CH15 - Leases

• Lease


  An agreement where the lessor (asset owner) conveys the right to use property, plant, or equipment, usually for a stated period of time, to the lessee (asset user)
• Leases


  • Can have very short or long-term structures
  • Some are just short-term rental contracts
  • Others may be economically similar to a sale from the lessor to the lessee
• Lease Classification


  • Lessee
  • Lessor
  • Finance Lease
  • Sales-Type lease
  • Operating lease
• Finance Lease/Sales-Type Lease


  Economically similar to a sale of the asset from the lessor to the lessee
• Operating Lease


  The lessor owns the asset economically
• Lease Classification Criteria


  • Ownership of the asset transfers to the lessee
  • The agreement contains a purchase option that the lessee is reasonably certain to exercise (bargain purchase option)
  • The lease term is for the "major part" of the remaining economic life of the underlying asset (75%)
  • The present value of the lease payments equals or exceeds "substantially all" of the fair value of the asset (90%)
  • The asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term
• Accounting for Finance Lease (Lessee)

  1. Lease Inception and First Payment

  2. Second Payment and Right-of-Use Asset Amortization
• Accounting for Operating Lease (Lessee)

  1. Lease Inception and First Payment

  2. Second Payment and Right-of-Use Asset Amortization
• Lessee: Comparing Finance Lease to Operating Lease

  Same: Recognize a right-of-use asset and a lease liability, both equal to the PV of the lease, Recognize interest expense using the effective interest method

  Different: Amortization of the right-of-use asset - Finance lease amortize on a straight line, Operating lease amortize such that the total lease expense is straight-line over the life of the lease
• Discount Rate Used in PV Calculation

  To calculate the PV of the lease, the lessee should use the lessor's implicit rate of the lease if known, otherwise the lessee uses its own incremental borrowing rate
• Amortization Period (Lessee)


  If ownership transfers to the lessee, or exercise of a purchase option is reasonably certain, then the lessee amortizes the right-of-use intangible asset over the underlying asset's useful (economic) life, otherwise it amortizes over the lease term
• Lessor Accounting


  • Sales-type lease without profit
  • Sales-type lease with profit
  • Operating lease
• Accounting for Lessor (sales-type without profit)

  1. Journal Entries

  2. Amortization Schedule for the Lease Payments

  3. Second payment (12/31/2019)
• Accounting for Lessor (sales-type with profit)


  1. Journal Entries

  2. First Lease Payment (January 1, 2019)

  3. Second payment (12/31/2019)
• Sales-Type Lease with and without Profit

  Lessor: When there is a selling profit, all lessor entries are precisely the same as the entries for a sales-type lease without a selling profit except for the entry at the beginning of the lease that includes the Cost of Goods Sold and Sales Revenue

  Lessee: The lessee's accounting is not impacted by whether or not the lessor recognizes a profit. The journal entries made by the lessee are precisely the same with or without a selling profit for the lessor.
• Accounting for Lessor (operating lease)

  Doesn't meet any of the criteria for a sale-type lease, Fundamental rights and responsibilities of ownership are retained by the lessor, A sale is not recorded by the lessor; the lessor records lease revenue on a straight-line basis, Lessee records the right-of-use asset and lease liability at inception
• Short-Term Lease – Shortcut Method


  A lease that has a maximum possible lease term (including any options to renew) of 12 months or less, Lessee can elect to not recognize a right-of-use asset or a lease liability and to recognize lease payments as expense over the lease term
• Accounting for leases with bargain purchase option (BPO)

  Finance/Sales-type Lease, There is an additional payment @ the exercise of option (i.e., bargain price), Lessee's amortization is over the useful life
• Sale-Leaseback Arrangements


  Involves two sequent transactions: 1) The sale of an asset to a lender, 2) The immediate lease of that asset back from the lender and subsequent lease payments from the lessee (original owner) to the lessor (lender)

  Advantages: Refinancing at a lower rate, Generating cash
• Accounting for a Sale-Leaseback

  Sale-Leaseback Approach: Record the sale of the asset including applicable gain or loss, and then record a lease for the leaseback portion in accordance with standard lease guidance

  Financing Arrangement: View the arrangement not as a sale, but as a loan by the lessor to the lessee for the "sale" price. The asset remains on the lessee's books, and the leaseback is accounted for as debt.
• Residual Value: Lessee's Perspective

  Unguaranteed - ignore, Guaranteed and less than or equal to the estimated residual fair value - do not include in PV calculation, Guaranteed and exceeds the estimated residual fair value - treat the excess as an additional payment, The entire guaranteed amount is used for lease classification
• Residual Value: Lessor's Perspective

  Lease receivable: PV (lease payments) + PV (residual value), If guaranteed residual value exceeds the estimated residual fair value, the excess is treated as an additional payment

  Sales revenue: PV (lease payments) = Lease receivable - PV (residual value)

  Cost of Goods Sold: Lessor's cost - PV (residual value)