Chapter 21 (ACCT-311) - CHAPTER REVIEW 1 Many businesses...

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CHAPTER REVIEW 1. Many businesses lease substantial portions of the property and equipment they use in their business organization as an alternative to ownership. Because leasing provides some financial, operating, and risk advantages over ownership, it has become the fastest growing form of capital investment. This increased significance of lease arrangements in recent years has intensified the need for uniform accounting and complete informative reporting of leasing transactions. Chapter 21 presents a discussion of the accounting issues related to leasing arrangements from the point of view of both the lessee and the lessor. Among the issues discussed are: (1) the classification of leasing arrangements, (2) the various methods used in accounting for leases, and (3) the financial statement disclosure requirements when leases are present. The Leasing Environment 2. (S.O. 1) 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. In return for this right, the lessee agrees to make rental payments over the lease term to the lessor. *Note: All asterisked (*) items relate to material contained in the Appendix to the chapter. Advantages of Leasing 3. In discussing the advantages of leasing arrangements, advocates point out that leasing allows for: (a) 100% financing, (b) protection against obsolescence, (c) flexibility, (d) less costly financing, (e) tax advantages, and (f) off-balance sheet financing. 4. A variety of opinions exist regarding the manner in which certain long-term lease arrangements should be accounted for. These opinions range from total capitalization of all long-term leases to the belief that leases represent executory contracts that should not be capitalized. The FASB requires capitalization of lease arrangements that are similar to installment purchases. In short, lease arrangements that transfer substantially all of the risks and rewards of ownership of property should be capitalized by the lessee. Transfer of Ownership Criteria 5. (S.O. 2) For accounting purposes of the lessee, all leases may be classified as operating leases or capital leases. For a lease to be recorded as a capital lease, the lease must be noncancelable and meet one of the following four criteria: a. The lease transfers ownership of the property to the lessee at the end of the lease.
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b. The lease contains a bargain purchase option. c. The lease term is equal to 75% or more of the estimated economic life of the leased property. d. The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90% of the fair value of the leased property. If the lease meets none of the four criteria, the lease should be classified and accounted
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Chapter 21 (ACCT-311) - CHAPTER REVIEW 1 Many businesses...

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