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In this chapter students will be able to: Explain the nature, economic substance, and advantages of lease transactions; describe the accounting criteria and procedures for capitalizing leases by the lessee; contrast the operating and capitalization methods of recording leases;...
PART III: Decision Tools Lecture 28 Accounting for Leases Learning Learning Objectives Objectives Explain the nature, economic substance, and advantages of lease transactions Describe the accounting criteria and procedures for capitalizing leases by the lessee Contrast the operating and capitalization methods of recording leases Identify the classifications of leases for the lessor Describe the lessor’s accounting for direct-financing leases Accounting Accounting for for Leases Leases Leasing Environment Special Accounting Problems Accounting by Lessee Accounting by Lessor Who are players? Capitalization criteria Economics of leasing Advantages of leasing Accounting differences Classification Sales-type leases Conceptual nature of a lease Capital lease method Direct-financing method Bargainpurchase option Operating method Initial direct costs Operating method Comparison Residual values Current versus noncurrent Disclosure Unresolved problems The The Leasing Leasing Environment 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: Information technology Transportation (trucks, aircraft, rail) Construction Agriculture LO Explain the nature, economic substance, and advantages of lease transactions The The Leasing Leasing Environment Environment Who Are the Players? Banks ► Wells Fargo ► Chase ► Citigroup ► PNC Independents 23% 47% Captive Leasing Market Share ► Caterpillar Financial Services Corp ► Ford Motor Credit (Ford) ► IBM Global Financing 26% LO The The Leasing Leasing Environment Environment Advantages of Leasing 100% financing at fixed rates Protection against obsolescence Flexibility Less costly financing Tax advantages Off-balance-sheet financing LO Explain the nature, economic substance, and advantages of lease transactions The The Leasing Leasing Environment 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 LO Explain the nature, economic substance, and advantages of lease transactions Accounting Accounting by by the the Lessor Lessor and and Lessee Lessee A lease is an agreement in which the lessor conveys the right to use property, plant, or equipment, usually for a stated period of time, to the lessee Lessor Lessor == Owner Owner of of property property Lessee Operating lease Capital lease Lessor Operating lease Capital lease Direct financing lease Sales-type lease The The Leasing Leasing Environment Environment Operating Lease Rent expense Cash xxx xxx Although technically legal title may not pass, the benefits from the use of the property Substance versus Form Capital Lease Leased equipment Lease liability xxx xxx LO Explain the nature, economic substance, and advantages of lease transactions Capital Capital Leases Leases and and Installment Installment Notes Notes Compared Compared Matrix, Inc acquires equipment from Apex, Inc by paying $193,878 every six months for the next three years The interest rate associated with the agreement is 9% Let’s look at the arrangement as an installment note payable and as a capital lease agreement First, let’s prepare an amortization schedule for the payments Date Payment Initial value $ 193,878 193,878 193,878 193,878 193,878 193,878 10 Effective Decrease Outstanding Interest in Balance Balance $ 1,000,000 $ 45,000 $ 148,878 851,122 38,300 155,578 695,544 31,300 162,578 532,966 23,983 169,895 363,071 16,338 177,540 185,532 8,346 185,532 - Accounting Accounting by by the the Lessee Lessee Operating Method The lessee assigns rent to the periods benefiting from the use of the asset and ignores, in the accounting, any commitments to make future payments Illustration: Assume Adams accounts for it as an operating lease Adams records this payment on January 1, 2012, as follows Rent Expense Cash 45 9,968 9,968 LO Contrast the operating and capitalization methods of recording leases Accounting Accounting by by the the Lessee Lessee Comparison of Capital Lease with Operating Lease Date 2012 Finance Lease Depreciation Interest Expense Expense $ $ 3,160 $ 11,473 $ Diff 9,968 $ 1,505 2013 8,313 2,479 10,792 9,968 824 2014 8,313 1,730 10,043 9,968 75 2015 8,313 906 9,219 9,968 (749) 2016 8,313 8,313 9,968 (1,655) 49,840 $ 46 8,313 Total Operating Lease Expense 41,565 $ 8,275 $ 49,840 $ LO Contrast the operating and capitalization methods of recording leases Accounting Accounting by by the the Lessor Lessor Benefits to the Lessor Interest revenue Tax incentives High residual value 47 LO Identify the classifications of leases for the lessor Accounting Accounting by by the the Lessor Lessor Economics of Leasing A lessor determines the amount of the rental, based on the rate of return—the implicit rate—needed to justify leasing the asset If a residual value is involved (whether guaranteed or not), the company would not have to recover as much from the lease payments 48 LO Identify the classifications of leases for the lessor Accounting Accounting by by the the Lessor Lessor Fieval Leasing Company signs an agreement on January 1, 2012, to lease equipment to Reid Company The following information relates to this agreement 49 The term of the non-cancelable lease is years with no renewal option The equipment has an estimated economic life of years The cost and fair value of the asset at January 1, 2012, is $343,000 The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $61,071, none of which is guaranteed The agreement requires equal annual rental payments, beginning on January 1, 2012 Collectability of the lease payments is reasonably predictable There are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor LO Identify the classifications of leases for the lessor Accounting Accounting by by the the Lessor Lessor Assuming the lessor desires a 10% rate of return on its investment, calculate the amount of the annual rental payment required Residual value $ PV of single sum (i=10%, n=6) x 0.56447 PV of residual value $ 34,473 Fair market value of leased equipment $ 343,000 Present value of residual value (34,473) - Amount to be recovered through lease payment PV factor of annunity due (i=10%, n=6) Annual payment required 50 61,071 308,527 ÷ 4.79079 $ 64,400 LO Identify the classifications of leases for the lessor Accounting Accounting by by the the Lessor Lessor Classification of Leases by the Lessor a Operating leases b Direct-financing leases c Sales-type leases 51 LO Identify the classifications of leases for the lessor Accounting Accounting by by the the Lessor Lessor Classification of Leases by the Lessor A sales-type lease involves a manufacturer’s or dealer’s profit, and a directfinancing lease does not 52 LO Identify the classifications of leases for the lessor Accounting Accounting by by the the Lessor Lessor Classification of Leases by the Lessor A lessor may classify a lease as an operating lease but the lessee may classify the same lease as a capital lease 53 LO Accounting Accounting by by the the Lessor Lessor Direct-Financing Method (Lessor) In substance the financing of an asset purchase by the lessee Lessor records: 54 A lease receivable instead of a leased asset Receivable is the present value of the minimum lease payments LO Describe the lessor’s accounting for direct-financing leases Accounting Accounting by by the the Lessor Lessor Amortization schedule for the lessor 55 LO Accounting Accounting by by the the Lessor Lessor Prepare all of the journal entries for the lessor for 2012 and 2013 1/1/12 Lease Receivable 343,000 Equipment 1/1/12 Cash 343,000 64,400 Lease Receivable 12/31/12 Interest Receivable Interest Revenue 56 64,400 27,860 27,860 LO Describe the lessor’s accounting for direct-financing leases Accounting Accounting by by the the Lessor Lessor Prepare all of the journal entries for the lessor for 2012 and 2013 1/1/12 12/31/12 Cash Lease Receivable 36,540 Interest Receivable 27,860 Interest Receivable Interest Revenue 57 64,400 24,206 24,206 LO Describe the lessor’s accounting for direct-financing leases Accounting Accounting by by the the Lessor Lessor Operating Method (Lessor) 58 Records each rental receipt as rental revenue Depreciates leased asset in the normal manner LO Describe the lessor’s accounting for direct-financing leases Accounting Accounting by by the the Lessor Lessor Illustration: Assume Fieval accounts for the lease as an operating lease It records the cash rental receipt as follows: Cash 64,400 Rental Revenue 64,400 Depreciation is recorded as follows: Depreciation Expense Accumulated Depreciation 46,989 46,989 ($343,000 – 61,067) / years = 57,167 59 LO Describe the lessor’s accounting for direct-financing leases ... operating and capitalization methods of recording leases Identify the classifications of leases for the lessor Describe the lessor’s accounting for direct-financing leases Accounting Accounting for. .. consisting of interest and principal Journal Entries for Capitalized Lease 28 LO Describe the accounting criteria and procedures for capitalizing leases by the lessee Accounting Accounting by... classifications of leases for the lessor Accounting Accounting by by the the Lessor Lessor Classification of Leases by the Lessor a Operating leases b Direct-financing leases c Sales-type leases 51 LO