FinAcct - Leases
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What is the nature of a Lease?
1. Physical transfer of property and the right to its use from a lessor, who keeps legal title to the property, to a lessee, in exchange for lease payments.
2. Substance of lease terms can vary widely, from short-term rental to a ful transfer of all risks and benefits.
Why would a corporation Lease?
- - Perhaps improved cash flow for lessee
- - Tax benefits may accrue to lessee
- - Hedge agaist risk of obsolescense
- - Repossession easier in case of default
- - Desirable accounting treatment - off balance sheet financing tool.
What are the Critical Characteristics in substance versus form inquiry regarding leases?
- 1. Does title pass to lessess automatically?
- if not, is it likely to pass?
2. Is the length of the lease term substantial relative to property life?
3. Are lease payments substantial relative to FMV of property?
What is the difference of a Capital Lease and Operating Lease?
A capital lease, is a lease that shares the majority of characteristics of a purchase are called capital leases, and are accounted for as if they were purchases.
All other leases are called operating leases, and are accounted for as if they were short term rentals.
What are the characteristics of a Capital Lease?
1. Lease automatically transfers title at the end of the lease term to the lessee; or
2. Lease has a bargain purchase element; or
3. Lease term equals 75% or more of the expected useful life of the property; or
4. Present value of minimum lease payments is at least 90% of the FMV of the property.
***If any of these tests are met, a lease is treated as a capital lease and accounted for as if it were a purchase of the property.
How do you Account for Capital Leases?
- Teat lease as a purchase, recording assets and related liabilities at lease inception.
- - Assets and liabilities recorede at the PV of the minimum lease payments.
- - Use the lesser of the imbedded reate in the lease or the incremental borrowing rate of the lessee to discount the lease payments.
How do you account for Operating Leases?
- Treat lease as short terim rental, a two-party executory contract.
- - No asset or liability is recorded at lease inception
- - Cash payments are simply rental expenses
- - Disclosure Required: All non-cancellable lease payments per year for 5 years.
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