Chapter 12. Leases. ACTG 6580. Objectives. Discuss the characteristics of a lease Explain the difference between a finance and operating lease Use IAS 17 to correctly classify leases Discuss the incentives to misclassify leases. Objectives.
(IAS 17 para 4)
RRI entered into a lease on January 1, 2010, with Magical Mobile Transport (MMT) for a customized carriage. MMT will provide a carriage to RRI that has RRI’s logo molded into the iron work of the frame, carved into various areas of the woodwork and painted on the side of the doors. Additionally, MMT is providing custom-made pulling devices on the carriage to accommodate RRI’s Clydesdale horses.
See next slide for terms of the lease arrangement.Lease Classification for Lessee Example
Negotiated price (fair value) of $10,000 for the carriage at the inception date of the lease.
Unguaranteed residual value of $3,951. RRI does not absorb any gains or losses in the fluctuations of the fair value of the residual value.
End-of-term purchase option of $4,000.
Remaining economic life of five years.
Depreciation policy for the carriage is the straight-line method.
Ownership is not transferred at the end of the lease term.Lease Classification for Lessee Example
IFRS: Journal Entries - Lessee
Lease with MMT for carriage
Finance lease liability – current $2,099
Finance lease liability – non-current 4,583
To record the capital lease of the auto based on the PV of the MLP (since this is lower than the fair value).
Finance lease liability – current $ 2,099
Interest expense 401
To record the lease payment and related interest expense. Interest expense is calculated as 6% multiplied by the PV of MLP of $6,682.
(Continued on next slide.)
Depreciation expense – carriage $2,227
Accumulated depreciation– carriage $2,227
To record the depreciation for the carriage over the lease term of three years ($6,682/3) given that this is shorter than the life of the asset of five years. The depreciation is based on this term as capitalization was based on an indicator where ownership transfer is not reasonably assured.
Finance lease liability – non-current $2,225
Finance lease liability – current $2,225
To reclassify the PV of the MLP payments due within the next year of $2,225.
The collectability of the lease payments from RRI are reasonably assured, and no uncertainties exist regarding non-reimbursable costs to be incurred by MMT.
MMT’s carrying value of the carriage ($8,000) is less than the fair value of the carriage ($10,000).
MMT is a manufacturer lessor and market rates are the same as its implicit rate.
MMT incurred $500 of initial costs for credit checks in executing the lease.Lessor Accounting Example
Example 2 – lessor accounting
The same terms of the lease arrangements between MMT and RRI apply to this example, while also considering the additional information below:
IFRS: The MMT lease is classified as a finance lease.
MMT lease for carriage
The sale of the leased asset is recorded at the lower of the fair value of the leased asset ($10,000) or the PV of MLP at market rates (6%) ($6,683 as shown in the table below). The cost of goods sold is the carrying value of the leased asset of $8,000 less the PV of the unguaranteed residual value of $3,317 ($3,951 discounted at 6% for three years).
The net investment in the lease is $10,000, calculated as the PV of the three lease payments of $2,500 each ($6,683)plus the PV of the unguaranteed residual value of $3,951 ($3,317).
Initial direct lease expense $500
To recognize the expenses for the initial direct costs of $500 as MMT is a manufacturer lessor.
Finance lease receivable – current $1,900
Finance lease receivable – non-current 8,100
Cost of goods sold 4,683
Inventory – carriage $ 8,000
To record the sale of the leased asset for net investment in the lease (fair value of the leased asset or if lower the PV of MLP) and related cost of goods sold for the carrying value of the leased asset less the present value of the unguaranteed residual value of $3,317 ($3,951 discounted at 6% for three years).
Interest income $ 600
Lease receivable – current 1,900
To record the lease payment and related interest income. Interest expense is calculated as 6% multiplied by the net investment in the lease of $10,000.
Lease receivable – current $2,014
Lease receivable – non-current $2,014
To reclassify the lease payments due within the next year of $2,014.