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Lecture18 2010.11.16 PreClass

Lecture18 2010.11.16 PreClass - Lecture 18 Accounting for...

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Lecture 18 Accounting for Leases
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Announcements HW #3 deadline (11/24 Wednesday 9am) – Covers material in today’s lecture Exam #2 available for pick up during TA office hours No class next Wednesday No office hours next week • Recitation: – P10-10, AP10-7, CP10-1, CP10-4
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Goals of Today’s Class What is a lease? Criteria for Capital Leases Criteria for Operating Leases Example for Operating Lease Example for Capital Lease Disclosures for Safeway
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Leases LEASE : The owner (or lessor ) of property or equipment permits another party (or lessee) to use property for a specified period of time in exchange for periodic cash payments. ACCOUNTING FOR LEASES - CONCEPTS : A lease is an executory contract or an exchange of promises. Generally Accepted Accounting Principles (GAAP) recognize an asset or liability only when an exchange or transaction takes place. The signing of a lease is not a transaction per se . That is, the signing of the lease contract usually is accompanied by the transfer of the asset to the lessee, it does not provide for the transfer of ownership of the asset. Moreover, by itself, it does not impose an obligation on the lessee. The lessee’s obligation arises from having access to the leased assets in accordance with the terms of the lease contract. However, in certain cases, the conditions for a transaction are assumed to be met when the economic effect of the lease agreement is substantively equivalent to the purchase/sale of the asset financed by a mortgage-type obligation.
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Leases There are two different methods which may be used to account for a lease. The choice between them depends on the features of the lease contract: 1) Capital Lease method -- the lease is accounted for as a purchase (sale)-financing transaction. 2) Operating Lease method -- the lease is accounted for as an executory contract. (i.e. as a rental contract which imposes no reportable liability on the firm until the "rented" assets are used).
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Criteria for a Capital Lease If the lease is non-cancelable and any one of the following criteria are met, a lease is accounted for as a capital lease : 1) Ownership of the asset is transferred to the lessee at the end of the lease term. 2) A "bargain purchase" option exists . A bargain purchase option exists if the lessee can purchase the asset for a price that seems sufficiently less than the estimated fair market value on the exercise date that the option is likely to be exercised. 3) The lease term is equal to or greater than 75% of the estimated useful life of the asset. 4) At the inception of the lease (e.g., signing date), the present value of the minimum lease payments is equal to or greater than 90% of the estimated fair market value of the equipment.
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