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ACCOUNTING FOR LEASES. CHAPTER 15 LEASES. Learning Objectives. Overview : Lease. Types of Leases Lease Agreements Classification criteria in order to distinguish between the types of leases Accounting for types of leases: Both lessee and lessor Disclosure & Presentation.

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accounting for leases
ACCOUNTING FOR LEASES

CHAPTER 15

LEASES

learning objectives
Learning Objectives
  • Overview : Lease.
  • Types of Leases
  • Lease Agreements
  • Classification criteria in order to distinguish between the types of leases
  • Accounting for types of leases:
    • Both lessee and lessor
  • Disclosure & Presentation
economic advantages to leasing
Economic Advantages to Leasing
  • No down payment.
  • Avoid risks of ownership.
  • Flexibility.
  • Protection against obsolescence
  • use of an asset without showing the resources/sources.. Off-balance-sheet financing
  • …….
accounting by the lessor lessee
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>>>

accounting for leases and classifications fasb 13
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.

classification of lease
CLASSIFICATION OF LEASE

LEASES

LESSOR

LESSEE

CAPITAL LEASE

CAPITAL LEASE

OPERATING LEASE

OPERATING LEASE

transfers ownership

rental agreements

DIRECT

FINANCING

SALES

TYPE

Classification Criteria:…>

classification of lease1
CLASSIFICATION OF LEASE

LEASES

PART I

PART II

LESSOR

LESSEE

CAPITAL LEASE

OPERATING LEASE

transfers ownership

rental agreements

Classification Criteria:…>

1 fasb 13 criteria
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

  • 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)

  • 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

slide9

CLASSIFICATION OF LEASE:LESSEE

MUST MEET JUST ONE CRITERIA

Lease Agreement

Non-Cancellable

Operat ing

Lease

Transfer

of

Ownership

Bargain

Purchase

Lease Term

>= 75%

PV of

Payments

>= 90%

No

No

No

No

Yes

Yes

Yes

Yes

Capital Lease

Determine if the risks/rewards of ownership transferred to lessee

accounting for capital lease purchase ownership lessee books
ACCOUNTING FOR CAPITAL LEASEPURCHASE/OWNERSHIPLESSEE (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
calculation of capital lease lessee books
Calculation of CAPITAL LEASELESSEE (books)
  • Determine the criteria: (any one…)
  • Lease is classified as: CAPITAL LEASE

LESSEE’S BOOKS

DR. ASSET: LEASE PROPERTY

CR. LEASE OBLIGATION (PAYABLE)

capialized amount lessee
CAPIALIZED AMOUNTLessee
  • 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

residual value rv guaranteed or unguaranteed
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
slide14

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)
capital leases lessee
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:
  • Its incremental borrowing rate, or
  • The implicit interest rate used by the lessor.
accounting for capital lease lessee
ACCOUNTING FORCAPITAL 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)

Let’s

Illustrate…

Asset is subsequently Depreciated *

depreciation of asset rules
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)
executory costs
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
lease part ii accounting for leases lessor
LEASEPART IIAccounting for Leases- Lessor
  • Classification of Lease: LESSOR’S BOOK
classification of lease lessor
CLASSIFICATION OF LEASE: LESSOR

LEASES

LESSOR

LESSEE

CAPITAL LEASE

CAPITAL LEASE

OPERATING LEASE

OPERATING LEASE

DIRECT

FINANCING

SALES

TYPE

Classification Criteria:…>

slide21

Accounting by the Lessor

Classification of Leases by the Lessor

slide22

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.

nonoperating leases lessor
Nonoperating Leases: - Lessor

If the lessor is not a manufacturer or dealer, the fair value of the leased asset is typically the lessor’s cost-

DIRECT 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

depreciation not recorded by lessor
Depreciation: NOT RECORDED BY LESSOR
  • Asset is removed from the Lessor’s books

Illustration: DIRECT FINANCING…. LESSOR-

initial direct costs
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
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)
slide28

Sales-Type Lease: LESSOR

Total payments – sale price = interest

accounting for sales type lease lessor
Accounting for Sales-Type LeaseLESSOR

Record:

  • Receivable (PV) & Sales
  • Cost of goods sold / reducing the inventory
  • Any Initial Direct Costs recognized as an expense immediately
  • Reimbursement of executory costs – same as direct financing
sales type lease with guaranteed residual value
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
lessee disclosures
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 non-cancelable subleases.
international accounting of leases
International Accounting of Leases
  • IAS 17 relies on the exercise of accounting judgment to distinguish between operating and capital leases.