2 Introductory Lecture – Includes Flow Charts Accounting for LeasesChapter21Also includes slides from 11th edition prepared by Jep Robertson and Renae Clark - New Mexico State UniversityAnd has slides added by Teresa Gordon (University of Idaho)Intermediate Accounting12th EditionKieso, Weygandt, and WarfieldPrepared by Coby Harmon, University of California, Santa Barbara
3 Learning ObjectivesExplain the nature, economic substance, and advantages of lease transactions.Describe the accounting criteria and procedures for capitalizing leases by the lessee.Contrast the operating and capitalization methods of recording leases.Identify the classifications of leases for the lessor.Describe the lessor’s accounting for direct-financing leases.Identify special features of lease arrangements that cause unique accounting problems.Describe the effect of residual values, guaranteed and unguaranteed, on lease accounting.Describe the lessor’s accounting for sales-type leases.List the disclosure requirements for leases.
4 Teresa’s Specific Objectives Be able to classify a lease from the perspective of lessor and lesseeBe able to prepare journal entries for lessor and lessee – for both operating and capital-type leasesBe able to research FARS to resolve complications not mentioned in text
5 Special Accounting Problems Accounting for LeasesLeasing EnvironmentAccounting by LesseeAccounting by LessorSpecial Accounting ProblemsWho are players?Advantages of leasingConceptual nature of a leaseCapitalization criteriaAccounting differencesCapital lease methodOperating methodComparisonEconomics of leasingClassificationDirect-financing methodOperating methodResidual valuesSales-type leasesBargain purchase optionInitial direct costsCurrent versus noncurrentDisclosureUnsolved problems
6 The lease gives the lessee the right to use specific property. The lease is a contractual agreement between the lessor and the lessee.The lease gives the lessee the right to use specific property.The lease specifies the duration of the lease and rental payments.The obligations for taxes, insurance, and maintenance may be assumed by the lessor or the lessee.LEASE = A contract specifying the terms under which the owner of an asset agrees to transfer the right to use the asset to another party.The “Parties” to a LeaseLessee: The party granted the right to use the property under the terms of a lease.Has possession and use of the assetLessor: The owner of the property that is rented (leased) to another party.The legal owner of the asset
7 Cancellation Provision Lease ContractsCancellation ProvisionSpecifies under whatcircumstances the leasemay be canceled.Rental payment requiredover lease term – may include planned increases.Lease PaymentLease TermDelineates the time period the lease is to be in force. May include renewal periods.226
8 Lease Contracts Residual Value Purchase Option Who is responsible for market value of leasedasset at end of lease term?Purchase OptionGrants lessee the right topurchase the asset at the end of the lease term. The option price may or may not be a bargain.247
9 Other Terms You Will Learn Contingent rentalsBargain renewal optionBargain purchase optionNonrenewal penaltyGuaranteed residual valueInterest rate implicit in the leaseUnguaranteed residual valueExecutory costsInitial direct costsMinimum lease paymentsIncremental borrowing rate
10 The Leasing Environment Advantages of Leasing100% Financing at Fixed Rates.Protection Against Obsolescence.Flexibility.Less Costly Financing.Tax Advantages.Off-Balance-Sheet Financing.
11 The Leasing Environment Benefits to the LessorInterest Revenue.Tax Incentives.High Residual Value.Making a sale that would otherwise go to a competitor that provides a leasing option
12 The Leasing Environment 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.Operating LeaseCapital LeaseJournal Entry:Rent expense xxxCash xxxJournal Entry:Leased equipment xxxLease obligation xxxLargest group of leased equipment involves:Information technology, Transportation (trucks, aircraft, rail), Construction and Agriculture.A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized (only noncancellable leases may be capitalized).Statement of Financial Accounting Standard No. 13, “Accounting for Leases,” 1980LO 1 Explain the nature, economic substance, and advantages of lease transactions.
13 Accounting by the Lessee Leases that DO NOT meet any of the four criteria are accounted for as Operating Leases.Lease AgreementOperat ingLeaseTransferofOwnershipBargainPurchaseLease Term>= 75%PV ofPayments>= 90%NoNoNoNoYesYesYesYesCapital Lease
14 Accounting by Lessee Capital Lease Operating Lease Lease Agreement Is there transferof ownership?YesIs there a bargainpurchase option?YesNoIs lease term equalto or greater than75% of economiclife ?YesNoIs present valueof paymentsequal to or morethan 90% FMV?YesNoMy students in previous semesters found this slide particularly helpfulOperatingLease11th Ed Slide
15 Accounting by the Lessor Classification of Leases by the LessorIllustration 21-11A sales-type lease involves a manufacturer’s or dealer’s profit, and a direct-financing lease does not.
16 Accounting by the Lessor Classification of Leases by the LessorIllustration 21-12A lessor may classify a lease as an operating lease but the lessee may classify the same lease as a capital lease.
17 Accounting by Lessor Operating Lease Sales type Direct financing yes Lease AgreementDoes lease meetGroup 1 criteria?NoOperatingLeaseIs collectibility ofpayments assured?NoyesIs lessor’sperformancesubstantiallycomplete ?NoyesMy students in previous semesters found this slide particularly helpfulNoSales typeDirectfinancingyesyesDoes asset FMVequal lessor’sbook value?11th Ed Slide
18 Later we’ll talk about International Financial Reporting Standards IFRS Flowchart
19 From KPMG webcast Spring 2008 Additional indicators are things like:Cancellation losses borne by lesseeChanges in fair value of residual borne by lesseeBargain lease renewal option