1. What is a lease?
A contractual arrangement by which a lessor (owner) provides a lessee (user) the right to use an asset for a specified period of time. In return for this right, the lessee agrees to make stipulated, periodic cash payments during the term of the lease.
2. What is the difference between an operating lease and a capital lease?
Operating lease: Fundamental rights and responsibilities of ownership are retained by the lessor and that the lessee merely is using the asset temporarily.
Capital Lease: Installment purchases/sales that are formulated outwardly as leases.
3. What are the advantages of leasing assets rather than purchasing them? (pages 860)
-Can offer tax saving advantages over purchases.
-Can facilitate asset acquisition.
-Lease to obtain "off-balance-sheet financing.
4. List the four classification criteria used to distinguish capital leases from operating leases. (Note: The lease must have a noncancelable lease term to qualify as a capital lease.) How many of the four criteria must a lease meet to be a capital lease?
1) The agreement specifies that ownership of the asset transfers to the lessee.
2) The agreement contains a bargain purchase option.
3) The noncancelable lease term is = to 75% or more of the expected economic life of the asset.
4) The PV of the "minimum
5. What is a bargain purchase option? (page 863)
A provision in the lease contract that gives the lessee the option of purchasing the leased property at a bargain price.
6. What is a bargain renewal option? How does this affect the lease term used in criterion 3? (page 863)
Gives the lessee the option to renew the lease at a bargain rate. That is, the rental pmt is sufficiently lower than the expected fair rental of the property at the date the option becomes exercisable that exercise of the option appears reasonably assured
7. What amounts are included in minimum lease payments (as part of criterion 4)? (page 864)
1) The total of periodic rental pmts
2) Any guaranteed residual value
3) Any bargain purchase option price
8. In addition to meeting at least one of the four criteria listed in question four, what two criteria must (both) be met in order for a lessor to classify a lease as a capital lease? (page 864)
1) The collectability of the lease pmts must be reasonably predictable.
2) If any costs to the lessor have yet to be incurred, they are reasonably predictable. (Performance by the lessor is substantially complete.)
9. Explain how the lessor and lessee account for rental payments under an operating lease. (page 866)
The periodic rental pmts are accounted for merely as rent by both parties to the transaction.
-Rent revenue: the lessor
-Rent expense: the lessee
10. Explain how the lessor and lessee recognize rental payments under an operating lease that are uneven. (page 867)
The total scheduled pmts ordinarily would be expensed equally (straight-line basis) over the lease term.
11. At what amount does a lessee record an asset acquired with a capital lease? (page 868)
The amount recorded (capitalized) by the lessee is the PV of the minimum lease pmts. But if the FV of the asset is lower than this amount, the recorded value of the asset should be limited to FV.
12. A lessee must depreciate an asset acquired with a capital lease. What period should be used as the as the useful life of the asset? (page 871)
The period used would be the term of the lease, unless the lease provides for transfer of title of a BPO.
13. How does a sale-type lease differ from a direct-financing lease for the lessor? (page 873- 874)
The lessor receives a manufacturer's or dealer's profit on the "sale" of the asset in a sales-type lease.
A direct-financing lease is a lease in which the lessor finances the asset for the lessee and earns interest revenue over the lease term.
Accounting
14. Explain the lessee's treatment of a BPO when computing the present value of the minimum lease payments (MLP). (page 876)
The lessee ADDS the PV of the BPO price to the PV of periodic rental pmts when computing the amount to be recorded as a leased asset and a lease liability.
15. Explain the lessor's treatment of a BPO when computing periodic rental payments. (page 876 or 877)
The lessor, when computing periodic rental pmts, SUBTRACTS the PV of the BPO price from the amount to be recovered (FV) to determine the amount that must be recovered from the lessee through the periodic rental pmts.
16. How does a BPO affect depreciation computations made by the lessee? (page 877)
-The lessee normally depreciates a leased asset over the term of the lease.
-A BPO affects depreciation computations made by the lessee by depreciating the asset its useful life.
17. Explain how a BPO affects the noncancelable lease term used in criterion three (see question 4 from previous assignment) when a BPO is exercisable before the end of the lease. For example, the lease term is 10 years but the BPO is exercisable after 8
Since a BPO is expected to be exercised, the lease term ends for accounting purposes when the option becomes exercisable. So after 8 years, the lease term would end.
18. What is residual value of leased property? (page 878)
An estimate of what its commercial value will be at the end of the lease term.
19. When would a lessee include a residual value in the computation of the present value of minimum lease payments? (page 879) (The book does not mention at this point that a guaranteed residual value also affects depreciation recognized by the lessee.)
When the lease agreement includes a guarantee by the lessee that the lessor will recover a specified residual value when custody of the asset reverts back to the lessor at the end of the lease term. (guaranteed residual value)
20. When would a lessor include a residual value in the computation of the periodic lease payments? (page 880 - 882 or Illustration 15-13 on page 883) (3 reasons)
1) When the residual value is guaranteed by the lessee.
2) When the residual value is NOT guaranteed.
3) When the residual value is guaranteed by a third party guarantor.
1. What are executory costs? (page 883)
Maintenance, insurance, taxes, and any other costs usually associated with ownership.
2. When the periodic lease payments include an amount for executory costs, how does this affect the minimum lease payments? (Are they included in minimum lease payments?) (page 884)
Executory costs are NOT included in the MLPs.
3. In the following situations, which rate should the lessee use as the discount rate when computing the present value of minimum lease payments? (pages 884 - 886)
Column 1) Is implicit rate known by lessee?
Column 2) Implicit rate
Column 3) Lessee's incr
1) 10%
2) 9%
3) 11%
4. What are initial direct costs? (page 886)
Costs incurred by the lessor that are associated directly with originating a lease and are essential to acquire the lease. (EX: legal fees, commissions)
5. When does a lessor recognize initial direct costs as an expense under each of the following lease types? (page 886 - 887) Mark the correct column with an X.
Column 1) Lease type
Column 2) (a) Expense over life of the lease
or (b) Expense at inception o
1) a
2) a
3) b
OPERATING LEASES- (lessor or lessee?) retains rights and responsibilities of ownership:
1. Payments are recorded as Rent ____ (lessee) or Rent _____ (lessor).
2. When payments are not equal, must use _____-_____ method for recording rent expense. That is,
Lessor
1) Expense, Revenue
2) straight-line, periods, Prepaid Rent, Rent Payable
3) lessee
4) lessee, disclosed, notes
LESSEE - the entity leasing (using) the asset
For lessees, all leases are either
1. _____ leases or
2. ____ leases
To be a capital (nonoperating) lease, the lease must contain a ________ lease term, and one of four criteria must be met.
1.
2.
3.
4.
(Note:
1) operating
2) capital
noncancelable
1) Transfer of ownership
2) Bargain purchase option
3) Economic life test - lease term is at least 75% of economic life of asset
4) Recoverability of investment test - PV of MLP is at least 90% of fair value of asset
LESSOR - the entity that owns the asset and lets lessee use it.
For lessors, a lease is one of the following:
1. operating lease
2. capital lease:
a. _______ lease
b. _______ lease
To be a capital lease for the lessor, the contract must meet one of the fo
a) direct-financing
b) sales type
1) collectibility, lease payments, reasonably predictable
2) costs, incurred, reasonably predictable
CAPITAL LEASES:
1. (Lessee or Lessor?) records the asset on the books and then depreciates (amortizes) it.
2. (Lessee or Lessor?) records liability on books and uses the effective interest method to recognize interest.
3. At inception of the lease, the as
1) Lessee
2) Lessee
3) a) present value
b) fair value
MINIMUM LEASE PAYMENTS include:
a.
b.
c.
d.
a) minimum rental payments excluding executory costs
b) any guaranteed residual value
c penalty for failure to renew or extend the lease
d) Bargain purchase option (BPO) (this is too good to pass up so lessee will pay it to get the asset)
EXECUTORY COSTS:
1) Includes the cost of (3 different things).
If the lessor makes these payments, a portion of the lease payments will be to cover executory costs. In this case, the executory costs are deducted from the periodic payments to determine the
1) insurance, maintenance and taxes related to the leased asset
DISCOUNT RATE USED BY LESSEE:
1. ______ borrowing rate unless
2. the _____ rate used by lessor is ____ to lessee and is (greater or less?) than incremental borrowing rate.
1) incremental
2) implicit, known, less
DIRECT FINANCING LEASE:
The lessor is simply _____ the asset and earns only ______ ______.
financing, interest revenue
SALES TYPE LEASE:
The lessor not only finances the asset and earns interest revenue; the lessor also earns a _____ _____ on the sale.
A ______ ______ is earned when there is a difference between the cost (book value) and the fair value of the asset when l
gross profit
gross profit
Guaranteed Residual:
1) Direct financing Lease
a) Include in 90% test. (Recovery of investment test)
b) Include in lease receivable as part of MLP.
2) Sales type lease
a) Include in 90% test. (Recovery of investment test)
b)Include in lease receivable as
...
Bargain Purchase Option:
1. Not all purchase options are bargain purchase options.
2. By definition, a BPO results in a _____ lease for the lessee and for the lessor (if the additional criteria are met).
3. The lessee will purchase the asset because this
2) capital
3) included
4) lessee, useful life
Guaranteed Residual Value:
1. This is an additional payment (in form of asset worth this amount or cash to make up the difference) and is (excluded or included?) in the minimum lease payments by both lessee and lessor.
2. The or lessee depreciates the ass
1) included
2) salvage, loss
3) does NOT
Unguaranteed Residual Value:
1. An unguaranteed residual is the amount the lessor expects the asset to be worth when returned. This amount is used by the lessor when setting the payments.
2. The lessee ignores an unguaranteed residual (may not be aware of
4) Sales Revenue, COGS, present value