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25 Cards in this Set

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-Contractual agreement between a lessor, who conveys the right to use real or personal property (an asset),
-and a lessee, who agrees to pay periodic rents over a specified time.
Operating Leases
-(Rental Agreement) includes a lessor, who collects rent, and a lessee, who uses the leased asset and pays periodic rent for such use.
-Lessee merely uses the asset, there is no transfer of ownership, or of any risk or benefit of ownership.
Lessee Accounting for Operating Leases
1. Rent Expense: lessee records rent expense over the lease term, usually on the S/L basis.
2. Lease Bonus (prepayment): for future expenses, should be classified as an asset (deferred charge) and amortized over the the life of the lease using the S/L method (DR. Deferred Charge, CR. Cash or A/P)
3. Leasehold Improvements: permanently affixed to property, revert back to lessor at the end of lease. Should be capitalized and added to the PP&E/Intangible asset section of B/S.*
*Depreciated or amortized over the lesser of: (1) Lease Life or (2) Asset/Improvement Life
4. Rent Kicker: premium rent payment required for specific events. It is a period expense.
5. Refundable Security Deposit: reported as an asset until refunded by the lessor.
6. Free or Reduced Rent Consideration: lessee must take total rent to be paid for the entire lease term and divide it evenly over each period (matching principle)
Lessor Accounting for Operating Leases
1. Fixed Asset: cost of property included in the lessor's PP&E and depreciated over the asset's useful life.
2. Rental Income: reported using the S/L method.
3. Security Deposits: (1) Nonrefundable- deferred by the lessor (unearned revenue) and capitalized by the lessee (prepaid rent expense) until lessor considers the deposit earned. (2) Refundable- treat as a receivable by the lessee and a liability by the lessor until the deposit is refunded to the lessee.
4. Temporary Difference: (1) GAAP Rule- report prepaid rental income when earned. (2) Tax Rule- report prepaid rental income when received.
5. Lease Bonus: deferred (unearned income) and amortized (into income) over the life of the lease.
6. Free or Reduced Rent Consideration: lessor must take total rental income to be received over the entire lease term and divide it evenly over each period (matching/revenue recognition principle)
Capital (U.S.) / Finance (IFRS) Lease
-Transfers substantially all of the benefits and risks inherent in ownership of property to the lessee.
-Transaction is essentially an installment purchase in the form of a leasing arrangement.
-Lessee account for this type of lease as the acquisition of both an asset (leased asset under capital lease) and a related liability (obligation under capital lease).
-Lessor account for such a lease as a sales-type or a direct financing lease. Under IFRS, both types are referred to as finance leases.
-A sales-type lease results in a dealer's or manufacturer's profit or loss to the lessor.
-A direct financing lease doe not result in a profit or loss.
Lessee Capital Lease Criteria (U.S. GAAP)
-DR. Fixed Asset- Leased Property, CR. Liability- Obligation under Capital Lease
-Must meet just one condition to capitalize (OWNS) but criteria (N) & (S) can't be used for a lease that begins w/in the last 25% of the original estimated economic life of the leased property.
-(O) Ownership transfers at the end of lease (upon final payment or required buyout)
-(W) Written option for bargain purchase
-(N) Ninety (90%) percent of leased property FV ≤ PV of lease payments
-(S) Seventy-five (75%) percent or more of economic life is being committed in lease term.
Lessee Capital Lease Criteria (IFRS)
-(O) Ownership during the lease transfers to the lessee by the end of the lease term.
-(W) Written bargain purchase option is contained in the lease.
-(E) Economic life of the asset is mostly used even if title doesn't transfer.
-(S) Substantially all of the FV of the leased asset is equal to the PV of the minimum lease payments.
-(F) Fluctuation in the FV of the residual result in gains and losses to the lessee.
-(A) Ability to continue the lease for a secondary period at a bargain rent is held by the lessee.
-(C) Canceling the lease is an option for the lessee and they incur the lessor's losses associated w/ the cancellation.
-(S) Specialized nature of the leased assets let only the lessee use them w/out modification.
Lessor Sales-Type/Direct Financing Criteria
-Under GAAP, if a lease, at inception, meets all 3 conditions, it will be classified by the lessor as a sale-type or direct financing lease.
-Additional criteria that must be met for the lessor mean that it is possible for a lessee to classify a lease as capital while the lessor classifies the same lease as operating.
-(L) Lessee "owns" the leased property (meets any 1 of the 4 lessee's criteria.
-(U) Uncertainties don't exist regarding unreimbursable costs to be incurred by the lessor.
-(C) Collectibility of the lease payments is reasonably predictable.
Sales-Type Lease
-FV of the leased property at the inception of the lease differs from the cost or carrying amount to the lessor.
-This difference gives rise to a manufacturer's or dealer's profit or loss.
-2 Profits on Sale: (1) Gain on sale, (2) Interest Income
Direct Financing Lease
-FV of the leased property at the inception of the lease is the same as the cost or carrying amount.
-1 Profit on Sale: (1) Interest Income
Lessor- Finance Lease Criteria (IFRS)
-Lessor classifies a lease as a finance lease if the lease transfers substantially all the risks and rewards inherent in ownership to the lessee. The lessee and lessor use the same criteria for lease classification so in most cases, both parties will classify the lease as the same type.
-IFRS doesn't classify as sales-type or direct financing but they do state that manufacturer or dealer lessors may recognize profit or loss at the inception of the lease, similar to sales-type lease accounting under GAAP.
Lessee Capital (Finance) Lease Accounting
1. Capitalized Amount: lessee records the lease as an asset and a liability at the lower (lesser) of- (1) FV of the asset at lease inception or, (2)* Cost = PV of all minimum lease payments.
*2. Include: PV of required payments, PV of a bargain purchase option, PV of any guaranteed residual value.
*3. Exclude: Executory costs**, Optional Buyout (not required and not a bargain).
**Under IFRS, initial direct costs of the lease paid by the lessee are added to the amount recognized as a finance lease asset. Therefore, at lease inception, the amount of the lease asset and the lease obligation may differ.
4. Interest Rate: when calculating the PV of the minimum lease payments, the lessee uses the lower (lesser) of the: (1) Rate implicit in lease (if known), or (2) Lessee's incremental borrowing rate (the rate available in the market to the lessee (not prime)).
Depreciation Method
-Leased asset should be depreciated in a manner consistent with the lessee's normal policies (generally S/L).
Capitalized Lease Assets - (Salvage Value) = Depreciable Base ÷ Periods of Benefit = Depreciation Expense (per period)
Period of Benefit (Depreciable Life)
1. Ownership Transfer and Written Bargain: estimated life of the asset is used
2. Ninety % FV and Seventy-Five % Life: lessee uses the lease term.
-IFRS Period of Benefit (Depreciable Life): depreciation period is the shorter (lesser) of the lease term and the useful life of the asset. If there is a reasonable certainty that the lessee will own the leased asset after the lease term, then the leased asset should be depreciated over its useful life.
Lease Amortization Liability and Asset on Lessee's Books
-The obligation under Capital (Finance) Lease account and the related Leased Asset account are recorded initially at the same amount. However, subsequent amortization of each account takes place independently and results in different account balances by the end of the first year.
-The lease liability is amortized using the effective interest method.
-The sum of all lease payments - the carrying amount (PV) of lease obligation = the amount of interest to be paid.
Lessee's F/S Disclosures of Leases
-In general disclose everything, the more the better. Just don't repeat yourself and don't disclose items that have not been recognized yet.
1. Capital Lease: assets, A/D, liabilities reported separately on B/S as current/noncurrent in same manner as other items. Current amortization charges to income including gross amount of assets under capital lease, future minimum lease payments in the aggregate and for the next 5 years, sublease rentals, contingent rentals.
2. Operating Disclosures: minimum future rental payments in total and for next 5 years, minimum sublease income, schedule of total rental expense and its composition. All this required for operating leases w/ noncancelable lease terms in excess of 1 year.
3. General Disclosures: basis of contingent rental payments, terms of renewal options, purchase options, escalation clauses, restrictions imposed.
Lessor Accounting- Sales-Type (Finance) Lease
1. Gross Investment = Minimum lease payments* + any unguaranteed residual value (recorded as Lease Payments Receivable on Lessor's books)
*Would include the periodic lease payments, plus any bargain purchase option or guaranteed residual value.
2. Net Investment = Gross Investment (#1) x PV (interest rate implicit in the lease)
3. Unearned Interest Revenue (contra-lease receivable) = Gross Investment (#1) - Net Investment (#2)*
*Future interest to be received, recognized over life of lease (effective interest method) and included in B/S as a deduction from the gross investment)
4. COGS = Cost of Asset (+ any direct costs incurred by lessor) - PV of Unguaranteed Residual Value**
**Charged against income in the period in which the corresponding sale is recorded.
5. Sales Revenue = PV of minimum lease payments + PV of any guaranteed residual value (doesn't include PV of unguaranteed residual value)
-Cost + Profit = PV = Selling Price = FV
Lessor Accounting- Direct Financing (Finance) Lease
1. Gross Investment = Minimum lease payments + Unguaranteed residual value (recorded as lease payments receivable).
2. Net Investment* = Gross Investment (#1) x PV
*Equals the gross investment plus any unamortized initial direct costs (amortized over the lease term by the effective interest method) less the unearned income.
3. Unearned Interest Revenue = Gross Investment (#1) - Net Investment (#2).**
**Amortized over the lease term by the effective interest method.
-No Sales Revenue and no COGS
-PV = Carrying amount of receivable = Cost of asset sold
-The owner of a property (seller-lessee) sells the property and simultaneously leases it back from the purchaser-lessor. Usually there's not visible interruption in the use of the property. Treated as single financing transactions where profit may be deferred and amortized.
-Under GAAP, 2 questions involved in determining the treatment for any profits: (1) Is the lease capital or operating? (2) What portion of the rights to the leaseback property is retained?
-Under IFRS, treatment of any profits is determined by whether it is an operating or finance lease.
Excess Profit on Sale-Leaseback
-GAAP only
1. Operating (Rent-back) Lease Excess Profit: amount of profit on the sale that exceeds the PV of the minimum lease payments.
-Sales Price - (Asset Net Book Value) = Tentative Gain
-Tentative Gain - (PV of Minimum Lease Payments) = Excess Gain (Keep)
2. Capital ("OWNS" back) Lease Excess Profit: amount of profit on sale that exceeds the recorded amount of the asset (same as operating lease unless leaseback asset is recorded at the lower FV).
-Recorded amount of the leaseback is the lesser of: (1) FV of the leased property or, (2) PV of the minimum lease payments.
Leaseback Accounting by Seller / Lessee (GAAP)
-Under GAAP, amount of deferred gain is determined by the retained rights to remaining use of the "leaseback" property. Rights to remaining use are determined by the PV of rent payments paid by the sell-lessee:
1. "Substantially All" Rights Retained (≥ 90%): Major, defer all gain and amortize over the leased asset.
2. Rights Less than "Substantially All" but Greater than "Minor" (≤ 90% but > 10%): defer gain up to the PV of the minimum leaseback payments (operating lease) or capitalized asset (capital lease). Gain in excess of this amount is recognized immediately.
3. "Minor" Portion of Rights Retained (≤ 10%): Recognize gain or loss at the time of sale-leaseback transaction. Gains aren't deferred.
4. Real Economic Loss: when FV of property < BV, excess of BV over FV is the loss which is recognized immediately.
5. Artificial Loss: when the sales price is below the FV, the loss is deferred and amortized over the leaseback period.
Amortization of Deferred Gain
1. Capital Leaseback: any deferred gain or loss is amortized in proportion to the amortization of the leased asset's life.
-Deferred gain (loss) recognized as an "unearned profit (loss) on sale-leaseback" (treated as valuation account of the leased (back) asset).
2. Operating Leaseback: deferred gain (loss) amortized in proportion to the gross rental expense over the life of the lease life.
-Deferred gain (loss) recognized as an "unearned profit (loss) on sale-leaseback" (reported as deferred credit (or debit) in the B/S).
Leaseback Accounting by Seller / Lessee (IFRS)
-Under IFRS, accounting for profit on a sale-leaseback depends on the classification of the lease.
1. Finance Lease: if sale-leasback transaction results in a finance lease, any profit from the transaction is deferred and amortized over the lease term.
2. Operating Lease: if sales-leaseback results in an operating lease, profit or loss from the transaction is recognized based on the leased asset's carrying amount, FV, and selling price.*
*1. Sales Price at FV (GR): no deferral, profit or loss recognized immediately.
2. Sales Price Above FV: any profit should be deferred and amortized over the period that the asset is expected to be used.
3. Sales Price Below FV: any profit or loss is recognized immediately but if the loss is compensated for by future lease payments at below market price, loss should be deferred and amortized over the period that the asset is expected to be used.
Leaseback Accounting by the Purchaser-Lessor
-Acquisition of the asset is accounted for as a purchase. If lease is an operating lease, it is accounted for as such.
-If lease is a capital lease, it is accounted for as a direct financing lease.
1. Accounting by Original Lessor: if original lessee enters into a sublease, original lessor's accounting for the lease will not change.
2. Sublease Classification by Original Lessee and Sublessee: may be classified as either an operating or capital lease. If original lease was an operating lease, sublease is also an operating lease.*
*-If original lease was a capital lease due to either, (1) Ownership transfer, or (2) Written bargain purchase option (OWNS), sublease is also capital lease.
-If original lease was capital lease b/c of (3) 90% FV or (4) 75% Life, sublease will be operating lease unless it can meet one of the capital lease requirements.