Chapter 21-1 Accounting for Leases Chapter21 Intermediate Accounting 12th Edition Kieso, Weygandt, and Warfield Prepared by Coby Harmon, University of.

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  • Slide 1
  • Chapter 21-1 Accounting for Leases Chapter21 Intermediate Accounting 12th Edition Kieso, Weygandt, and Warfield Prepared by Coby Harmon, University of California, Santa Barbara
  • Slide 2
  • Chapter 21-2 1. 1.Explain the nature, economic substance, and advantages of lease transactions. 2. 2.Describe the accounting criteria and procedures for capitalizing leases by the lessee. 3. 3.Contrast the operating and capitalization methods of recording leases. 4. 4.Identify the classifications of leases for the lessor. 5. 5.Describe the lessors accounting for direct-financing leases. 6. 6.Identify special features of lease arrangements that cause unique accounting problems. 7. 7.Describe the effect of residual values, guaranteed and unguaranteed, on lease accounting. 8. 8.Describe the lessors accounting for sales-type leases. 9. 9.List the disclosure requirements for leases. Learning Objectives
  • Slide 3
  • Chapter 21-3 Leasing Environment Who are players? Advantages of leasing Conceptual nature of a lease Accounting by Lessee Accounting by Lessor Special Accounting Problems Capitalization criteria Accounting differences Capital lease method Operating method Comparison Residual values Sales-type leases Bargain purchase option Initial direct costs Current versus noncurrent Disclosure Unsolved problems Economics of leasing Classification Direct-financing method Operating method Accounting for Leases
  • Slide 4
  • Chapter 21-4 Largest group of leased equipment involves: Information technology, Transportation (trucks, aircraft, rail), Construction and Agriculture. LO 1 Explain the nature, economic substance, and advantages of lease transactions. 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. The Leasing Environment
  • Slide 5
  • Chapter 21-5 Three general categories: Banks. Captive leasing companies. Independents. LO 1 Explain the nature, economic substance, and advantages of lease transactions. Who Are the Players? The Leasing Environment
  • Slide 6
  • Chapter 21-6 1. 1. 100% Financing at Fixed Rates. 2. 2. Protection Against Obsolescence. 3. 3. Flexibility. 4. 4. Less Costly Financing. 5. 5. Tax Advantages. 6. 6. Off-Balance-Sheet Financing. The Leasing Environment LO 1 Explain the nature, economic substance, and advantages of lease transactions. Advantages of Leasing
  • Slide 7
  • Chapter 21-7 Capitalize a lease that transfers substantially all of the benefits and risks of property ownership, provided the lease is noncancelable. Leases that do not transfer substantially all the benefits and risks of ownership are operating leases. The Leasing Environment LO 1 Explain the nature, economic substance, and advantages of lease transactions. Conceptual Nature of a Lease
  • Slide 8
  • Chapter 21-8 Operating Lease Capital Lease Journal Entry: Rent expense xxx Rent expense xxx Cash xxx Cash xxx Journal Entry: Leased equipment xxx Leased equipment xxx Lease obligation xxx Lease obligation xxx 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. Statement of Financial Accounting Standard No. 13, Accounting for Leases, 1980 A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized (only noncancellable leases may be capitalized). The Leasing Environment LO 1 Explain the nature, economic substance, and advantages of lease transactions.
  • Slide 9
  • Chapter 21-9 If the lessee capitalizes a lease, the lessee records an asset and a liability generally equal to the present value of the rental payments. Records depreciation on the leased asset. Treats the lease payments as consisting of interest and principal. Accounting by the Lessee LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee.
  • Slide 10
  • Chapter 21-10 To record a lease as a capital lease, the lease must be noncancelable. One or more of four criteria must be met: 1. 1. Transfers ownership to the lessee. 2. 2. Contains a bargain purchase option. 3. 3. Lease term is equal to or greater than 75 percent of the estimated economic life of the leased property. 4. 4. The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90 percent of the fair value of the leased property. Accounting by the Lessee LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee.
  • Slide 11
  • Chapter 21-11 LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Transfer of Ownership Bargain Purchase Lease Term >= 75% PV of Payments >= 90% OperatingLeaseOperatingLease NoNoNo No Yes Capital Lease Lease Agreement Yes Leases that DO NOT meet any of the four criteria are accounted for as Operating Leases. Accounting by the Lessee
  • Slide 12
  • Chapter 21-12 Recovery of Investment Test (90% Test) LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee 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 lessees incremental borrowing rate, then lessee must use the lessors rate.
  • Slide 13
  • Chapter 21-13 Recovery of Investment Test (90% Test) LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee Minimum lease payments: Minimum rental payment Guaranteed residual value Penalty for failure to renew Bargain purchase option Executory Costs: Insurance Maintenance Taxes Exclude from PV of Minimum Lease Payment calculation
  • Slide 14
  • Chapter 21-14 Asset and Liability Recorded at the lower of: 1. 1. the present value of the minimum lease payments (excluding executory costs) or 2. 2. the fair-market value of the leased asset. Asset and Liability Accounted for Differently LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee
  • Slide 15
  • Chapter 21-15 Asset and Liability Accounted for Differently LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee Depreciation Period 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.
  • Slide 16
  • Chapter 21-16 E21-1 (Capital Lease with Unguaranteed Residual Value) On January 1, 2007, Burke Corporation signed a 5-year noncancelable lease for a machine. The terms of the lease called for Burke to make annual payments of $8,668 at the beginning of each year, starting January 1, 2007. The machine has an estimated useful life of 6 years and a $5,000 unguaranteed residual value. Burke uses the straight-line method of depreciation for all of its plant assets. Burkes incremental borrowing rate is 10%, and the Lessors implicit rate is unknown. LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee Instructions (a) What type of lease is this? Explain. (b) Compute the present value of the minimum lease payments. (c) Prepare all journal entries for Burke through Jan. 1, 2008.
  • Slide 17
  • Chapter 21-17 E21-1 What type of lease is this? Explain. LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee Capitalization Criteria: 1. Transfer of ownership 2. Bargain purchase option 3. Lease term => 75% of economic life of leased property 4. Present value of minimum lease payments => 90% of FMV of property NO NO Lease term 5 yrs. Economic life6 yrs. YES 83.3% FMV of leased property is unknown. Capital Lease, #3
  • Slide 18
  • Chapter 21-18 E21-1 Compute present value of the minimum lease payments. LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee Payment $ 8,668 Present value factor (i=10%,n=5) 4.16986 PV of minimum lease payments $36,144
  • Slide 19
  • Chapter 21-19 E21-1 Lease Amortization Schedule LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee
  • Slide 20
  • Chapter 21-20 E21-1 Journal entries for Burke through Jan. 1, 2008. LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee
  • Slide 21
  • Chapter 21-21 E21-1 Journal entries for Burke through Jan. 1, 2008. LO 2 Describe the accounting criteria and procedures for capitalizing leases by the lessee. Accounting by the Lessee
  • Slide 22
  • Chapter 21-22 E21-1 Comparison of Capital Lease with Operating Lease LO 3 Contrast the operating and capitalization methods of recording leases. Accounting by the Lessee * * rounding *
  • Slide 23
  • Chapter 21-23 1. 1. Interest Revenue. 2. 2. Tax Incentives. 3. 3. High Residual Value. Accounting by the Lessor Benefits to the Lessor LO 4 Identify the classifications of leases for the lessor.
  • Slide 24
  • Chapter 21-24 A lessor determines the amount of the rental, based on the rate of return needed to justify leasing the asset. If a residual value is involved (whether guaranteed or not), the company would not have to recover as much from the lease payments Economics of Leasing Accounting by the Lessor LO 4 Identify the classifications of leases for the lessor.
  • Slide 25
  • Chapter 21-25 E21-10 (Computation of Rental) Morgan Leasing Company signs an agreement on January 1, 2007, to lease equipment to Cole Company. The following information relates to this agreement. 1. 1.The term of the noncancelable lease is 6 years with no renewal option. The equipment has an estimated economic life of 6 years. 2. 2.The cost of the asset to the lessor is $245,000. The fair value of the asset at January 1, 2007, is $245,000. 3. 3.The asset will revert to the lessor at the end of the lease term at which time the asset is expected to have a residual value of $43,622, none of which is guaranteed. 4. 4.The agreement requires annual rental payments, beg. Jan. 1, 2007. 5. 5.Collectibility of the lease payments is reasonably predictable. There are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. Accounting by the Lessor LO 4 Identify the classifications of leases for the lessor.
  • Slide 26
  • Chapter 21-26 Accounting by the Lessor LO 4 Identify the classifications of leases for the lessor. E21-10 (Computation of Rental) Assuming the lessor desires a 10% rate of return on its investment, calculate the amount of the annual rental payment required. x -
  • Slide 27
  • Chapter 21-27 a. a.Operating leases. b. b.Direct-financing leases. c. c.Sales-type leases. Classification of Leases by the Lessor Accounting by the Lessor LO 4 Identify the classifications of leases for the lessor.
  • Slide 28
  • Chapter 21-28 Classification of Leases by the Lessor Accounting by the Lessor LO 4 Identify the classifications of leases for the lessor. A sales-type lease involves a manufacturers or dealers profit, and a direct-financing lease does not. Illustration 21-11
  • Slide 29
  • Chapter 21-29 Classification of Leases by the Lessor Accounting by the Lessor LO 4 Identify the classifications of leases for the lessor. A lessor may classify a lease as an operating lease but the lessee may classify the same lease as a capital lease. Illustration 21-12
  • Slide 30
  • Chapter 21-30 In substance the financing of an asset purchase by the lessee. Direct-Financing Method (Lessor) Accounting by the Lessor LO 5 Describe the lessors accounting for direct-financing leases.
  • Slide 31
  • Chapter 21-31 Accounting by the Lessor E21-10 Prepare an amortization schedule that would be suitable for the lessor. * * rounding * LO 5 Describe the lessors accounting for direct-financing leases.
  • Slide 32
  • Chapter 21-32 Accounting by the Lessor E21-10 Prepare all of the journal entries for the lessor for 2007 and 2008. LO 5 Describe the lessors accounting for direct-financing leases.
  • Slide 33
  • Chapter 21-33 Accounting by the Lessor E21-10 Prepare all of the journal entries for the lessor for 2007 and 2008. LO 5 Describe the lessors accounting for direct-financing leases.
  • Slide 34
  • Chapter 21-34 Records each rental receipt as rental revenue. Depreciates the leased asset in the normal manner. Operating Method (Lessor) Accounting by the Lessor LO 5 Describe the lessors accounting for direct-financing leases.
  • Slide 35
  • Chapter 21-35 1. 1.Residual values. 2. 2.Sales-type leases (lessor). 3. 3.Bargain purchase options. 4. 4.Initial direct costs. 5. 5.Current versus noncurrent classification. 6. 6.Disclosure. Special Accounting Problems LO 6 Identify special features of lease arrangements that cause unique accounting problems.
  • Slide 36
  • Chapter 21-36 Lessee Accounting for Residual Value The accounting consequence is that the minimum lease payments, include the guaranteed residual value but excludes the unguaranteed residual value. Illustration: See previous E21-1 (Capital Lease with Unguaranteed Residual Value) Residual Values Special Accounting Problems LO 7 Describe the effect of residual values, guaranteed and unguaranteed, on lease accounting.
  • Slide 37
  • Chapter 21-37 Illustration (LESSEE and LESSOR Computations and Entries) On Jan. 1, 2007, Velde Company (lessee entered into a four-year, noncancellable contact to lease a computer for Exceptional Computer Company (lessor). Annual rentals of $16,228 are to be paid each Jan. 1. The cost of the computer to Exceptional Computer Company was $60,000 and has an estimated useful life of four years and a $5,000 residual value. Velde has guaranteed the lessor a residual value of $5,000. Velde has an incremental borrowing rate of 12% but has knowledge that Exceptional computer Company used a rate of 10% in setting annual rentals. Collection of the rentals is reasonably predictable and there are no important uncertainties regarding future unreimbursable costs to be incurred by the lessor. Special Accounting Problems LO 7 Describe the effect of residual values, guaranteed and unguaranteed, on lease accounting.
  • Slide 38
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