Accounting for Leases

1

• Accounting for Leases
• Leases are becoming a very important way for
  businesses to acquire productive assets.
• They allow for some or all of the following
  advantages to the lessee
• High levels of financing (up to 100)
• Protection from Obsolescence
• Flexibility
• Use of tax benefits not available to lessee
• Avoidance of alternative minimum tax
• Off balance sheet financing

2
Accounting Issue The primary issue for
accountants is when, if at all, to bring the
lease on to the balance sheet. The profession
has determined that when the risks and rewards of
ownership are transferred, the lease should be
treated as a purchase. Lease payments are shown
as an obligation for lessee at their present
value, and the asset is shown as leased
property The lessor removes the asset from its
balance, recognizes a receivable, and may
recognize profit from selling the
asset. Generally the accounting is symmetric
3

• Capitalization Criteria
• Lessee capitalizes lease if one of the following
  four conditions are met
• Ownership transfers to lessee at end of lease
• The lease contains a bargain purchase option
• The life of the lease is 75 or more of life of
  asset
• The present value of the minimum lease payments
  are 90or more of the fair value of the asset
• Lessor must also meet BOTH OF the following 2
  criteria
• Collectibility of payments is reasonable
  predictable
• No important uncertainties surround the amount of
  unreimbursable costs yet to be incurred by the
  lessor (substantial performance)

4

• Important Terms
• Minimum Lease Payments
• Guaranteed vs. Unguaranteed residual
• Executory Costs
• Direct Financing Lease
• Sales Type Lease
• Operation lease
• Gross and Net investment in the lease

5
Lessee Accounting Leases are capital or
operating, based on capitalization criteria. For
capital leases, capitalize the present value of
the minimum lease payments (do not include
ungauranted residual) as leased asset and lease
obligation, depreciate asset, and amortize
obligation. At end of lease, either remove if
returned, or convert to owned asset.
6

• Direct Financing Lease
• Have if cost to lessor equals market value of
  property
• Lessor books
• Lease payments receivable for the gross
  investment in the lease (the minimum lease
  payments plus the ungaurnated residual.
• Unearned interest revenue for the difference
  between the lease payments receivable and the
  fair value of the property.
• Credits the leased asset for the fair value.
• Amortize unearned interest to interest revenue
  using effective interest. Net out the residual
  against the lease payments receivable at end of
  life, can have a gain or loss on ungauranted
  residual.

7

• Sales-Type Lease
• Have if cost to lessor is less than market value
  of property
• Lessor books
• Lease payments receivable for the gross
  investment in the lease
• Unearned interest revenue for the difference
  between the lease payments receivable and fair
  value of the property.
• Sales for the present value of the minimum lease
  payments (does not include ungauranted residual)
• Credits inventory and debits cost of goods sold
  for the cost of the asset less the present value
  of any ungauranted receivable.
• Amortizes unearned interest to interest revenue.
• May have gain/loss on ungauranted receivable at
  end of lease.