Montclair State University

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Montclair State University

• Accounting 521
• Leases

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Leases
3
Leases

• A lease is a contractual arrangement by which the
  holder of the property (the lessor) permits its
  use by another party (the lessee) for a
  contracted period of time

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Advantages of Leasing

• Permits 100 financing
• Permits rapid equipment change
• Full cost write-off permitted for tax purposes
• Lease provisions more flexible than other debt
  agreements
• Leasing may not add to debt

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Growth in Use ofLeasing Contracts

• Year
• 1951
• 1960
• 1965
• 1970
• 1975
• 1980
• 1985
• 1990
• 1995
• 2000

• Percent of Companies
• Indicating Long-Term
• Leases
• 33
• 37
• 48
• 60
• 82
• 92
• 92
• 88
• 91
• 93

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Accounting for LeasesLessee
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Accounting for LeasesLessee

• Capital Lease
• Operating Lease

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Capital Lease

• Lessee records asset and liability
• Leased Equipment 100,000
• Lease Liability 100,000
• Amount equals present value of lease payments,
  excluding payments of executory costs

9
Capital Lease

• Leased Equipment 100,000
• Lease Liability 100,000
• Property Tax Expense 2,000
• Lease Liability 23,982
• Interest Expense 7,602
• Cash in Bank 33,584
• Depreciation Expense 20,000
• Accum. Depr.- Lsd Asset 20,000

10
Operating Lease

• Rent Expense 33,584
• Cash in Bank 33,584

11
Conceptual Views ofLease Accounting

• Do not capitalize any leased asset
• Capitalize all long-term leases
• Capitalize those leases similar to installment
  purchases

12
Objective of SFAS 13

• A lease that transfers substantially all of the
  benefits and risks incident to the ownership of
  property should be accounted for as the
  acquisition of an asset and the incurrence of an
  obligation by the lessee

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Capital Lease
The lease is a capital lease if one or more of
the following criteria are met

• Lease transfers ownership of property to lessee
• Lease contains a bargain purchase option

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Bargain Purchase Option

• A provision allowing lessee, at his/her option,
  to purchase the leased property for a price which
  is sufficiently lower than the expected fair
  value of the property at the date the option
  becomes exercisable that exercise of the option
  appears, at the inception of the lease, to be
  reasonably assured.

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Capital Lease
The lease is a capital lease if one or more of
the following criteria are met

• Lease transfers ownership of property to lessee
• Lease contains a bargain purchase option
• Lease term equals 75 or more of economic life of
  property

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Bargain Renewal Option

• A provision allowing the lessee, at his/her
  option, to renew the lease for a rental
  sufficiently lower than the fair rental of the
  property at the date the option becomes
  exercisable that exercise of the option appears,
  at the inception of the lease, to be reasonably
  assured.

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Capital Lease
The lease is a capital lease if one or more of
the following criteria are met

• Lease transfers ownership of property to lessee
• Lease contains a bargain purchase option
• Lease term equals 75 or more of economic life of
  property
• Present value of lease payments equals or exceeds
  90 of fair value of property

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Disclosure RequirementsOperating Leases

• Future minimum payments
• in aggregate
• for each of five succeeding years
• Rental expense for 3 years

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Disclosure RequirementsCapital Leases

• Amount of assets under capital leases
• in aggregate
• by major classes
• Amount of accumulated amortization
• Future minimum payments
• in aggregate
• for each of five succeeding years

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Disclosure RequirementsAll Leases

• General description of lessees leasing
  arrangements
• renewal options
• purchase options
• escalation clauses
• restrictions imposed by lease
• dividends
• additional debt
• further leasing

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Financial Statement Disclosureof Leases

• 1999
• Noncapitalized leases 331
• Capitalized and noncapitalized leases 215
• Capitalized lease only 12
• No leases disclosed 42
• Total companies 600

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(No Transcript)
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Sale and Leaseback

• Owner sells property and simultaneously leases it
  back from new owner
• Same capital lease/operating lease rules

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Types of Sale-LeasebackTransactions

• Minor leaseback
• seller-lessee retains only a minor interest (10
  or less) in property sold
• More than minor but less than substantial
• Substantially all
• seller-lessee retains substantially all (90 or
  more) of the ownership interest in the property
  sold

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Sale-LeasebackExample
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Sale-Leaseback Example

• 19x2
• Jan. 3 Cash in Bank 43,000,000
• Land 1,000,000
• Building 39,000,000
• Unearned Profit - Sale/Leasebk 3,000,000
• 3 Leased Land 1,000,000
• Leased Building 42,000,000
• Lease Obligation 43,000,000

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Sale-Leaseback Example
19x2 Dec. 31 Depreciation Expense Accum.
Depr. - Leased Bldg.
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42,000,000/60 years 700,000
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Sale-Leaseback Example
19x2 Dec. 31 Depreciation Expense
700,000 Accum. Depr. - Leased Bldg.
700,000
30
Sale-Leaseback Example
19x2 Dec. 31 Depreciation Expense
700,000 Accum. Depr. - Leased Bldg.
700,000 31 Unearn, Profit -
Sale/Lsebk Depreciation Expense
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3,000,000/60 years 50,000
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Sale-Leaseback Example
19x2 Dec. 31 Depreciation Expense
700,000 Accum. Depr. - Leased Bldg.
700,000 31 Unearn, Profit - Sale/Lsebk
50,000 Depreciation Expense 50,000
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Sale-Leaseback Example
19x2 Dec. 31 Depreciation Expense
700,000 Accum. Depr. - Leased Bldg.
700,000 31 Unearn, Profit - Sale/Lsebk
50,000 Depreciation Expense
50,000 31 Lease Obligation Taxes,
Insur., Maint. Exp. 350,000 Interest
Expense Cash in Bank 4,300,000
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43,000,000 x 8 3,440,000
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Sale-Leaseback Example
19x2 Dec. 31 Depreciation Expense
700,000 Accum. Depr. - Leased Bldg.
700,000 31 Unearn, Profit - Sale/Lsebk
50,000 Depreciation Expense
50,000 31 Lease Obligation Taxes,
Insur., Maint. Exp. 350,000 Interest
Expense 3,440,000 Cash in Bank
4,300,000
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Sale-Leaseback Example
19x2 Dec. 31 Depreciation Expense
700,000 Accum. Depr. - Leased Bldg.
700,000 31 Unearn, Profit - Sale/Lsebk
50,000 Depreciation Expense
50,000 31 Lease Obligation
510,000 Taxes, Insur., Maint. Exp.
350,000 Interest Expense 3,440,000
Cash in Bank 4,300,000
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Sale-Leaseback Example
19x3 Dec. 31 Depreciation Expense
700,000 Accum. Depr. - Leased Bldg.
700,000 31 Unearn, Profit - Sale/Lsebk
50,000 Depreciation Expense
50,000 31 Lease Obligation Taxes,
Insur., Maint. Exp. 350,000 Interest
Expense Cash in Bank 4,300,000
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43,000,000 - 510,000 42,490,000 x
8 3,399,200
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Sale-Leaseback Example
19x3 Dec. 31 Depreciation Expense
700,000 Accum. Depr. - Leased Bldg.
700,000 31 Unearn, Profit - Sale/Lsebk
50,000 Depreciation Expense
50,000 31 Lease Obligation
550,800 Taxes, Insur., Maint. Exp.
350,000 Interest Expense 3,399,200
Cash in Bank 4,300,000
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Sale-LeasebackSubstantially all

• When fair value of asset is less than book value,
  a loss is recognized immediately

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Sale-LeasebackMinor Leaseback

• Seller-lessee gives up most of the rights to the
  asset sold
• risks of ownership have been transferred
• transaction is a sale, not a financing
  transaction
• full gain or loss recognized

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Accounting for LeasesLessor
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Accounting for Lessors

• Lessee
• Operating
• Capital

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Accounting for Lessors

• Lessor
• Operating

• Lessee
• Operating
• Capital

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Accounting for Lessors

• Lessor
• Operating
• Direct Financing
• Sales-Type

• Lessee
• Operating
• Capital

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Accounting for LessorsDirect Financing Lease
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Direct Financing Lease

• Lessor agrees to purchase asset and lease it to
  lessee
• Normally represents financing arrangement by
  lessor
• Normally lessor not involved in direct sale of
  leased asset

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Direct Financing Lease if one or more of
following Group I requirements are met

• Lease transfers ownership of property to lessee
• Lease contains a bargain purchase option
• Lease term equals 75 or more of economic life of
  property
• Present value of lease payments equals or exceeds
  90 of fair value of property

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Direct Financing Lease and both of the
following Group II requirements are met

• Collectibility of the payments from lessee
  reasonably predictable
• No important uncertainties surround commitments
  by lessor

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Direct Financing LeaseAdditional Requirement

• The fair market value (FMV) of the leased asset
  at inception of the lease is approximately equal
  to the cost (or carrying amount) of the asset

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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 1
• 2

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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1
• 2

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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18
• 2

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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00
• 2

70,000,000 x 10 7,000,000
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00
  4,809,405.18
• 2

11,809,405.18 - 7,000,000.00 4,809,405.18
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00
  4,809,405.18 65,190,594.82
• 2

70,000,000.00 - 4,809,405.18 65,190,594.82
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12

65,190,594.82 x 10 6,519,059.48
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12

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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12

Lease Payments Receivable
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12
• (8 x 11,809,405.18) 94,475,241.44

Lease Payments Receivable
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12
• (8 x 11,809,405.18) 15,000,000
  109,475,241.44

Lease Payments Receivable 109,475,241.44
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12
• (8 x 11,809,405.18) 15,000,000
  109,475,241.44

Lease Payments Receivable 109,475,241.44 Equipmen
t
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12
• (8 x 11,809,405.18) 15,000,000
  109,475,241.44

Lease Payments Receivable 109,475,241.44 Equipmen
t 70,000,000.00
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12
• (8 x 11,809,405.18) 15,000,000
  109,475,241.44

Lease Payments Receivable 109,475,241.44 Equipmen
t 70,000,000.00 Unearned Interest Revenue -
Leases 39,475,241.44
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12
• (8 x 11,809,405.18) 15,000,000
  109,475,241.44

First Payment Cash in Bank 11,809,405.18
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12
• (8 x 11,809,405.18) 15,000,000
  109,475,241.44

First Payment Cash in Bank 11,809,405.18 Lease
Payments Receivable
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12
• (8 x 11,809,405.18) 15,000,000
  109,475,241.44

First Payment Cash in Bank 11,809,405.18 Lease
Payments Receivable 11,809,405.18
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12
• (8 x 11,809,405.18) 15,000,000
  109,475,241.44

First Payment Cash in Bank 11,809,405.18 Lease
Payments Receivable 11,809,405.18 Unearned
Interest Revenue - Leases 7,000,000.00 Interest
Revenue - Leases 7,000,000.00
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Direct Financing Lease

• Principal
• Year Payment Interest Reduction Principal
• 70,000,000.00 1 11,809,405.18 7,000,000.00 4,
  809,405.18 65,190,594.82
• 2 11,809,405.18 6,519,059.48 5,290,345.70 59,900,
  249.12
• (8 x 11,809,405.18) 15,000,000
  109,475,241.44

Second Payment Cash in Bank 11,809,405.18 Lease
Payments Receivable 11,809,405.18 Unearned
Interest Revenue - Leases 6,519,059.48 Interest
Revenue - Leases 6,519,059.48
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Accounting for LessorsSales-Type Lease
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Sales-Type Lease

• Manufacturer or dealer leases an asset that might
  otherwise be sold for a profit
• Lease must satisfy at least one of group I
  requirements and both of group II requirements

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Group I Requirements

• Lease transfers ownership of property to lessee
• Lease contains a bargain purchase option
• Lease term equals 75 or more of economic life of
  property
• Present value of lease payments equals or exceeds
  90 of fair value of property

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Group II Requirements

• Collectibility of the payments from lessee
  reasonably predictable
• No important uncertainties surround commitments
  by lessor

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Sales-Type Lease

• Manufacturer or dealer leases an asset that might
  otherwise be sold for a profit
• Lease must satisfy at least one of group I
  requirements and both of group II requirements
• Fair market value (FMV) of minimum lease payments
  plus the unguaranteed residual value is greater
  than the cost or carrying amount of leased asset

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Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1
• 2
• (20 x 40,000) 800,000

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Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2

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Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2

800,000.00 x 11 88,000.00
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Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2

79
Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2 189,101.25 76,878.86 112,222.39 586,676.36

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Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2 189,101.25 76,878.86 112,222.39 586,676.36
• (6 x 189,101.25) 1,134,607.50

Lease Payments Receivable 1,134,607.50
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Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2 189,101.25 76,878.86 112,222.39 586,676.36
• (20 x 33,500) 670,000

Lease Payments Receivable 1,134,607.50 Cost of
Goods Sold 670,000.00 Inventory 670,000.00
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Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2 189,101.25 76,878.86 112,222.39 586,676.36
• (20 x 40,000) 800,000

Lease Payments Receivable 1,134,607.50 Cost of
Goods Sold 670,000.00 Inventory 670,000.00 Sale
s 800,000.00
83
Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2 189,101.25 76,878.86 112,222.39 586,676.36

Lease Payments Receivable 1,134,607.50 Cost of
Goods Sold 670,000.00 Inventory 670,000.00 Sale
s 800,000.00 Unearned Interest Revenue -
Leases 334,607.50
84
Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2 189,101.25 76,878.86 112,222.39 586,676.36

Lease Payments Receivable 1,134,607.50 Cost of
Goods Sold 670,000.00 Inventory 670,000.00 Sale
s 800,000.00 Unearned Interest Revenue -
Leases 334,607.50
85
Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2 189,101.25 76,878.86 112,222.39 586,676.36

First Payment Cash in Bank 189,101.25 Lease
Payments Receivable 189,101.25
86
Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2 189,101.25 76,878.86 112,222.39 586,676.36

First Payment Cash in Bank 189,101.25 Lease
Payments Receivable 189,101.25 Unearned
Interest Revenue - Leases 88,000.00 Interest
Revenue - Leases 88,000.00
87
Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2 189,101.25 76,878.86 112,222.39 586,676.36

First Payment Cash in Bank 189,101.25 Lease
Payments Receivable 189,101.25 Unearned
Interest Revenue - Leases 88,000.00 Interest
Revenue - Leases 88,000.00
88
Sales-Type Lease

• Lease Pymts Unearned Net
• Year Receivable Int. Income Receivable Principal
  
• 1,134,607.50 334,607.50 800,000.00 800,000.00
• 1
• 2

First Payment Cash in Bank 189,101.25 Lease
Payments Receivable 189,101.25 Unearned
Interest Revenue - Leases 88,000.00 Interest
Revenue - Leases 88,000.00
89
Sales-Type Lease

• Lease Pymts Unearned Net
• Year Receivable Int. Income Receivable Principal
  
• 1,134,607.50 334,607.50 800,000.00 800,000.00
• 1 945,506.25 246,607.50 698,898.75 698,898.75
• 2

First Payment Cash in Bank 189,101.25 Lease
Payments Receivable 189,101.25 Unearned
Interest Revenue - Leases 88,000.00 Interest
Revenue - Leases 88,000.00
90
Sales-Type Lease

• Principal
• Year Payment Interest Reduction Principal
• 800,000.00
• 1 189,101.25 88,000.00 101,101.25 698,898.75
• 2 189,101.25 76,878.86 112,222.39 586,676.36

First Payment Cash in Bank 189,101.25 Lease
Payments Receivable 189,101.25 Unearned
Interest Revenue - Leases 76,878.86 Interest
Revenue - Leases 76,878.86
91
Sales-Type Lease

• Lease Pymts Unearned Net
• Year Receivable Int. Income Receivable Principal
  
• 1,134,607.50 334,607.50 800,000.00 800,000.00
• 1 945,506.25 246,607.50 698,898.75 698,898.75
• 2 756,405.00 169,728.64 586,676.36 586,676.36

Second Payment Cash in Bank 189,101.25 Lease
Payments Receivable 189,101.25 Unearned
Interest Revenue - Leases 76,878.86 Interest
Revenue - Leases 76,878.86
92
Operating Lease
93
Operating Lease

• None of group I requirements met and/or
• At least one of group II requirements not met

94
Operating LeaseEntry

• Cash in Bank 25,000
• Rental Income 25,000

95
Leases