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Chapter 15 - part 1(5).ppt

Chapter 15 - part 1(5).ppt - Leases Chapter 15 Part 1 15-2...

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Unformatted text preview: Leases Chapter 15 Part 1 15-2 Accounting by the Lessor and 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. Lessee Lessee == Renter Renter Lessor Lessor == Owner Owner of of property property 15-3 Capital Leases vs. Installment Notes Matrix, Inc. acquires equipment from Apex, Inc. by paying $193,878 every 6 months for the next 3 years. The interest rate associated with the agreement is 9%. 15-4 Inception of the Agreement At inception January 1 1) What is the initial entry if this was an installment note? 2) What is the initial entry if recorded as a capital lease? (lessee) 15-5 Classification Criteria Operating Lease Capital Lease A capital lease must meet one of four criteria: Ownership transfers to to the the lessee lessee at at the the end end of of the the lease lease term, term, or or .. .. .. A A bargain purchase option (BPO) (BPO) exists, exists, or or .. .. .. The The noncancelable noncancelable lease lease term term is is equal equal to to 75% or more of of the the expected expected economic economic life life of of the the asset, asset, or or The The PV PV of of the the minimum minimum lease lease payments payments is is 90% or more of the fair value of of the the asset. asset. 15-6 Classification Criteria A bargain purchase option (BPO) gives the lessee the right to purchase the leased asset at a price significantly lower than the expected fair value and the exercise of the option appears reasonably assured. The lease term is normally considered to be the noncancelable term of the lease plus any periods covered by bargain renewal options. If the inception of the lease occurs during the last 25% of an asset’s economic life, this criterion does not apply. For the lessee, a capital lease is treated as the purchase of an asset – the lessee records both an asset and liability at inception of the lease. 15-7 Additional Lessor Conditions The four conditions discussed apply to both the lessee and lessor. However, the lessor must meet two additional conditions for the lease to be classified as either a direct financing or sales-type 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. Performance by the lessor is substantially complete. Lessor = Owner of the property subject to the lease. 15-8 U. S. GAAP vs. IFRS Operating Leases Exercise Exercise 15-2 15-2 On On January January 1, 1, 2016, 2016, Winn Winn Heat Heat Transfer Transfer leased leased office office space space under under aa 44year year operating operating lease lease agreement. agreement. The The arrangement arrangement specified specified 44 annual annual rent rent payments payments of of $70,000 $70,000 each, each, beginning beginning January January 1, 1, 2016, 2016, and and at at each each January January 11 through through 2018. 2018. Winn Winn also also paid paid aa $112,000 $112,000 advance advance payment payment at at the the inception inception of of the the lease lease in in addition addition to to the the first first $70,000 $70,000 rent rent payment. payment. Winn Winn made made structural structural modifications modifications to to the the building building before before occupying occupying the the space space at at aa cost cost of of $200,000. $200,000. The The useful useful life life of of the the building building and and the the structural structural modifications modifications were were estimated estimated to to be be 30 30 years years with with no no residual residual value. value. Required: Prepare journal entries for Winn Heat Transfer from the inception of the lease through the end of 2016. Winn uses straight-line depreciation. 15-9 15-10 Leasehold Improvements Sometimes a lessee will make improvements to leased property that reverts back to the lessor at the end of the lease. Like other assets, leasehold improvement costs are allocated as depreciation expense over its useful life to the lessee, which is to be the shorter of the physical life of the asset or the lease term. 15-11 Operating Lease: Scheduled Rent Increases On January 1, 2016, HP Corporation signed a 5-year operating lease agreement to lease office space with payments due at December 31 of each year. Year Amount Frequency 2016 $6,000 Annual payment 2017 $10,000 Annual payment 2018 $17,000 Annual payment 2019 $22,000 Annual Required: payment 1)What is the lease expense for 2018? 2)What is the balance in Deferred Rent Expense Payable at the end of 2020 $28,000 Annual 2017? payment 3)What is the balance in Deferred Rent Expense Payable at the end of 2018? 15-12 Capital Leases – Lessee and Lessor The amount recorded (capitalized) is the present value of the minimum lease payments. However, the amount recorded cannot exceed the fair value of the leased asset. In calculating the present value of the minimum lease payments, the interest rate used by the lessee is the lower of: 1. Its incremental borrowing rate, or 2. The implicit interest rate used by the lessor. 15-13 Capital Leases – Lessee and Lessor If the lessor is not a manufacturer or dealer, the fair value of the leased asset typically is the lessor’s cost. When the lessor is a manufacturer or dealer, the fair value of the property at the inception of the lease is likely to be its normal selling price. 15-14 Capital Leases – Lessee and Lessor Depreciation Period • The lessee normally should depreciate a leased asset over the term of the lease. • If ownership transfers or a bargain purchase option is present (i.e., either of the first two classification criteria), the asset should be depreciated over its useful life. Direct Financing Leases Exercise 15-4 Edison Leasing leased high-tech electronic equipment to Manufacturers Southern on January 1, 2016. Edison purchased the equipment from International Machines at a cost of $130,266. Required: 1)Prepare a lease amortization schedule 2)Prepare entries for Edison Leasing (lessor) from the inception of the lease through January 1, 2017. 3)Prepare entries for Manufacturers Southern (lessee) from the inception of the lease through April 1, 2016 and annual depreciation 15-15 15-16 Sales-Type Leases If the lessor is a manufacturer or dealer, the fair value of the leased asset generally is higher than the cost of the asset. At At inception inception of of the the lease, lease, the the lessor lessor will will record record the the cost cost of of goods goods sold sold as as well well as as the the sales sales revenue revenue (PV (PV of of payments). payments). 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. 15-17 Sales-Type Leases Exercise 15-5: Manufacturers Southern leased high-tech electronic equipment from International Machines on January 1, 2016. International Machines manufactured the equipment at a cost of $100,000. Required: 1) Prepare appropriate entries for International Machines from January 1, 2016 through July 1, 2016 (lessor) 2) Prepare appropriate entries for Manufacturers Southern from January 1, 2016 through July 1, 2016 (lessee) 15-18 Bargain Purchase Options and Residual Value A bargain purchase option (BPO) is a provision of some lease contracts that gives the lessee the option of purchasing the leased property at a bargain price. The expectation that the option price will be paid effectively adds an additional cash flow to the lease for both the lessee and the lessor. As a result: LESSEE LESSEE adds adds the the present present value value of of the the BPO BPO price price to to the the present present value value of of periodic periodic rental rental payments payments when when computing computing the the amount amount to to be be recorded recorded aa leased leased asset asset and and aa lease lease liability. liability. LESSOR, LESSOR, when when computing computing periodic periodic rental rental payments, payments, subtracts subtracts the the present present value value of of the the BPO BPO price price from from the the amount amount to to be be recovered recovered (fair (fair value) value) to to determine determine the the amount amount that that must must be be recovered recovered from from the the lessee lessee through through the the periodic periodic rental rental payments. payments. Bargain Purchase Option (BPO) Exercise 15-18 Universal Leasing leases electronic equipment under long-term direct financing leases. Universal earns interest under these arrangements at a 12% annual rate. The company leased an electronic typesetting machine it purchased for $44,900 to a local publisher, Desktop Inc., on December 31, 2015. The lease contract specified annual payments of $9,626 beginning January 1, 2016, the inception of the lease, and each December 31 through 2017 (3-year lease term). The publisher had the option to purchase the machine on December 30, 2018, the end of the lease term, for $26,700 when it was expected to have a residual value of $30,700. Required: Prepare the appropriate entries for Universal Leasing from the inception of the lease through the end of the lease term. 15-19 15-20 Group Work: Capital Leases Exercise 15-3: Manufacturers Southern leased high-tech electronic equipment from Edison Leasing on January 1, 2016. Edison purchased the equipment from International Machines at a cost of $127,024. Required: 1)Prepare full amortization table (until end of lease) 2)Record journal entries for Manufacturers Southern (lessee) from January 1, 2016 through July 1, 2016 3)Prepare the entry for depreciation on December 31, 2016 ...
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