Introductory Lecture – Includes Flow Charts
Accounting for Leases
Chapter
21
Intermediate Accounting
12th Edition
Kieso, Weygandt, and Warfield
Prepared by Coby Harmon, University of California, Santa Barbara
2
Learning Objectives
1.
Explain the nature, economic substance, and advantages of
lease transactions.
2.
Describe the accounting criteria and procedures for
capitalizing leases by the lessee.
3.
Contrast the operating and capitalization methods of recording
leases.
4.
Identify the classifications of leases for the lessor.
5.
Describe the lessor’s accounting for direct-financing leases.
6.
Identify special features of lease arrangements that cause
unique accounting problems.
7.
Describe the effect of residual values, guaranteed and
unguaranteed, on lease accounting.
8.
Describe the lessor’s accounting for sales-type leases.
9.
List the disclosure requirements for leases.
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Teresa’s Specific Objectives



Be able to classify a lease from the perspective
of lessor and lessee
Be able to prepare journal entries for lessor and
lessee – for both operating and capital-type
leases
Be able to research FARS to resolve
complications not mentioned in text
4




The lease is a contractual agreement between
the lessor and the lessee.
The lease gives the lessee the right to use
specific property.
The lease specifies the duration of the lease and
rental payments.
The obligations for taxes, insurance, and
maintenance may be assumed by the lessor or
the lessee.
6
Lease Contracts
Cancellation
Provision
Lease Payment
Lease Term
Specifies under what
circumstances the lease
may be canceled.
Rental payment required
over lease term – may
include planned increases.
Delineates the time
period the lease is to be
in force. May include
renewal periods.
7
Lease Contracts
Residual Value
Purchase Option
Who is responsible for
market value of leased
asset at end of lease
term?
Grants lessee the right to
purchase the asset at the
end of the lease term.
The option price may or
may not be a bargain.
8
Other Terms You Will Learn






Contingent rentals
Bargain renewal option
Bargain purchase option
Nonrenewal penalty
Guaranteed residual
value
Interest rate implicit in the
lease





Unguaranteed residual
value
Executory costs
Initial direct costs
Minimum lease payments
Incremental borrowing
rate
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The Leasing Environment
Advantages of Leasing
1.
100% Financing at Fixed Rates.
2. Protection Against Obsolescence.
3. Flexibility.
4. Less Costly Financing.
5. Tax Advantages.
6. Off-Balance-Sheet Financing.
10
The Leasing Environment
Benefits to the Lessor
1.
Interest Revenue.
2. Tax Incentives.
3. High Residual Value.
4. Making a sale that would otherwise go to
a competitor that provides a leasing
option
11
The Leasing Environment
The issue of how to report leases is the case of substance versus
form. Although technically legal title may not pass, the benefits
from the use of the property do.
Operating Lease
Journal Entry:
Rent expense
Cash
Capital Lease
xxx
xxx
Journal Entry:
Leased equipment xxx
Lease obligation
xxx
A lease that transfers substantially all of the benefits and risks
of property ownership should be capitalized (only noncancellable
leases may be capitalized).
Statement of Financial Accounting Standard No. 13,
“Accounting for Leases,” 1980
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LO 1 Explain the nature, economic substance,
and advantages of lease transactions.
Accounting by the Lessee
Leases that DO NOT
meet any of the four
criteria are accounted
for as Operating Leases.
Lease Agreement
No
Transfer
of
Ownership
Yes
No
Bargain
Purchase
No
Lease Term
>= 75%
Yes
Capital Lease
Yes
PV of
Payments
>= 90%
Yes
No
O
p
e
r
a
t
i
n
g
L
e
a
s
e
13
Accounting by Lessee
Lease Agreement
Is there transfer
of ownership?
No
Yes
Yes
Is there a bargain
purchase option?
No
11th Ed
Slide
Capital
Lease
Yes
Is lease term equal
to or greater than
75% of economic
life ?
Yes
No
Operating
Lease
Is present value
of payments
equal to or more
than 90% FMV?
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Accounting by the Lessor
Classification of Leases by the Lessor
Illustration 21-11
A sales-type lease involves a manufacturer’s or dealer’s profit, and a
direct-financing lease does not.
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Accounting by the Lessor
Classification of Leases by the Lessor
Illustration 21-12
A lessor may classify a lease as an operating lease but the lessee
may classify the same lease as a capital lease.
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Accounting by Lessor
Lease Agreement
Does lease meet
Group 1 criteria?
yes
Sales type
No
Is collectibility of
payments assured?
yes
11th Ed
Slide
No
No
Is lessor’s
performance
substantially
complete ?
No
yes
Operating
Lease
Direct
financing
Does asset FMV
equal lessor’s
book value?
yes
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Later we’ll talk about International Financial Reporting Standards
IFRS FLOWCHART
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From KPMG webcast Spring 2008