Chapter 21 Accounting For Leases

Front 1

Advantages of leasing for Lessee

Back 1

1) Financing benefits a) 100% financing
b) fewer restrictions and more flexible than other lease agreements
c) creates claim against leased assets, not all assets

Hint 1

2)Risk Benefit - risk is born by lessor
3) Tax benefit - lessee can write off full cost of asset, including parts related to land

Front 2

Advantages of leasing of Lessee continued

Back 2

4) Financial Reporting Benefit - operating leases do not add liability or asset on balance sheet.

Hint 2

5) Billing benefit- certain contract work leasing may permit contractor to charge more because interest in rental payments is allowed as a contract charge

Front 3

Capital Lease

Back 3

A lease that transfers substantially all the risks and benefits or ownership is in substance a purchase by the lessee and sale by the lessor and is a capital lease.

Front 4

Operating Lease

Back 4

A lease that does not transfer all the risks and benefits of ownership.

Front 5

Lessee Classifications

Back 5

1) Capital lease
2) Operating lease

Front 6

Lessor lease classifications

Back 6

1) Sales type lease
2) Direct financing lease
3) Operating lease

Front 7

Criteria applicable to lessee and lessor

Back 7

a. lease transfers ownership of property to the lessee by the end of the lease term

b. lease contains bargain purchase option

Hint 7

c. lease term is equal to 75% or more of the estimated economic life of the property

d. present value of the minimum lease payment is equal to 90% or more of the fair value of the property.

Front 8

Criteria applicable to lessor only

Back 8

a. collectibillity of minimum lease payment is reasonably assured

b. No important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor under the lease

Front 9

Classification by the lessee

Back 9

a. Capital lease - meets one or more criteria for lessee

b. Operating lease - does not meet any criteria applicable to lessee

Front 10

Lessor - Sales type lease

Back 10

1) one or more criteria for lessee
2) both criteria for Lessor
3) must result in manufacturers or dealers profit or loss- Fair value of leased property at the inception of the lease is greater or less than cost or carrying value

Front 11

Lessor - Direct Financing Lease

Back 11

1 ) One criteria for lessee is met
2) both criteria for lessor is met
3) Must not result in manufacturer or dealers loss or profit

Front 12

Operating lease

Back 12

Lease that meets none of the lessee's criteria or does not meet both lessor's criteria, all leases other than sale-type and direct financing leases

Front 13

Annuity Due

Back 13

Payments made at beginning of each period

Hint 13

as opposed to regular annuity payment made at end of each period.

Front 14

Effective interest method

Back 14

payment calculated with constant interest rate applied to new principal balance

Front 15

Executory Costs

Back 15

Ownership type costs such as insurance, maintenance, and property taxes

Hint 15

usually paid by the lessee in a capital lease

Front 16

Minimum lease payment

Back 16

lease payment minus the executory costs paid by the lessor when calculating present value

Front 17

Classification of Capital Lease

Back 17

1)Present value of next year's payment

Hint 17

current liability is the same each year (NPV of each payment)
remainder must be calculated. remainder is non current. For Finance lease the following PMT-PVyr2 pmt, PMT-PVyr3 pmt etcetra to get current portion (subtracting out unearned interest on lease)

Front 18

Classification of Capital Lease on Balance Sheet

Back 18

Change in the present value

Hint 18

Current liability is amount by which total balance of lease liability will decrease in the next year.

Front 19

Guaranteed residual value

Back 19

Company agrees to residual value at end of the lease (no transfer of ownership or bargain purchase option)

Hint 19

Leased equipment value as follows
Present value of leased equipment rate x years. (annuity)

Present value of guaranteed residual value of property pv 1 time payment

Front 20

Capital lease example (payment at end of year)

Back 20

Dr Lease Equipment 100,000
Cr Capital Lease Obligation 100,000

Dr Interest Expense 12,000
Capital Lease Obligation 20,923.45
Cash 32,923.45

Hint 20

Dr Depreciation Expense 25,000
Cr Accum Depreciation
Leased Equpment 25,000
2nd annual pmt
Dr Interest Expense 9489.19
Dr Capital Lease Obligation 23,434.26
Cr Cash 32,923.45

Front 21

Capital lease example (payment at beginning of year) annuity due

Back 21

Dr Lease Equipment 112,000
Cr Capital Lease Obligation 112,000
1st payment Jan 1
Dr Capital Lease Obligation 32,923.45
Cr Cash 32,923.45

Hint 21

Dr Depreciation Expense 28,000
Cr Accumulated Depreciation 28,000
Dec 31 pmt
Dr Interest Expense 9,489.19
Cr Accrued Interest on Capital
Lease Obligation 9,489.19
Jan 1 pmt
Dr Accrued Interest on CL 9,489.19
Dr Capital Lease Obligation 23,434.26
Cash 32,923.45
Cr

Front 22

Bargain Purchase Option

Back 22

Present value of payments discount at rate+ present value of 1 pmt for the bargain purchase option

Hint 22

Dr Leased Equipment 128,160.63
Cr Capital Lease Obligation 128,160.63

Front 23

Operating Lease (Lessor)

Back 23

Dr Equipment leased to others 300,000
Cr Cash 300,000
Collection of annual payment
Dr Cash 50,000
Cr Rental Revenue 50,000

Hint 23

Dr Insurance Expense 2,000
Cr Cash 2,000
Dr Depreciation Expense
leased equipment 30,000
Cr Accum Depreciation
leased to others 30,000

Front 24

Direct Financing Lease (no unguaranteed residual value)

Back 24

Dr Equipment leased to others 100,000
Cr Cash 100,000
Dr Lease Receivable 131,693.80
Cr Equipment lease to others 100,000
Cr Unearned Interest: lease 31,693.80

Hint 24

Dr Cash 32,923.45
Cr Lease Receivable 32,923.45
Dr Unearned Interest Lease 12,000
Cr Interest Revenue Lease 12,000

Front 25

Direct Financing Lease No ungauranteed residuals payment in advance

Back 25

Dr. Equipment leased to others 391,371.20
Cr Cash 391,371.20
Lease receivable 500,000
Equipment leased to others 391371.20
Unearned interest:leases 108,628.80

Hint 25

Dr Cash 100,000
Cr Lease Receivable 100,000
Dr Unearned Interest: Lease 40,791.97
Cr Interest Revenue :Lease 40,791.97

Front 26

Present Value of Equipment

Back 26

is present value of payments plus present value of residual value or bargain price option

Hint 26

Lease amount is recorded at undiscounted amount

Front 27

Sales Type Lease

Back 27

Difference between sales type lease and direct financing are manufacturer's or dealer's gross profit or loss and accounting for initial direct costs

Hint 27

dealers loss or profit is difference between sales price (minimum lease pmt at implicit rate of interest) cost or carrying value of asset plus any indirect costs less present value of unguaranteed residual value accruing to the lessor

Front 28

Sales Type Lease example (annuity due) Lessor

Back 28

Dr. Lease Receivable 300,500
Cr. Sales Revenue 190,008.49
Cr. Unearned Interest: Lease 110,491.51
Dr. Cost of Asset Leased 120,000
Cr. Merchandise Inventory 120,000

Hint 28

Dr. Cash 30,000
Cr. Lease Receivable 30,000

Dr. Unearned Interest: Leases 19,201.02
Cr. Interest Revenue: Leases 19,201.02

Front 29

Statement of Cash Flows leases (Lessee)

Back 29

lessee: operating lease each payment is cash outflow from operations

lessee: sales lease each interest payment is operating cash outflow, principal is financing outflow

Front 30

Statement of Cash Flows leases (Lessor)

Back 30

Lessor: operating lease, each payment received as cash inflow from operations
Direct financing lease: asset purchase as cash outflow from operations, Interest received inflow from operations and principal as cash inflow from investing activities

Hint 30

Sales Type Lease: cash paid for asset as cash outflow from operations and payment received as cash inflow from operations

Front 31

Executory Costs (Lessee)

Back 31

Always subtract out from lease payment. Expensed yearly by lesee on capital lease
Subtract from yearly lease pmt when calculating NPV or lease. Also, that amount is the yearly lease pmt plus the executory costs

Hint 31

Dr Executory Costs
Dr Capital lease Obligation
Cr Cash

Front 32

Depreciation Costs

Back 32

Expense Yearly for capital lease

Hint 32

Dr. Depreciation Expense
Cr Accum Depreciation Leased Equipment

Front 33

Annuity Due Lease

Back 33

Interest Expense Accrues at end of year, even though payment wont be until 1st of year.

Hint 33

At first of year accrued interest is debited to get rid of liability ie
Dr Executory Costs 3,450
Dr Accrued Interest 28,614
Dr Capital Lease Obligation 37,936
Cr Cash 70,000