· 1 CORPORATE FINANCIAL REPORTING 21 - Financial Reporting Of Leases Dilutive Securities and EPS

· 2 S IMPLE L EASE E XAMPLE Equipment costs $30,000 new, LESSEE leases the equipment for 3 years, payments at the beginning of each year. Lessee expects a residual value of $10,000 at the end of the 3 years and wants to earn 10%/year on the unpaid balance. The equipment has a 7 year life. 1/2/12 1/2/13 1/2/14 12/31/14 | | | | $30,000 $10,000 HOW MUCH ARE THE ANNUAL LEASE PAYMENTS?

· 3 S IMPLE L EASE E XAMPLE Suppose you “believed” the equipment was not your asset so you did not record the asset or liability – in financial reporting terminology you would be saying the lease was an “operating lease.”

· 4 S IMPLE L EASE E XAMPLE if it is an Operating Lease 1/2/12 1/2/13 1/2/14 12/31/14 | | | | $8,220 $8,220 $8,220 How should you record the lease payments?

· 5 S IMPLE L EASE E XAMPLE if it is a capital Lease Now, suppose you believed the equipment was your asset – in reporting terminology you would be saying the lease were a “capital (or finance/financing) lease.”

· 6 S IMPLE L EASE E XAMPLE if it is a capital Lease 1/2/12 1/2/13 1/2/14 12/31/14 | | | | $ 30,000 $10,000 At 1/2/12 : (Assume for now, the residual value was not guaranteed by the lessee.)

· 7 S IMPLE L EASE E XAMPLE if it is a capital Lease Lessee is making 3 payments of $8,220 - a total of $24,660; but the liability is recorded at $22,486

· 8 S IMPLE L EASE E XAMPLE if it is a capital Lease 1/2/12 1/2/13 1/2/14 12/31/14 | | | | $ 30,000 10,000 At 1/2/12 - 1/2/14 :

Liabilities 9 L EASES – W HICH I S I T? (OR HOW TO AVOID CAPITAL LEASES) Can the lessee cancel the lease? yesno Does title transfer at the lease end? yes BOO ! no CAPITAL Is there a bargain purchase option? yes LEASE no Is the lease for ≥ ¾ of the asset’s useful life? yes no Is the PVMLP ≥ 90% assets fair value? yes no HURRAY ! OPERATING LEASE

· 10 L EASES I NTERNATIONAL V IEW IAS 17 is similar to FAS 13, but is more “principles” based – it gives situations that individually or in combination would lead you to classify a lease as a finance lease. The idea is that a finance lease transfers substantially all the risks and rewards of ownership to the lessee.

· 11 L EASES A dditional C onsiderations Residual value - unguaranteed or guaranteed Executory costs treatment Lessee’s interest rate - incremental borrowing rate unless…

· 12 L EASES A dditional C onsiderations Lessor Accounting Lessor’s Initial Direct Costs (IDC): 1-incremental direct costs (paid to 3 rd parties) & 2-internal direct costs (internal indirect costs – are not IDC and are expensed immediately)

· 13 L EASES A dditional C onsiderations Real Estate Sale and Leaseback

· 14 S ALE A ND L EASEBACK (Appendix 21 A) Fairly Common Transactions (or pair of transactions)

· 15 S ALE A ND L EASEBACK Seller / lessee’s accountant looks at it as two (related) transactions. Transaction 1 – the sale – like the sale of PPE in ACCT 3220, but with a difference: gains/losses are not recorded immediately.* Transaction 2 – the leaseback – treated as either an operating or capital lease. * There are two exceptions to this general rule.

· 16 L EASES – W HAT Y OU S HOULD D O W HEN R EADING F INANCIAL S TATEMENTS: IAS and American standards differ in detail, but both give you a method to “undo” management maneuvers to avoid capital leases.

· 17 T HE L EASE: L ESSOR A CCOUNTING LESSEE: LESSOR: Operating lease Operating lease Sales type lease Capital lease or Direct financing lease

· 18 T HE L EASE: L ESSOR A CCOUNTING In general, if it is a capital lease for the lessee, then the lessor considers the asset to be sold, but not always. To be considered “sold” the lessor has two additional criteria that must be met: Lessor is “certain” of payment and Lessor has no material uncertain costs.