
If the lessor is not a manufacturer or
dealer, the fair value of the leased
asset is typically the lessor’s costDIRECT FINANCING LEASE
When the lessor is a manufacturer or dealer,
the fair value of the property at the inception
of the lease is likely to be its normal selling
price
– SALES TYPE LEASE
Direct-Financing Lease: Lessor
Depreciation:
NOT RECORDED BY LESSOR
• Asset is removed from the Lessor’s books
Illustration: DIRECT FINANCING…. LESSOR-
25
Initial Direct Costs
costs incurred by the lessor in
negotiating/preparing a lease agreement.
e.g. Legal fees, commissions
• Operating Leases − Capitalize and amortize
over the lease term by the lessor.
• Direct Financing Leases − not expensed ;
deferred and recognized over the lease term
• Sales type leases: expensed at the inception
of the lease (selling expense)
How should the lease be
classified by LESSOR
• Since the fair value equals the lessor’s
carrying value, there is no dealer’s profit,
making this a direct financing lease.
• Prepare appropriate entries for Canfor
(lessor)
27
Sales-Type Lease: LESSOR
Total payments – sale price = interest
Accounting for Sales-Type Lease
LESSOR
Record:
1. Receivable (PV) & Sales
2. Cost of goods sold / reducing the
inventory
3. Any Initial Direct Costs recognized as an
expense immediately
4. Reimbursement of executory costs – same
as direct financing
29
Sales Type Lease with Guaranteed
Residual Value
• Guaranteed Residual Value: Both Lessee and
Lessor include Guaranteed Residual Value in
calculating MLP
• If RV is not guaranteed by Lessee (Lessee exclude
in MLP)
• LESSOR:
– Lessor : even if it is not guaranteed by lessee, lessor
expects to receive from 3rd party
– Includes residual value in their receivable
– But the sales revenue and COGS are reduced by the
same amounts
30
Lessee Disclosures
• For capital leases, disclose
– Gross amount of assets recorded under
capital leases.
– Future MLP in the aggregate and for each
of the five succeeding years.
– Total minimum sublease rentals to be
received in the future under noncancelable subleases.
(continued)
International Accounting
of Leases
• IAS 17 relies on the exercise of accounting
judgment to distinguish between operating and
capital leases.