1. ACCOUNTING FOR LEASES
CHAPTER 15
LEASES

2. Learning Objectives Overview : Lease. Types of Leases Lease Agreements
Classification criteria in order to distinguish between the types of leases
Accounting for types of leases:
Both lessee and lessor
Disclosure & Presentation

3. Economic Advantages to Leasing
No down payment.
Avoid risks of ownership.
Flexibility.
Protection against obsolescence
use of an asset without showing the resources/sources.. Off-balance-sheet financing
…….

4. Accounting by the Lessor/Lessee
A lease is a contractual agreement:
lessor (Owner of Property) conveys the right to use property to
lessee (User/Renter) in return for periodic cash payments
For stated period of time
The lessee receives the beneficial use of property in the lease. The lessor owns the property, and the lessee is the party who uses the assets and makes lease payments.
From the perspective of the lessee, we have two types of leases. The first lease is referred to as an operating lease, and the second is known as a capital lease. We view a capital lease as an in-substance purchase of an asset.
From the perspective of the lessor, we have three types of leases. We have an operating lease, a direct-financing-type lease, and a sales-type lease.
Classification of leases>>> 4

5. Accounting for Leases and classifications: FASB 13
Fundamental Rights and Responsibilities
Recognize the true Substance over the Form of the lease
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.

6. CLASSIFICATION OF LEASE
LEASES
LESSOR
LESSEE
CAPITAL LEASE
CAPITAL LEASE
OPERATING LEASE
OPERATING LEASE
transfers ownership
rental agreements
DIRECT
FINANCING
SALES
TYPE
Classification Criteria:…>

7. CLASSIFICATION OF LEASE
LEASES
PART I
PART II
LESSOR
LESSEE
CAPITAL LEASE
OPERATING LEASE
transfers ownership
rental agreements
Classification Criteria:…>

8. 1. FASB (13) CRITERIA 1. Transfer of Ownership
The lease contract includes a provision that the title to the leased asset passes to the lessee by the end of the lease term
Bargain Purchase Option (BPO)
Makes it reasonably assured that the lessee will acquire asset
allows the lessee to buy the leased asset
at a price significantly lower than the asset’s fair value when the option is exercisable (BARGAIN PRICE)
Term: 75% of economic Life – Lease term is equal to 75% or more of the economic life of the leased asset
4. Asset Value: Present value of the minimum lease payments is greater than or equal to 90% of the FMV of the leased asset on the lease signing - what is included in Lease payments

9. MUST MEET JUST ONE CRITERIA
CLASSIFICATION OF LEASE:LESSEE
MUST MEET JUST ONE CRITERIA
Lease Agreement
Non-Cancellable
Operat ing
Lease
Transfer of
Ownership
Bargain
Purchase
Lease Term
>= 75%
PV of
Payments
>= 90% No No No No
Yes
Yes
Yes
Yes
Capital Lease
Determine if the risks/rewards of ownership transferred to lessee

10. ACCOUNTING FOR CAPITAL LEASE PURCHASE/OWNERSHIP LESSEE (books)
Determine the criteria:
1. Ownership transfer
2. Bargain purchase option
3. PV of MLP (minimum lease payment) is equal to 90% of more
4. Lease term 75% or more of estimated economic life

11. Calculation of CAPITAL LEASE LESSEE (books)
Determine the criteria: (any one…)
Lease is classified as: CAPITAL LEASE
LESSEE’S BOOKS
DR. ASSET: LEASE PROPERTY
CR. LEASE OBLIGATION (PAYABLE)

12. CAPIALIZED AMOUNT Lessee
The Lessee records the lease an asset/liability:
LESSER OF:
1. FAIR VALUE of the asset at the inception of lease or
2. PV of MLP (PVMLP)
Question: what should be included in the PVMLP

13. Residual Value (RV) Guaranteed or Unguaranteed
Estimated Value at the end of the lease term!
GUARANTEED RV is additional payment at the end of the lease term
If Bargain Purchase Option:
GRV becomes irrelevant
UNGUARANTEED: not required to make additional payment at the end of the lease term

14. Accounting by the Lessee
PV OF MINIMUM LEASE PAYMENTS (PVMLP)
Minimum lease payments:
PV rental payment (usually beginning of the period)
Plus: PV Guaranteed residual value
(unguaranteed : NOT included in PVMLP)

15. CAPITAL Leases - Lessee
The amount recorded (capitalized) is the PVMLP.
However, the amount recorded cannot exceed the fair value of the leased asset.
the interest rate used by the lessee is the lower of:
Its incremental borrowing rate, or
The implicit interest rate used by the lessor.
Part I From the viewpoint of the lessee, the amount recorded as the asset will be the present value of the minimum lease payments. However, the amount recorded as the asset can never exceed the fair value of that asset.
Part II
In calculating the present value of the minimum lease payment, the interest rate used will be the lower of the lessee’s incremental borrowing rate, or the implicit rate used by the lessor to set the lease payment amount.

16. ACCOUNTING FOR CAPITAL LEASE: LESSEE
Asset user
Asset & Liability are recognized
Amount: PV of Lease payments
Including any BPO or Guarantee Residual Value (GRV)
Lease payments reduction in Lease Liability &
Increases to interest expense (relates to liability)
Let’s
Illustrate…
Asset is subsequently Depreciated *

17. Depreciation of Asset: Rules*:
Transfer of Ownership: Depreciate over asset life (Legal form)
Bargain purchase option: Depreciate over the asset life (legal form)
Term (75%) : Depreciate lease term (substance over form)
Asset Value (90% FV): Depreciate over lease term (substance over form)

18. Executory Costs
Ownership of the asset is responsible for Insurance, maintenance, etc
Capital Lease: Lessee gets the benefit of using the asset (LESSEE’s expense)
Dr. Maintenance expense (executory costs)
Cr Cash
(if included in lease payment – deduct to calculate PV MLP)
If lessor makes the payment, these costs are reimbursed by lessee by recording the expense

19. LEASE PART II Accounting for Leases- Lessor
Classification of Lease: LESSOR’S BOOK

20. CLASSIFICATION OF LEASE: LESSOR
LEASES
LESSOR
LESSEE
CAPITAL LEASE
CAPITAL LEASE
OPERATING LEASE
OPERATING LEASE
DIRECT
FINANCING
SALES
TYPE
Classification Criteria:…>

21. Accounting by the Lessor
Classification of Leases by the Lessor

22. Classification of Leases by the Lessor
Accounting by the Lessor
Classification of Leases by the Lessor
If any costs to the lessor to be incurred, are reasonably predictable
A lessor may classify a lease as an operating lease but the lessee may classify the same lease as a capital lease.

23. Nonoperating Leases: - Lessor
If the lessor is not a manufacturer or dealer, the fair value of the leased asset is typically the lessor’s cost-
DIRECT FINANCING LEASE
When the lessor is a manufacturer or dealer, the fair value of the property at the inception of the lease is likely to be its normal selling price
– SALES TYPE LEASE
If the lessor is not a manufacturer or dealer of the asset being leased, the fair value of the leased asset usually will be equal to the lessor’s cost. However, when the lessor is a manufacturer or dealer, the fair value of the leased property at inception of lease will usually be more than the cost of the asset in the hands of the lessor.

24. Direct-Financing Lease: Lessor

25. Depreciation: NOT RECORDED BY LESSOR
Asset is removed from the Lessor’s books
Illustration: DIRECT FINANCING…. LESSOR-

26. e.g. Legal fees, commissions
Initial Direct Costs
costs incurred by the lessor in negotiating/preparing a lease agreement.
e.g. Legal fees, commissions
Operating Leases − Capitalize and amortize over the lease term by the lessor.
Direct Financing Leases − not expensed ; deferred and recognized over the lease term
Sales type leases: expensed at the inception of the lease (selling expense)
Initial direct costs are costs incurred by the lessor to draw-up and consummate the lease agreement. For operating leases, the lessor would capitalize these costs and amortize them, generally using the straight-line method, over the lease term. For a direct-financing type lease, the initial direct costs are included as part of the gross investment in the lease. When we include the initial direct costs in a direct-financing type lease, we must calculate a new implicit interest rate that previously was unknown to the lessor.

27. How should the lease be classified by LESSOR
Since the fair value equals the lessor’s carrying value, there is no dealer’s profit, making this a direct financing lease.
Prepare appropriate entries for Canfor (lessor)

28. Sales-Type Lease: LESSOR
Total payments – sale price = interest

29. Accounting for Sales-Type Lease LESSOR
Record:
Receivable (PV) & Sales
Cost of goods sold / reducing the inventory
Any Initial Direct Costs recognized as an expense immediately
Reimbursement of executory costs – same as direct financing

30. Sales Type Lease with Guaranteed Residual Value
Guaranteed Residual Value: Both Lessee and Lessor include Guaranteed Residual Value in calculating MLP
If RV is not guaranteed by Lessee (Lessee exclude in MLP)
LESSOR:
Lessor : even if it is not guaranteed by lessee, lessor expects to receive from 3rd party
Includes residual value in their receivable
But the sales revenue and COGS are reduced by the same amounts

31. Lessee Disclosures For capital leases, disclose
Gross amount of assets recorded under capital leases.
Future MLP in the aggregate and for each of the five succeeding years.
Total minimum sublease rentals to be received in the future under non-cancelable subleases.
On the next three screens, we will outline the lessee’s disclosure requirements for leases. Be sure you read each screen carefully.

32. (continued)

35. International Accounting of Leases
IAS 17 relies on the exercise of accounting judgment to distinguish between operating and capital leases.