INTERMEDIATE Intermediat ACCOUNTING Intermediat e e Accounting Accounting F I F T E E N T H 21-1 E D I T I O N Prepared by Coby Harmon Prepared by Prepared by University of California, Barbara CobySanta Harmon Harmon Westmont College SantaCoby University of California, Barbara University of California, Santa Barbara Westmont College kieso weygandt warfield team for success PREVIEW OF CHAPTER 21 Intermediate Accounting 15th Edition Kieso Weygandt Warfield 21-2 21 Accounting for Leases LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should be able to: Explain the nature, economic substance, and advantages of lease transactions Describe the lessor’s accounting for directfinancing leases Describe the accounting criteria and procedures for capitalizing leases by the lessee Identify special features of lease arrangements that cause unique accounting problems Contrast the operating and capitalization methods of recording leases Explain the advantages and economics of leasing to lessors and identify the classifications of leases for the lessor Describe the effect of residual values, guaranteed and unguaranteed, on lease accounting Describe the lessor’s accounting for salestype leases List the disclosure requirements for leases 21-3 Investment in Debt Securities Different motivations for investing: 21-4 To earn a high rate of return To secure certain operating or financing arrangements with another company LO The Leasing Environment A lease is a contractual agreement between a lessor and a lessee, that gives the lessee the right to use specific property, owned by the lessor, for a specified period of time Largest group of leased equipment involves: 21-5 Information technology equipment Transportation (trucks, aircraft, rail) Construction Agriculture LO The Leasing Environment 21-6 Illustration 21-2 What Do Companies Lease? LO The Leasing Environment Who Are the Players? Banks ► Wells Fargo ► Chase ► Citigroup Independents ► International Lease Finance Corp Financial Services Corp Credit (Ford) 23% 21-7 ► Caterpillar ► Ford Motor ► PNC 47% Captive Leasing Companies Market Share ► IBM Global Financing 26% LO The Leasing Environment Advantages of Leasing 100% financing at fixed rates Protection against obsolescence Flexibility Less costly financing Tax advantages Off-balance-sheet financing 21-8 LO 21-9 LO The Leasing Environment Conceptual Nature of a Lease Capitalize a lease that transfers substantially all of the benefits and risks of property ownership, provided the lease is noncancelable Leases that not transfer substantially all the benefits and risks of ownership are operating leases 21-10 LO APPENDIX 21A SALE-LEASEBACKS Determining Asset Use To the extent the seller-lessee continues to use the asset after the sale, the sale-leaseback is really a form of financing Lessor should not recognize a gain or loss on the transaction If the seller-lessee gives up the right to the use of the asset, the transaction is in substance a sale 21-90 Gain or loss recognition is appropriate LO 10 APPENDIX 21A SALE-LEASEBACKS Lessee If the lease meets one of the four criteria for treatment as a capital lease, the seller-lessee should 21-91 Account for the transaction as a sale and the lease as a capital lease Defer any profit or loss it experiences from the sale of the assets that are leased back under a capital lease Amortize profit over the lease term LO 10 APPENDIX 21A SALE-LEASEBACKS Lessee If none of the capital lease criteria are satisfied, the sellerlessee accounts for the transaction as a sale and the lease as an operating lease 21-92 Lessee defers such profit or loss and amortizes it in proportion to the rental payments over the period when it expects to use the assets LO 10 APPENDIX 21A SALE-LEASEBACKS Lessor If the lease meets one of the lease capitalization criteria in Group I and both in Group II, the purchaser-lessor records the transaction as a purchase and a direct-financing lease If the lease does not meet the criteria, the purchaser-lessor records the transaction as a purchase and an operating lease 21-93 LO 10 APPENDIX 21A SALE-LEASEBACKS Sale-Leaseback Example American Airlines on January 1, 2014, sells a used Boeing 757 having a carrying amount on its books of $75,500,000 to CitiCapital for $80,000,000 American immediately leases the aircraft back under the following conditions: The term of the lease is 15 years, noncancelable, and requires equal rental payments of $10,487,443 at the beginning of each year The aircraft has a fair value of $80,000,000 on January 1, 2014, and an estimated economic life of 15 years American pays all executory costs American depreciates similar aircraft that it owns on a straight-line basis over 15 years 21-94 The annual payments assure the lessor a 12 percent return American’s incremental borrowing rate is 12 percent LO 10 APPENDIX 21A SALE-LEASEBACKS Sale-Leaseback Example This lease is a capital lease to American because the lease term exceeds 75 percent of the estimated life of the aircraft and because the present value of the lease payments exceeds 90 percent of the fair value of the aircraft to CitiCapital CitiCapital should classify this lease as a direct-financing lease 21-95 LO 10 APPENDIX Illustration 21A-1 21-96 21A SALE-LEASEBACKS RELEVANT FACTS - Similarities 21-97 Both GAAP and IFRS share the same objective of recording leases by lessees and lessors according to their economic substance—that is, according to the definitions of assets and liabilities Much of the terminology for lease accounting in IFRS and GAAP is the same Under IFRS, lessees and lessors use the same general lease capitalization criteria to determine if the risks and rewards of ownership have been transferred in the lease LO 11 Compare the accounting for leases under GAAP and IFRS RELEVANT FACTS - Differences 21-98 One difference in lease terminology is that finance leases are referred to as capital leases in GAAP GAAP for leases uses bright-line criteria to determine if a lease arrangement transfers the risks and rewards of ownership; IFRS is more general in its provisions GAAP has additional lessor criteria: payments are collectible and there are no additional costs associated with a lease IFRS requires that lessees use the implicit rate to record a lease unless it is impractical to determine the lessor’s implicit rate GAAP requires use of the incremental rate unless the implicit rate is known by the lessee and the implicit rate is lower than the incremental rate LO 11 RELEVANT FACTS - Differences 21-99 Under GAAP, extensive disclosure of future non-cancelable lease payments is required for each of the next five years and the years thereafter Although some international companies (e.g., Nokia) provide a year-by-year breakout of payments due in years through IFRS does not require it The FASB standard for leases was originally issued in 1976 The standard (SFAS No 13) has been the subject of more than 30 interpretations since its issuance The IFRS leasing standard is IAS 17, first issued in 1982 This standard is the subject of only three interpretations One reason for this small number of interpretations is that IFRS does not specifically address a number of leasing transactions that are covered by GAAP Examples include lease agreements for natural resources, sale-leasebacks, real estate leases, and leveraged leases LO 11 ON THE HORIZON Lease accounting is one of the areas identified in the IASB/FASB Memorandum of Understanding The Boards have issued proposed rules based on “right of use,” which requires that all leases, regardless of their terms, be accounted for in a manner similar to how finance leases are treated today That is, the notion of an operating lease will be eliminated, which will address the concerns under current rules in which no asset or liability is recorded for many operating leases A final standard is expected in 2013 You can follow the lease project at either the FASB (http://www.fasb.org) or IASB (http://www.iasb.org) websites 21-100 LO 11 IFRS SELF-TEST QUESTION Which of the following is not a criterion for a lease to be recorded as a finance lease? a There is transfer of ownership b The lease is cancelable c The lease term is for the major part of the economic life of the asset d There is a bargain-purchase option 21-101 LO 11 IFRS SELF-TEST QUESTION Under IFRS, in computing the present value of the minimum lease payments, the lessee should: a use its incremental borrowing rate in all cases b use either its incremental borrowing rate or the implicit rate of the lessor, whichever is higher, assuming that the implicit rate is known to the lessee c use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee d use the implicit rate of the lessor, unless it is impracticable to determine the implicit rate 21-102 LO 11 IFRS SELF-TEST QUESTION A lease that involves a manufacturer’s or dealer’s profit is a (an): a direct financing lease b finance lease c operating lease d sales-type lease 21-103 LO 11 Copyright Copyright © 2013 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein 21-104 ...PREVIEW OF CHAPTER 21 Intermediate Accounting 15th Edition Kieso Weygandt Warfield 21- 2 21 Accounting for Leases LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should... lease accounting Describe the lessor’s accounting for salestype leases List the disclosure requirements for leases 21- 3 Investment in Debt Securities Different motivations for investing: 21- 4... benefits and risks of ownership are operating leases 21- 10 LO 21 Accounting for Leases LEARNING LEARNINGOBJECTIVES OBJECTIVES After studying this chapter, you should be able to: Explain the nature,