Acct Chapter 211 Accounting for Leases Leases are becoming a very important way for businesses to acquire productive assets. They allow for some or all of the following advantages to the lessee: High levels of financing (up to 100%) Protection from Obsolescence Flexibility Use of tax benefits not available to lessee Avoidance of alternative minimum tax Off balance sheet financing

Acct Chapter 212 Accounting Issue The primary issue for accountants is when, if at all, to bring the lease on to the balance sheet. The profession has determined that when the risks and rewards of ownership are transferred, the lease should be treated as a purchase. Lease payments are shown as an obligation for lessee at their present value, and the asset is shown as leased property The lessor removes the asset from its balance, recognizes a receivable, and may recognize profit from selling the asset. Generally the accounting is symmetric

Acct Chapter 213 Capitalization Criteria Lessee capitalizes lease if one of the following four conditions are met: Ownership transfers to lessee at end of lease The lease contains a bargain purchase option The life of the lease is 75% or more of life of asset The present value of the minimum lease payments are 90%or more of the fair value of the asset Lessor must also meet BOTH OF the following 2 criteria: Collectibility of payments is reasonable predictable No important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor (substantial performance)

Acct Chapter 214 Important Terms Minimum Lease Payments Guaranteed vs. Unguaranteed residual Executory Costs Direct Financing Lease Sales Type Lease Operation lease Net investment in the lease

Acct Chapter 215 Lessee Accounting Leases are capital or operating, based on capitalization criteria. For capital leases, capitalize the present value of the minimum lease payments (do not include ungauranted residual) as leased asset and lease obligation, depreciate asset, and amortize obligation. At end of lease, either remove if returned, or convert to owned asset.

Acct Chapter 216 Direct Financing Lease Have if cost to lessor equals market value of property Lessor books: Lease receivable for the present value of the lease payments plus the residual (whether guaranteed or not) Removes the asset leased from its balance sheet Apportion each payment between interest and principal. Net out the residual against the lease payments receivable at end of life, can have a gain or loss on ungauranted residual.

Acct Chapter 217 Sales-Type Lease Have if cost to lessor is less than market value of property Lessor books: Lease receivable for the present value of the minimum lease payments plus the PV of the unguaranteed residual Sales for the present value of the minimum lease payments (does not include ungauranted residual) Credits inventory for the cost of the asset Debits cost of goods sold for the cost of the inventory less the unguaranteed residual Amortize the receivable to interest revenue May have gain/loss on ungauranted residual at end of lease.

Acct Chapter 218 Residuals by Lessee Unguaranteed is ignored by lessee as they just give the property back and have no obligation Guaranteed is included in asset and the obligation by lessee Lessee can have a gain or loss at the end of the lease depending on the fair value at the end of lease versus the guaranteed residual

Acct Chapter 219 Residuals and Direct Financing Accounting is the same whether the residual is guaranteed or not since the lessor gets it back and is bearing the risk of its value Lessor can have a gain or loss at the end if the residual is not guaranteed.

Acct Chapter 2110 Sales Type and Residual Guaranteed residual is included in the sale and the cost of goods sold Unguaranteed is included in the receivable and the full cost of asset is removed from inventory Cost of goods sold and sales are reduced by the PV of the unguaranteed residual, thus treating that part of the asset as essentially not being sold