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Chapter+21+Leases+Part+I-Student - Accounting for Leases...

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Unformatted text preview: Accounting for Leases Accounting for Leases Part II Part Lessee Lessee Chapter Chapter 21 21 Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield Chapter 21-1 Adapted from slides prepared by Coby Harmon, University of California, Santa Barbara Learning Objectives Learning Objectives 9. Explain the nature, economic substance, and advantages of lease transactions. Describe the accounting criteria and procedures for capitalizing leases by the lessee. Contrast the operating and capitalization methods of recording leases. Identify the classifications of leases for the lessor. Describe the lessor’s accounting for direct­financing leases. Identify special features of lease arrangements that cause unique accounting problems. Describe the effect of residual values, guaranteed and unguaranteed, on lease accounting. Describe the lessor’s accounting for sales­type leases. List the disclosure requirements for leases. 10. Describe basic differences in U. S. GAAP and IFRS in accounting for leases. 1. 2. 3. 4. 5. 6. 7. 8. Chapter 21-2 Accounting for Leases Accounting for Leases Leasing Leasing Environment Environment Who are Who players? players? Advantages of Advantages leasing leasing Conceptual Conceptual nature of a lease nature Accounting Accounting Lessee Lessee Capitalization Capitalization criteria criteria Accounting Accounting differences differences Capital lease Capital method method Operating Operating method method Comparison by Accounting Accounting Lessor Lessor by Economics of Economics leasing leasing Classification Direct-financing Direct-financing method method Operating Operating method method Special Special Accounting Problems Problems Residual values Sales-type Sales-type leases leases Bargain Bargain purchase option purchase Initial direct costs Current versus Current noncurrent noncurrent Disclosure Likely Changes Chapter 21-3 The Leasing Environment The Leasing Environment 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. Largest group of leased equipment involves: Information technology, Transportation (trucks, aircraft, rail), Construction and Agriculture. Chapter 21-4 LO 1 Explain the nature, economic substance, and advantages of lease transactions. The Leasing Environment The Leasing Environment Who Are the Players? Three general categories: Banks Captive leasing companies Independents Chapter 21-5 LO 1 Explain the nature, economic substance, and advantages of lease transactions. The Leasing Environment The Leasing Environment Advantages of Leasing 1. 2. Protection Against Obsolescence. 3. Flexibility. 4. Less Costly Financing. 5. Tax Advantages. 6. Chapter 21-6 100% Financing at Fixed Rates. ***Off­Balance­Sheet Financing***. LO 1 Explain the nature, economic substance, and advantages of lease transactions. The Leasing Environment The Leasing Environment Conceptual Nature of a Lease A lease that transfers substantially all of the benefits and risks of property ownership is a capital lease, provided the lease is noncancelable. A lease that does not transfer substantially all the benefits and risks of ownership is an operating lease. Chapter 21-7 LO 1 Explain the nature, economic substance, and advantages of lease transactions. The Leasing Environment The Leasing Environment 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. Capital Lease-Lessee Journal Entry: Leased equipment xxx Lease liability xxx Operating Lease-Lessee Journal Entry: Rent expense Cash xxx xxx A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized (only noncancellable leases may be capitalized). Pre­Codification: Statement of Financial Accounting Standard No. 13, “Accounting for Leases,” 1980 Chapter 21-8 LO 1 Explain the nature, economic substance, and advantages of lease transactions. Accounting by the Lessee Accounting by the Lessee If the lessee capitalizes a lease, the lessee records an asset and a liability generally equal to the present value of the minimum lease payments. Records depreciation on the leased asset. Treats the lease payments as consisting of interest and principal. Chapter 21-9 LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee Accounting by the Lessee Accounting Lessee Accounting Lessee To record a lease as a capital lease, the lease must be noncancelable. One or more of four criteria must be met: 1. Transfers ownership to the lessee (at the end of the lease the lessee gets to keep it). 2. Contains a bargain purchase option (ex. buy for $1). 3. Lease term is equal to or greater than 75 percent of the estimated economic life of the leased property. 4. The present value of the minimum lease payments (excluding executory Chapter 21-10 costs) equals or exceeds 90 percent of the fair value of the leased property. Accounting by the Lessee Accounting by the Lessee Leases that DO NOT meet any of the four criteria are accounted for as Operating Leases. Lease Agreement No No No Transfer of Ownership Bargain Purchase Lease Term >= 75% of econ. life PV of Payments >= 90% of FV Y es Y es Y es Y es Capital Lease Chapter 21-11 No O p e r a t i n g L e a s e LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee Accounting by the Lessee Recovery of Investment Test (90% Test) Discount Rate Lessee computes the present value of the minimum lease payments using its incremental borrowing rate, with one exception. If the lessee knows the implicit interest rate computed by the lessor and it is less than the lessee’s incremental borrowing rate, then lessee must use the lessor’s rate. Chapter 21-12 LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee Accounting by the Lessee Recovery of Investment Test (90% Test) Minimum lease payments: Minimum rental payment Guaranteed residual value­ in the contract Penalty for failure to renew Bargain purchase option Executory Costs: Chapter 21-13 Insurance Maintenance Taxes Exclude from PV of Minimum Lease Payment calculation LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Capital Lease-Accounting by the Lessee Capital Lease-Accounting by the Lessee Asset and Liability Recorded at the lower of: 1. the present value of the minimum lease payments (excluding executory costs) or 2. the fair­market value of the leased asset. Chapter 21-14 LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Capital Lease-Accounting by the Lessee Capital Lease-Accounting by the Lessee Depreciate the Capital Asset If lease transfers ownership, depreciate asset over the economic life of the asset. If lease does not transfer ownership, depreciate over the term of the lease. Chapter 21-15 LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee Accounting by the Lessee On January 1, 2008 Kemp Corporation entered into a 4­year noncancelable contract to lease a machine from Aker Co.. The terms of the lease called for Kemp to make annual payments of $16,228 at the beginning of each year, starting January 1, 2008. The machine has an estimated useful life of 5 years. Kemp will return the machine to Aker at the end of the lease and is guaranteeing $5,000 residual value. The cost of the machine to Aker Company was $60,000. Kemp uses the straight­line method of depreciation for all of its plant assets. Kemp’s incremental borrowing rate is 12%, and the Lessor’s implicit rate is 10% (known by Kemp). Instructions (a) What type of lease is this? Capital Lease- economic life test Chapter 21-16 (b) Prepare all journal entries for Kemp through Jan. 1, 2009. Accounting by the Lessee Accounting by the Lessee What type of lease is this? Capitalization Criteria: 1. Transfer of ownership NO 2. Bargain purchase option NO 3. Lease term => 75% of economic life of leased property 4. Present value of minimum lease payments => 90% of FMV of property (annuity due) Chapter 21-17 Lease 4 years Life 5 year 80% YES PV =56,585 PV FMV= 60,000 FMV= 94.3% YES LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee Accounting by the Lessee Compute present value of the minimum lease payments. $16,228 $5,000 X 3.48685 56,585 Chapter 21-18 x .68301 3,415 $60,000 Capital Lease-Accounting by the Lessee Capital Lease-Accounting by the Lessee Journal Entries 1/1/2008 Leased Machine Under Capital Lease Leased Liability Leased 60,000 Lease Liability Cash Cash 16,228 Chapter 21-19 60,000 16,228 Accounting by the Lessee Accounting by the Lessee Date Jan. 1, 2006 Jan. 1, 2006 Jan. 1, 2007 Jan. 1, 2008 Jan. 1, 2009 Dec. 31, 2009 Chapter 21-20 Annual Lease Payment $16,228 16,228 16,228 16,228 5,000 Interest 10% 4,377 3,192 1,889 454 Reduction of Lease Lease Receivable Receivable $16,228 11,851 13,036 14,339 4,546 $60,000 $43,772 31,921 18,885 4,546 0 Capital Lease-Accounting by the Lessee Capital Lease-Accounting by the Lessee What journal entries are needed on 12/31/2008? Record Depreciation Expense Accrue interest expense Depreciation Expense 13,750 Accum. Depreciation- Cap. Leases 13,750 Accum. (60,000-5,000 / 4) Interest Expense Interest Payable Interest Chapter 21-21 4,377 4,377 Capital Lease-Accounting by the Lessee Capital Lease-Accounting by the Lessee What journal entry is needed on 1/1/2009? Lease Liability Interest Payable Cash Cash Chapter 21-22 11,851 4,377 16,228 LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Capital Lease-Accounting by the Lessee Capital Lease-Accounting by the Lessee Chapter 21-23 What entries are needed in future years? Continue the same entries for each year: depreciation, interest, Continue and payments and LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Capital Lease-Accounting by the Lessee Capital Lease-Accounting by the Lessee What entry should be made when the machine is returned to What Aker? Aker? Interest Expense 454 Lease Liability 4,546 Accum. Depreciation- CapLs. 55,000 Lease Machine Under Cap. Lease 60,000 Lease Chapter 21-24 LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Capital Lease-Accounting by the Lessee Capital Lease-Accounting by the Lessee What if the FV of the machine is only $4,000 at the time it is What returned to Aker? returned Interest Exepnse 454 Lease Liability 4,546 Accum. Depr.- Cap. Lease 55,000 Loss on Cap. Lease 1,000 Lease Machine under Cap. Ls 60,000 Lease Cash 1,000 Chapter 21-25 LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee Accounting by the Lessee Accounting Accounting Change Assumptions Change Assumptions Change Change Now Now assume that the lease did not meet any of the criteria for a capital lease. of How How should the company account for the lease? Operating Lease! lease? Chapter 21-26 perating Lease Entries perating Lease Entries When payments are made: Rent Expense 16,228 Cash 16,228 No asset is recorded. No liability is recorded. No depreciation is recorded. Chapter 21-27 ...
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