Intermediate accounting 17e stice skousen cengage chapter 15

Stice | Stice | Skousen Intermediate Accounting,17E Leases PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University 15-1 © 2010 Cengage Learning Economic Advantages to Leasing Over Purchasing For Forthe theLessee Lessee No down payment Avoid risks of ownership Flexibility For Forthe theLessor Lessor Increased sales Ongoing business relationship with lessee Residual value retained 15-2 Simple Example • Owner Company owns a piece of equipment with a market value of $10,000 • User Company wishes to acquire the equipment • User Company can borrow $10,000 from the bank at 10% interest Payments would be $2,638 each year for five years (continues) 15-3 Simple Example • User Company can lease the equipment from Owner Company for five years and make five annual “rental” payments of $2,638 Owner maintains title throughout At the end of the lease, the equipment is no longer useful • Should Owner Company recognize an equipment sale when the lease is signed? (continues) 15-4 Simple Example Key accounting issues for Owner Company • Has effective ownership of the equipment been passed from Owner to User? • Is the transaction complete? • Is Owner Company reasonably certain the five annual payments can be collected from User Company? (continues) 15-5 Simple Example Key accounting issues for User Company • On the date the lease is signed, should User recognize the lease equipment as an asset and the obligation to make the lease payment as a liability? • The answer hinges on whether effective ownership, as opposed to legal ownership, of the equipment changes hands when Owner and User sign the lease agreement (continues) 15-6 Simple Example The economic substance of this lease is that the lease signing is equivalent to the transfer of effective ownership, and the fact that Owner retains legal title of the equipment during the lease period is a mere technicality The arrangement should be treated as a sale by Owner and a purchase by User 15-7 Simple Example Scenario Scenario One One The lease agreement stipulates that Owner Company is to maintain legal title to the equipment for the 5-year lease period, but title is to pass to User at the end of the lease Even though this is a leasing arrangement, the transfer of title at the end indicates that this is in substance a purchase 15-8 Simple Example Scenario Scenario Two Two The lease agreement stipulates that Owner Company is to maintain legal title to the equipment for the 5-year lease period, but at the end of the lease period User has the option to buy the equipment for $1 the equipment to User Company Offering for a bargain price at the end of the lease indicates that this is in substance a purchase 15-9 Simple Example Scenario Scenario Three Three The useful life of the equipment is just five years Accordingly, when the lease term is over, the equipment can no longer be used by anyone else Because the life of this asset and the lease term are the same, this arrangement is in substance a purchase 15-10 Accounting for Sales-Type Leases—Lessor American AmericanManufacturing ManufacturingCo Co.(Lessor) (Lessor) To record entries on January 1, 2011: Lease Payments Receivable 250,192 Sales 250,192 Cost of Goods Sold Finished Goods Inventory Deferred Initial Direct Costs Cash Lease Payments Receivable Executory Costs 175,000 160,000 15,000 65,000 60,000 5,000 15-56 Accounting for Sales-Type Leases—BPO or Guaranteed R/V • The minimum lease payments will include the following if they are part of the agreement: • A lump sum (from a bargain purchase option) at the end of the lease term OR • A guaranteed residual value • The receivable is increased by the gross amount of the bargain purchase option or the guaranteed residual value 15-57 Accounting for Sales-Type Leases—BPO or Guaranteed R/V Using the data from Exhibit 15-5, American Manufacturing offers a bargain purchase option of $75,000 at the end of five years (continues) 15-58 Accounting for Sales-Type Leases—BPO or Guaranteed R/V American AmericanManufacturing ManufacturingCo Co.(Lessor) (Lessor) To record entries on January 1, 2011: Lease Payments Receivable 296,761 Sales 296,761 Cost of Goods Sold Finished Goods Inventory Deferred Initial Direct Costs Cash Lease Payments Receivable Executory Costs 175,000 160,000 15,000 65,000 60,000 5,000 15-59 Accounting for Sales-Type Leases—Unguaranteed R/V When a sales-type lease does not contain a bargain purchase option or a guaranteed residual value, but the economic life of the leased asset exceeds the lease term, the residual value will remain with the lessor This is called an unguaranteed residual value 15-60 Accounting for Sales-Type Leases—Unguaranteed R/V Compare the entries below with the ones on Slide15-56 To record entries on January 1, 2011: Lease Payments Receivable 250,192 Sales 250,192 Cost of Goods Sold ($175,000 – $46,569) 128,431 Finished Goods Inventory ($160,000 – 160,000 15,000 $46,569) Deferred Initial Direct Costs Lease Payments Receivable Finished Goods Inventory 46,569 Left click on the button to go to Slide 15-56, then type “61” and press the “Enter” key to return to this slide 46,569 15-61 Sale of Asset During Lease Term If the leased asset in Exhibit 15-8 below is sold on December 31, 2013, for $140,000 before the rental payment is made (the Lease Payments Receivable balance is $104,132),… (continues) 15-62 Sale of Asset During Lease Term …the following journal entry would be recorded on December 31, 2013, to record the sale: Cash Interest Revenue Lease Payments Receivable Gain on Sale of Leased Asset 140,000 10,413 104,132 25,455 15-63 Treatment of Leases on Lessor’s Statement of Cash Flows In 2011, American Manufacturing’s income before any lease-related items is $200,000 Net income for the year can be computed as follows: Income before lease-related items Lease-related sales Lease-related cost of goods sold Leased-related interest revenue Net income $200,000 250,192 (175,000) 19,019 $294,211 15-64 Disclosure Requirements for Leases • For an operating lease, the lease-related asset and liability are off-balance-sheet items • It is important for the financial statement user to be able to interpret the associated note • Lessee is required to provide enough note disclosure to allow the users to quantify the magnitude of the operating leases • Lessor is required to provide enough disclosure to allow the financial statement user to figure out the extent to which leaserelated sales and rentals have impacted the lessor’s financial statements 15-65 International Accounting of Leases • IAS 17 relies on the exercise of accounting judgment to distinguish between operating and capital leases • A proposal, titled “Accounting for Leases: A New Approach,” suggests that all lease contracts longer than one year be accounted for as capital leases • This proposal is still under discussion 15-66 Sale-Leaseback Transactions On January 1, 2011, Hopkins Inc sells equipment having a carrying value of $750,000 to Ashcroft Co for $950,000 and immediately leases back the equipment Terms of the lease are: The term of the lease is 10 years, noncancelable A down payment of $200,000 is required plus equal lease payments of $107,107 at the beginning of each year The implicit rate is 10% (continues) 15-67 Sale-Leaseback Transactions The equipment has a fair value of $950,000 and an expected life of 20 years Straight-line depreciation is used Hopkins has an option to renew the lease for $10,000 per year for 10 years, the rest of its economic life Title passes at the end of the lease (continues) 15-68 Sale-Leaseback Transactions (continues) 15-69 Sale-Leaseback Transactions 15-70 ... I==10%) 5; 10%) Obligations under Capital LeasesNN==5; 60,000 Cash 65,000 (continues) 15- 28 (continues) 15- 29 Accounting for Capital Leases—Lessee Marshall Marshall Corp Corp Entries Entries on... reasonably certain the five annual payments can be collected from User Company? (continues) 15- 5 Simple Example Key accounting issues for User Company • On the date the lease is signed, should User recognize... fixed noncancelable lease period plus all renewal option periods that are likely to be exercised 15- 15 Residual Value • The market value of the leased property at the end of the lease term is referred