ACC327_CH21_Notes

ACC327_CH21_Notes - Chapter 21 1. Accounting for Leases A...

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Chapter 21 Accounting for Leases 1. A lease is a contract 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. A. A key concept is that the lease conveys less than total interest in the property (i.e., the lessor typically still legally owns the property). The lessor owns the property. The lessee uses the property for a fee. 2. Because leasing offers several advantages over outright ownership of an asset, it has become the fastest growing form of capital investment. Some of these advantages to the lessee are A. Less capital outlay upfront (i.e., easier to finance) B. Protection against obsolescence (e.g., leasing computers) C. Tax advantage for leasing land 1. If land is owned, no tax deduction is allowed for depreciation; however, if land is leased, lease payments are tax deductible. D. Off-balance sheet financing may occur 1. An asset is acquired yet the liability for its acquisition may not be recorded under certain conditions. 3. Leases that transfer substantially all of the rights and risks of ownership should be capitalized by lessees. For a lessee, a lease is considered a capital lease if any one of the following four criteria is met: A. The lease transfers title of the property by the end of the lease.
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B. The lease contains a bargain purchase option (BPO). C. The lease term is > 75% of the asset's expected useful life. D. The present value of the minimum lease payments (MLPs), excluding executory costs, is > 90% of the asset's fair market value. 1. The last two criteria do not apply if the lease term begins in the final 25% of the asset’s life. 4. Capital leases for lessees. A. Under a capital lease, the lessee treats the lease transaction as if the asset is purchased. 1. The lessee records an asset and a liability usually for the present value of the MLPs (but the asset may not be recorded above its FMV). B. In determining the present value of MLPs, three concepts must be considered. 1. What to include in MLPs? MLPs include the following: a. minimum rental payments - which are simply the minimum payments the lessee is obligated to make. b. any guaranteed residual value (GRV) - a GRV means the lessee guarantees that the asset will have a certain value when it
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reverts to the lessor. Any deficiency at the end of the lease must be made up by the lessee. c. any bargain purchase option (BPO) - a BPO is an option to buy the asset at the end of the lease term at a price markedly below the asset's expected FMV. d. any penalty for failure to renew – the amount the lessee must pay if it fails to renew the lease if the agreement specifies it must be renewed. 2. Who is making payments for executory costs (i.e., cost of insur- ance, maintenance, taxes etc.)? a. If lessor makes payments for executory costs, lessee must
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This note was uploaded on 04/10/2011 for the course ACC 327 taught by Professor Sign during the Spring '11 term at S. Alabama.

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ACC327_CH21_Notes - Chapter 21 1. Accounting for Leases A...

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