Accounting for Leases Part 5

Chapter 15 - Leases Exercise 15-21 Requirement 1 January 1 Cash................................................................................ Unearned rent revenue*.............................................. Deferred initial direct cost.............................................. Cash............................................................................ December 31 Unearned rent revenue.................................................... Rent revenue*............................................................. 20,873 20,873 2,062 2,062 20,873 20,873 Lease expense ($2,062 ÷ 3 years)....................................... Deferred initial direct cost.......................................... 687 Depreciation expense ($100,000 ÷ 6 years)........................ Accumulated depreciation.......................................... 16,667 * 687 16,667 Alternatively, Rent revenue. Either way, an adjusting entry is needed at the end of the reporting period to assure that the earned portion of the payment is recorded in Rent revenue and the unearned portion in Unearned rent revenue Requirement 2 January 1 Proof that new effective rate is 9% (not required): $102,062 ÷ 4.88965** = $20,873 lessor’s lease net investment payments ** present value of an annuity due of $1: n=6, i=9% Exercise 15-21 (concluded) January 1 Lease receivable (fair value / present value)........................ 100,000 Chapter 15 - Leases Inventory of equipment (lessor’s cost)........................... 100,000 Lease receivable.............................................................. Cash (initial direct costs)................................................. 2,062 Cash (lease payment).......................................................... Lease receivable.......................................................... 20,873 2,062 20,873 December 31 Interest receivable........................................................... Interest revenue (9% x [$100,000 + 2,062 – 20,873])........ 7,307 Requirement 3 January 1 Lease receivable (fair value / present value)........................ Cost of goods sold (lessor’s cost)...................................... Sales revenue (fair value / present value)......................... Inventory of equipment (lessor’s cost)........................... 100,000 85,000 7,307 100,000 85,000 Selling expense............................................................... Cash (initial direct costs)................................................. 2,062 Cash (lease payment).......................................................... Lease receivable.......................................................... 20,873 December 31 Interest receivable........................................................... Interest revenue (10% x [$100,000 – 20,873])................. 2,062 20,873 7,913 7,913 Exercise 15-22 January 1, 2011, 2012, 2013 Cash................................................................................ Rent revenue............................................................... Deferred initial direct cost.............................................. Cash............................................................................ 137,000 137,000 2,400 2,400 Chapter 15 - Leases December 31, 2011, 2012, 2013 Lease expense ($2,400 ÷ 3 years)....................................... Deferred initial direct cost.......................................... Depreciation expense ($800,000 ÷ 8 years)........................ Accumulated depreciation.......................................... 800 800 100,000 100,000 Exercise 15-23 1. January 1, 2011 Lease receivable (fair value / present value)........................ Inventory of equipment (lessor’s cost)........................... 500,000 500,000 Lease receivable.............................................................. Cash (initial direct costs)................................................. 4,242 Cash (lease payment).......................................................... Lease receivable.......................................................... 184,330 4,242 184,330 2. Effective rate of interest revenue: The initial direct costs increase the net investment: $500,000 + $4,242. The new effective rate is the discount rate that equates the net investment and the future lease payments: $504,242 ÷ ? ** = $184,330 lessor’s lease net investment payments ** present value of an annuity due of $1: n=3, i= ?% Rearranging algebraically: $504,242 ÷ $184,330= 2.73554. When you consult the present value table for an annuity due, you search row 3 (n=3) for this value and find it in the 10% column. So the effective interest rate is 10%. The net investment is amortized at the new rate. 3. December 31, 2011 Interest receivable........................................................... Interest revenue (10% x [$500,000 + 4,242 – 184,330]).... 31,991 31,991 Chapter 15 - Leases Exercise 15-24Requirement 1 Inception of the Lease, January 1, 2011 Lease receivable (fair value)............................................. Cost of goods sold (lessor’s cost)...................................... Sales revenue (fair value).............................................. Inventory of equipment (lessor’s cost)........................... 300,000 265,000 300,000 265,000 Selling expense............................................................... Cash (initial direct costs)................................................. 7,500 Cash (lease payment).......................................................... Lease receivable.......................................................... 69,571 7,500 69,571 Requirement 2 December 31, 2011 Interest receivable........................................................... Interest revenue (8% x [$300,000 – 69,571).................... 18,434 18,434 Chapter 15 - Leases Exercise 15-25 List A List B j_ 1. Effective rate times balance. a. PV of BPO price. k_ 2. Realization principle. b. Lessor’s net investment. c_ 3. Minimum lease payments plus c. Lessor’s gross investment. unguaranteed residual value. d. Operating lease. l_ 4. Periodic lease payments plus e. Depreciable assets. lessee-guaranteed residual value. f. Loss to lessee. b_ 5. PV of minimum lease payments plus g. Executory costs. PV of unguaranteed residual value. h. Depreciation longer than lease term. n_ 6. Initial direct costs. i. Disclosure only. d_ 7. Rent revenue. j. Interest expense. m_8. Bargain purchase option. k. Additional lessor conditions. e_ 9. Leasehold improvements. l. Lessee’s minimum lease payments f_10. Cash to satisfy residual value m. Purchase price less than fair guarantee. value. g_11. Capital lease expense. n. Sales-type lease selling expense. a_12. Deducted in lessor’s computation o. Lessor’s minimum lease payments. of lease payments. h_13. Title transfers to lessee. i_14. Contingent rentals. o_15. Lease payments plus lessee-guaranteed and 3rd-party-guaranteed residual value. Chapter 15 - Leases Exercise 15-26 Requirement 1 Present value of periodic lease payments* ($102,771 x 7.49236**) $770,000* * rounded ** present value of an annuity due of $1: n=13, i=11% The lease meets at least one (actually 3 of 4 in this case) criteria for classification as a capital lease. January 1, 2011 Cash (given)...................................................................... Airplanes (carrying value).............................................. Deferred gain on sale-leaseback (difference)................ 770,000 620,000 150,000 Leased airplane (present value of lease payments)................... Lease payable (present value of lease payments)............... 770,000 Lease payable ................................................................. Cash............................................................................ 102,771 770,000 102,771 Requirement 2 December 31, 2011 Interest expense (11% x [$770,000 – 102,771])....................... Interest payable .......................................................... 73,395 73,395 Depreciation expense ($770,000 ÷ 15 years*)..................... Accumulated depreciation.......................................... 51,333 Deferred gain on sale-leaseback ($150,000 ÷ 15 years)....... Depreciation expense ................................................. 10,000 51,333 * The airplane is depreciated over its remaining useful life rather than the lease term because title transfers to the lessee. 10,000 Chapter 15 - Leases Exercise 15-27 When the leaseback is a finance (capital) lease, the gain is recognized over the useful life of the asset under U.S. GAAP as shown in the previous exercise. But, under IAS No. 17, the gain is recognized over the lease term as shown below (13 years rather than 15 years). Present value of periodic lease payments* ($102,771 x 7.49236**) $770,000* * rounded ** present value of an annuity due of $1: n=13, i=11% The lease meets at least one (actually 3 of 4 in this case) criteria for classification as a capital lease. January 1, 2011 Cash (given)...................................................................... Airplanes (carrying value).............................................. Deferred gain on sale-leaseback (difference)................ 770,000 620,000 150,000 Leased airplane (present value of lease payments)................... Lease payable (present value of lease payments)............... 770,000 Lease payable ................................................................. Cash............................................................................ 102,771 December 31, 2011 Interest expense (11% x [$770,000 – 102,771])....................... Interest payable .......................................................... 770,000 102,771 73,395 73,395 Depreciation expense ($770,000 ÷ 15 years*)..................... Accumulated depreciation.......................................... 51,333 Deferred gain on sale-leaseback ($150,000 ÷ 13 years).... Depreciation expense ................................................. 11,538 51,333 * The airplane is depreciated over its remaining useful life rather than the lease term because title transfers to the lessee. 11,538 Chapter 15 - Leases Requirement 1 Exercise 15-28 January 1, 2011 Cash (given)...................................................................... Accumulated depreciation (cost – carrying amount)........... Building (original cost).................................................. Deferred gain on sale-leaseback (difference)................ 800,000 350,000 1,000,000 150,000 Requirement 2 December 31, 2011 Rent expense.............................................................................. Cash (lease payment)...................................................... Deferred gain on sale-leaseback ($150,000 ÷ 12 years)....... Rent expense .............................................................. 100,000 100,000 12,500 12,500 When the leaseback is an operating lease, the gain is amortized over the lease term under U.S. GAAP. But, under IAS No. 17, the gain is recognized immediately: Exercise 15-29 January 1, 2011 Cash (given)...................................................................... Accumulated depreciation (cost – carrying amount)........... Building (original cost).................................................. Gain on sale-leaseback (difference).............................. December 31, 2011 Rent expense.............................................................................. Cash (lease payment)...................................................... 800,000 350,000 1,000,000 150,000 100,000 100,000 Chapter 15 - Leases Requirement 1 E x e r c i s e 1 5 3 0 The specific citation that specifies the disclosure requirements pertaining to a sellerlessee in a sale-leaseback transaction is FASB ACS 840–40–50–1: “Leases–SalesLeaseback Transactions–Disclosure.” Requirement 2 The financial statements of a seller-lessee should include a description of the terms of the sale-leaseback transaction, including future commitments, obligations, provisions, or circumstances that require or result in the seller-lessee's continuing involvement. FASB ACS 840–40–50–2 also indicates that the lessee should disclose a general description of its leasing arrangements including, but not limited to, the basis on which contingent rental payments are determined, terms of renewal or purchase options and escalation clauses, and restrictions imposed by lease agreements. Chapter 15 - Leases Exercise 15-31 Note: Because exercise of the option appears at the inception of the lease to be reasonably assured, payment of the option price ($100,000) is expected to occur when the option becomes exercisable (at the end of the 10th year). When the leased property includes both land and a building and the lease is expected to transfer ownership by exercise of a BPO, the lessee should record each leased asset separately. The present value of the minimum lease payments is allocated between the leased land and leased building accounts on the basis of their relative fair values. Present value of lease payments ($200,000 x 6.75902**) Plus: Present value of the BPO price ($100,000 x .38554*) Present value of minimum lease payments * present value of $1: n=10, i=10% ** present value of an annuity due of $1: n=10, i=10% $1,351,804 38,554 $1,390,358 Chapter 15 - Leases January 1, 2011 Leased land (fair value)..................................................... Leased building ($1,390,358 – 400,000)............................. Lease liability (calculated above)................................... Lease liability.................................................................. Cash (annual lease payment)........................................... December 31, 2011 Depreciation expense ([$990,358 – 150,000] ÷ 20 years)...... Accumulated depreciation – leased building.............. Interest expense ([$1,390,358 – 200,000] x 10%).................... Interest payable .......................................................... 400,000 990,358 1,390,358 200,000 200,000 42,018 42,018 119,036 119,036 Exercise 15-32 The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is: 1. Definition of a bargain purchase option: FASB ACS 840–10–20: “Leases–Overall–Glossary.” Also found in Master Glossary. 2. Lessor’s gross investment in a sales-type lease: FASB ACS 840–30–30–6: “Leases–Capital Leases–Initial Measurement–Gross Investment in a Sales-Type Lease or Direct Financing Lease–Gross Investment in a Sales-Type Lease or Direct Financing Lease. 3. The disclosures required in the notes to the financial statements for an operating lease. FASB ACS 840–20–50: “Leases–Operating Leases–Disclosure.” FASB ASC 840–20–50–1: "Leases–Operating Leases–Disclosure–Lessees" Chapter 15 - Leases 4. The additional disclosures necessary in the notes to the financial statements if the operating lease has a lease term greater than one year. FASB ASC 840–20–50–2: "Leases–Operating Leases–Disclosure–Lessee”