1. Financial Accounting 3
Module 5
Leases

2. Theoretical foundation
Substance of a lease
Lease capitalization
Leasing vs. Owning
Minimum lease payments
Periodic payments and
Guaranteed residual value
Bargain purchase option
Failure to renew penalty

3. Lessee
Financing Lease
Decision 1
Operating Lease

4. Capital if any of the following;
Title of asset will transfer at end of lease
Lease term is at least 75% of asset’s economic life
Present value of the minimum lease payments is at least 90% of the fair market value of the leased asset
The nature of the asset.

5. Lessee accounting Operating lease Record lease payments as an expense;
DR lease expense
CR cash
In the case of uneven payments, a liability or asset needs to recorded.

6. Lessee accounting con’t
Financing lease
Capitalize the asset (max. is FMV)
Record lease liability at PV of MLP
Amortize over the period of time that the lessee will have use of the asset

7. Lessee accounting con’t
Interest expense;
DR interest expense
CR lease liability
Lease payment;
DR lease liability
CR cash
Amortize the asset over the term of use

8. Lessee accounting con’t
Interest expense;
DR interest expense
CR lease liability
Lease payment;
DR lease liability
CR cash
Both
DR lease liability
DR interest expense
CR cash

9. Cash flow Operating lease – Financing lease –
operating section, part of net income. Make sure to adjust for non-cash expenses. (forgiven first payments)
Financing lease –
financing section - cash payment amount for the change in lease liability
operating section – cash payment for interest expense, add back the non-cash amortization expense

10. Disclosures The next five years of lease payments.
The interest portion of these payments.
The interest rate

11. Direct financing lease
Lessor
Direct financing lease
Capital lease
Decision 2
Sales-type lease
Decision 1
Operating lease

12. Lessor Accounting Decision 1 – capital if Any of the following
Title passes
75% of life
PV of MLP’s is 90% of FMV
And both of the following
Collectibility is assured
No significant unestimable, unreimbursable costs

13. Lessor accounting con’t
Decision 2
Sales-type lease
Lessor buys or manufactures asset to “sell” for a profit
Reports a gross profit (sale less cost of goods sold) at time of sell and financing revenue over the life of the lease
Direct financing –
financing company,
asset delivered directly to lessee,
reports finance revenue only over the life of the lease