Financial Accounting 3 Module 5 Leases

Theoretical foundation Substance of a lease Lease capitalization Leasing vs. Owning Minimum lease payments Periodic payments and Guaranteed residual value Bargain purchase option Failure to renew penalty

Lessee Financing Lease Decision 1 Operating Lease

Capital if any of the following; Title of asset will transfer at end of lease Lease term is at least 75% of asset’s economic life Present value of the minimum lease payments is at least 90% of the fair market value of the leased asset The nature of the asset.

Lessee accounting Operating lease Record lease payments as an expense; DR lease expense CR cash In the case of uneven payments, a liability or asset needs to recorded.

Lessee accounting con’t Financing lease Capitalize the asset (max. is FMV) Record lease liability at PV of MLP Amortize over the period of time that the lessee will have use of the asset

Lessee accounting con’t Interest expense; DR interest expense CR lease liability Lease payment; DR lease liability CR cash Amortize the asset over the term of use

Lessee accounting con’t Interest expense; DR interest expense CR lease liability Lease payment; DR lease liability CR cash Both DR lease liability DR interest expense CR cash

Cash flow Operating lease – Financing lease – operating section, part of net income. Make sure to adjust for non-cash expenses. (forgiven first payments) Financing lease – financing section - cash payment amount for the change in lease liability operating section – cash payment for interest expense, add back the non-cash amortization expense

Disclosures The next five years of lease payments. The interest portion of these payments. The interest rate

Direct financing lease Lessor Direct financing lease Capital lease Decision 2 Sales-type lease Decision 1 Operating lease

Lessor Accounting Decision 1 – capital if Any of the following Title passes 75% of life PV of MLP’s is 90% of FMV And both of the following Collectibility is assured No significant unestimable, unreimbursable costs

Lessor accounting con’t Decision 2 Sales-type lease Lessor buys or manufactures asset to “sell” for a profit Reports a gross profit (sale less cost of goods sold) at time of sell and financing revenue over the life of the lease Direct financing – financing company, asset delivered directly to lessee, reports finance revenue only over the life of the lease