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Accounting for Leases
Chapter 21
Intermediate Accounting12th Edition
Kieso, Weygandt, and Warfield
Prepared by Coby Harmon, University of California, Santa Barbara
Introductory Lecture – Includes Flow Introductory Lecture – Includes Flow ChartsCharts
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1. Explain the nature, economic substance, and advantages of lease transactions.
2. Describe the accounting criteria and procedures for capitalizing leases by the lessee.
3. Contrast the operating and capitalization methods of recording leases.
4. Identify the classifications of leases for the lessor.5. Describe the lessor’s accounting for direct-financing
leases.6. Identify special features of lease arrangements that
cause unique accounting problems.7. Describe the effect of residual values, guaranteed and
unguaranteed, on lease accounting.8. Describe the lessor’s accounting for sales-type leases.9. List the disclosure requirements for leases.
Learning Objectives
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Teresa’s Specific Objectives Be able to classify a lease from the perspective
of lessor and lessee Be able to prepare journal entries for lessor and
lessee – for both operating and capital-type leases
Be able to research FARS to resolve complications not mentioned in text
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The lease is a contractual agreement between the lessor and the lessee.
The lease gives the lessee the right to use specific property.
The lease specifies the duration of the lease and rental payments.
The obligations for taxes, insurance, and maintenance may be assumed by the lessor or the lessee.
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Lease Contracts
Cancellation Provision
Specifies under whatcircumstances the leasemay be canceled.
Lease TermDelineates the time period the lease is to be in force. May include renewal periods.
Rental payment requiredover lease term – may include planned increases.
Lease Payment
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Lease Contracts
Residual Value Who is responsible for market value of leasedasset at end of lease term?
Purchase Option
Grants lessee the right topurchase the asset at the end of the lease term. The option price may or may not be a bargain.
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Other Terms You Will Learn Contingent rentals Bargain renewal option Bargain purchase option Nonrenewal penalty Guaranteed residual
value Interest rate implicit in the
lease
Unguaranteed residual value
Executory costs Initial direct costs Minimum lease payments Incremental borrowing
rate
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1. 100% Financing at Fixed Rates. 2. Protection Against Obsolescence.3. Flexibility.4. Less Costly Financing.5. Tax Advantages.6. Off-Balance-Sheet Financing.
The Leasing EnvironmentAdvantages of Leasing
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1. Interest Revenue.2. Tax Incentives.3. High Residual Value.4. Making a sale that would otherwise
go to a competitor that provides a leasing option
The Leasing EnvironmentBenefits to the Lessor
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Operating Lease Capital LeaseJournal Entry: Rent expense xxx Cash xxx
Journal Entry: Leased equipment xxx Lease obligation
xxx
The issue of how to report leases is the case of substance versus form. Although technically legal title may not pass, the benefits from the use of the property do.
Statement of Financial Accounting Standard No. 13, “Accounting for Leases,” 1980
A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized (only noncancellable leases may be capitalized).
The Leasing Environment
LO 1 Explain the nature, economic substance, and advantages of lease transactions.
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Transferof
OwnershipBargain Purchase
Lease Term>= 75%
PV of Payments
>= 90%
Operat ing
Lease
NoNo NoNo NoNo
NoNo
Yes
Capital Lease
Lease Agreement
Yes Yes Yes
Leases that DO NOT meet any of the four criteria are accounted for as Operating Leases.
Accounting by the Lessee
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Lease Agreement
Is there transferof ownership?
Yes
Is there a bargainpurchase option?
Yes No
Is lease term equalto or greater than75% of economic
life ?
Yes No
CapitalLease
OperatingLease
Is present valueof payments
equal to or morethan 90% FMV?
Yes
No1111thth Ed Ed SlideSlide
Accounting by Lessee
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Classification of Leases by the Lessor
Accounting by the Lessor
A sales-type lease involves a manufacturer’s or dealer’s profit, and a direct-financing lease does not.
Illustration 21-11
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Classification of Leases by the Lessor
Accounting 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.
Illustration 21-12
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Lease Agreement
Does lease meet Group 1 criteria?
No
Is collectibility ofpayments assured?
No yes
Is lessor’s performancesubstantiallycomplete ?
No yes
OperatingLease
Directfinancing
yesyes
Does asset FMVequal lessor’sbook value?
No
Sales type
Accounting by Lessor
1111thth Ed Ed SlideSlide