Intermediate II Final
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What are the 4 criteria for a capital lease?
- 1. Specifies ownership of asset transfers to lessee
- 2. Contains a bargain purchase option
- 3. Lease term is greater than or equal to 75% of the asset's expected economic life.
- 4. Present value of minimum lease payments is greater than or equal to 90% of the asset's fair value
What are the 2 additional conditions for a lessor's classification of a capital lease?
- 1. The collectibility of the lease payments must be reasonably predictable.
- 2. If any costs to the lessor have yet to be incurred, they are reasonably predictable.
Effective Rate x Balance
Additional Lessor Conditions
Minimum lease payments plus unguaranteed residual value
Lessor's gross investment
Periodic lease payments plus lessee-guaranteed residual value
Lessee's minimum lease payments
Initial direct costs
Sales-type lease selling expense
PV of minimum lease payments plus PV of unguaranteed residual value
Lessor's net investment
Bargain Purchase Option
- Purchase price less than fair value OR
- Depreciation longer than lease term
Cash to satisfy residual value guarantee
Loss to lessee
Capital lease expense
Deducted in lessor's computation of lease payments
PV of BPO price
Title transfers to lessee
Depreciation longer than lease term
Lease payments plus lessee-guaranteed and third-party-guaranteed residual value
Lessor's minimum lease payments
What are the three types of leases for the lessor?
Operating, Sales-Type, and Direct Financing
What are the 2 types of leases for the lessee?
Operating and Capital
What types of leases are essentially installment purchases?
What are the 3 things that generally make up minimum lease payments?
- The total of periodic rental payments
- Any guaranteed residual value
- Any bargain purchase option price
How do you account for a leasehold improvement?
The lessee depreciates the cost over the useful life of the improvement.
How does a lessee record a leased asset?
At the present value of the minimum lease payments OR the asset's fair value, whichever is lower.
How should one account for depreciation of a leased asset?
The lessee should depreciate the leased asset over the term of the lease. However, if ownership transfers or a BPO is present, the asset should be depreciated over its useful life.
What is a BPO?
A bargain purchase option. The lessee has the option of purchasing an asset at a substantially lower price than fair value.
How does a lessee account for a direct financing lease?
Simply as a capital lease.
What types of expenses will the lessee have under a direct financing lease?
Interest and Depreciation.
How does an operating lease appear on the balance sheet?
It doesn't. However, with a capital lease, an asset and a liability are created.
At the inception of a capital lease, the guaranteed residual value should be:
Included as part of minimum lease payments at present value.
For a direct-financing lease, the gross investment of the lessor is equal to the:
Minimum lease payments plus the unguaranteed residual value accruing to the lessor at the end of the lease term.
Initial direct costs incurred by the lessor under a sales-type lease should be:
Expensed in the period incurred.
Journal entry for a capital lease purchase of machinery:
- D: Leased Machinery
- C: Lease Payable
Journal entry for Capital Lease Payment:
- D: Interest Expense (Interest Rate x Outstanding Balance)
- D: Lease Payable
- C: Cash
What type of lease is more in the nature of a rental agreement?
What do we refer to periodic payments made at the beginning of each period as?
How do you account for advance payments on operating leases?
Classify the payment as prepaid rent and allocate it over the lease term as rent expense/revenue.
Journal Entry for Operating Lease Payment (Lessor)
- D: Cash
- C: Unearned rent revenue
Journal Entry for Operating Lease Payment (Lessee)
Who depreciates the cost of the asset under a capital lease? How long is the depreciation period?
- The lessee.
- The depreciatin period is restricted to the lease term unless the lease provides for transfer of title or a BPO.
What is a direct financing lease?
A lease in which the lessor finances the asset for the lessee and earns interest revenue over the lease term.
What is a sales-type lease?
A lease where in addition to interest revenue earned over the lease term, the lessor receives a manufacturer's or dealer's profit on the sale of the asset.
Journal Entry for Sales-Type Lease (Lessor)
- D: Lease Receivable (PV of lease payments)
- D: COGS (Lessor's cost)
- C: Sales Revenue (PV of lease payments)
- C: Inventory of Equipment (Lessor's Cost)
What does the difference between the total payments and their present value (selling price of the asset) represent?
Who, if anyone, includes the BPO as an additional payment as a component of minimum lease payments?
Both the lessor and the lessee.
What does the lessee do with the BPO when computing the amount to be recorded as a leased asset/liability?
They add the PV of the BPO to the PV of payments.
What does the lessor do with the BPO when computing periodic rental payments?
They subtract the PV of the BPO from the amount that must be recovered from the lessee.
What does the lessor's gross income consist of?
Total of periodic rental payments and any residual value.
How is guaranteed residual value?
An additional lease payment that is to be paid in property, or cash, or both.
What should the lessee do in a scenario where the residual value of the asset is less than the guaranteed residual value?
The lessee is required to pay the difference and records the payment as a loss.
What are executory costs?
Maintenance, insurance, taxes, and other costs usually associated with ownership.
What should the lessee do if the lessor's implicit rate is unknown? If the rate is known?
- If the rate is unknown, they should use their own incremental borrowing rate.
- If the rate is known, the lessee should use the lower of the 2 rates.
What is included in determination of gross investment in the lease?
Total of minimum lease payments plus any unguaranteed residual value.
What should the lessee do with a real estate lease that is expected to transfer ownership and includes both land and a building?
Record each leased asset separately. The PV of minimum lease payments is allocated based on relative fair values.
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