University:
California State University, Northridge
Course:
ACCT 350 | Intermediate Financial Accounting I
Academic year:

2024
Views:

498

Pages:

17
Author:

candyhaddington

Leases Chapter 15 Part 1 Intermediate Accounting Lease Lease- a contract specifying the terms under which the owner of an asset agrees to transfer the right to use the asset to another party. Parties Involved in a Lease • Lesse- the party granted the right to use the property under the terms of a lease. • Lessor- The owner of the property that is rented (leased) to another party. Economic Advantages to Leasing 1. No down payment. 2. Avoid risks of ownership. 3. Flexibility. Advantages to the Lessor • Increased sales. • Ongoing business relationship with lessee. • Residual value retained. Simple Example Owner Company owns a piece of equipment with a market value of $10,000. User Company wishes to acquire the equipment for use in its operations. Simple Example One option for User Company is to purchase the equipment from Owner by borrowing $10,000 from a bank at an interest rate of 10%. Owner would repay the principal and interest by making five annual payments of $2,638. Simple Example Alternatively, User Company can lease the asset from Owner Company for five years, making annual “rental” payments of $2,638. Buy $2,638 annually Lease $2,638 annually Simple Example • The key accounting issues for Owner Company: 1. Has effective ownership passed? 2. Does Owner Company have any significant responsibility remaining? 3. Is Owner Company reasonable certain that they five annual payments can be collected? • The key accounting issue for User Company: • Should User recognize the leased equipment as an asset and a liability to make the lease payments? Simple Example Scenario One The lease agreement stipulates that Owner Company is to maintain legal title to the equipment for the 5-year lease period, but title is to pass to User at the end of the lease. Even though this is a leasing arrangement, the transfer of title at the end indicates that this is in substance a purchase. Simple Example Scenario Two The lease agreement stipulates that Owner Company is to maintain legal title to the equipment for the 5-year lease period, but at the end of the lease period User has the option to buy the equipment for $1. Offering the equipment to User Company for a bargain price at the end of the lease indicates that this is in substance a purchase. Simple Example Scenario Three The useful life of the equipment is just five years. Accordingly, when the lease term is over, the equipment can no longer be used by anyone else. Because the life of this asset and the lease term are the same, this arrangement is in substance a purchase. Simple Example Scenario Four The present value of the lease payments equals the $10,000 market value of the equipment on the lease signing date. Because the life of this asset and the lease term are the same, this arrangement is in substance a purchase. Different Lease Types • Capital leases are accounted for as if the lease agreement transfers ownership of the asset from the lessor to the lessee. • Operating leases are accounted for as rental agreements, with no transfer of effective ownership associated with the lease Nature of Leases Cancellation Provision Bargain Purchase Option Specifies under what circumstances the lease may be canceled. Grants lessee the right to purchase the asset at the end of the lease term for less than the residual value. Lease Term Delineates the time period the lease is to be in force. Residual Value Market value of leased asset at end of lease term. Minimum Lease Payment Rental payment required over lease term plus any payment for residual value. Lease Classification Criteria A lease is classified as a capital lease by the lessee if it is non-cancelable and meets any one of the following criteria: 1. The lease transfers ownership of the leased asset to the lessee by the end of the lease term. 2. The lease contains an option allowing the lessee to purchase the asset at the end of the lease term at a bargain price. 3. The lease term is equal to 75% or more of the estimated economic life of the asset. 4. The present value of the lease payments at the beginning of the lease is 90% or more of the fair market value of the leased asset. Lease Classification Criteria Yes Transfer of Ownership? No Yes Bargain Purchase Option? No Yes Yes Capital Lease Term >75% of Useful Life? No PV Payment >90% of FMV? No Operating Lease