Transcript Intangible Assets

Accounting for Leases
ACCTG 5120
David Plumlee
1
What is a Lease?
“ A lease is a contractual agreement
between a lessor (owner) and a lessee
(renter) that gives the lessee the right
to use property owned by the lessor for
a specific period of time in return for
rental payments.”
page2
Accounting for Leases
Before 1976 most leases accounted for leases as
rental agreements. Why was this accounting
found lacking ?
Over time lease agreements began to
resemble installment purchases where
Companies were in effect borrowing
money to buy an asset
page3
Classification of Leases
What is the economic nature of a capital lease?
One that transfers substantially all the risks and
benefits of ownership to the lessee.
What is the economic nature of an operating lease?
One that does not transfer the risks and
benefits of ownership to the lessee;a rental
agreement
page4
Accounting for Capital Leases


Accounting reflects economic substance,
not legal form
Make it appear as though company
purchased an asset with borrowed funds



an asset and an obligation
interest expense on obligation
depreciation on asset
page5
Is this a Capital Lease?
Does it meet ANY ONE of the four criteria?
•Lease transfers ownership of asset
•automatically by end of lease term or
•through a bargain purchase option
•Lease term is at least 75% of asset’s estimated
economic life
•PV of minimum lease payments is at least 90% of
asset’s fair market value at beginning of lease term
page6
Minimum Lease Payments
Leases without a BPO

Minimum rental payments plus

Any guaranteed residual value plus


amount the lessee guarantees lessor will realize
on the asset at the end of the lease term
Penalties for failure to renew lease if at the
beginning of lease term renewal does not
appear to be reasonably assured
page7
MLP continued
What are executory costs?
Payments to the lessor to reimburse him/her
for operating costs like repairs and
maintenance or insurance
Are they included in MLP?
NO!
page8
Minimum Lease Payments
What is a bargain purchase option?
An option to purchase asset at end of lease term at
a price sufficiently below expected market value that
exercise of option appears reasonably assured
What is the MLP for leases with a BPO?
PV of rental payments and the BPO at the
end of the lease term.
page9
Capital Lease Example
 6-year lease
 Annual payment due at year end = $18,287
 No BPO and legal title does not pass at the
end of lease term
 FMV of leased asset = $75,185
 Economic life of asset = 10 years
 Appropriate interest rate = 12%
 Est. salvage value = $3,185
page10
Present Value of MLP
$18,287 $18,287 $18,287 $18,287 $18,287 $18,287
1
2
3
4
5
6
PV = $18,287 x PVIFA(n=6, r=12%)
= $18,287 x 4.11141
= $75,185
page11
Lessee Journal Entries



Inception of lease: record leased
asset and lease obligation at present
value of MLP
Record payments
At period end accrue:


depreciate asset
record interest expense
page12
Inception of Lease Term
JE to record leased asset and lease obligation
at present value of MLP?
leased asset
lease obligation
$75,185
$75, 185
page13
Depreciation Expense
On what does the depreciation period
used depend?
If bargain purchase option exists or
title passes during lease term, use
economic life
Otherwise use lease term
page14
Basis for Depreciation
What ending values are used for depreciation?
Salvage value if depreciating over
economic life
Guaranteed residual value if
depreciating over lease term
page15
Record Depreciation Expense
What is the depreciable basis of this asset?
$75,185 (Salvage value is irrelevant because
the asset reverts to the lessor.)
$75,185/6yrs = $12,531
depreciation expense $12,531
accum. depreciation
$12,531
page16
Lease Amortization Table
Date
Payment
Interest
Reduction
In Obligation
Balance
0
1
2
3
4
5
6
page17
Lease Amortization Table
PV of the min. lease payments
Date
0
1
2
3
4
5
6
Payment
Interest
Reduction
In Obligation
Balance
75,185
18,287
18,287
18,287
18,287
18,287
18,287
page18
Lease Amortization Table
Date Payment (a) Interest (b)
0
1
2
3
4
5
6
18,287
18,287
18,287
18,287
18,287
18,287
9,022
7,910
6,665
5,271
3,709
1,959
Reduction
In Obligation (a-c)
9,265
10,377
11,622
13,016
14,578
16,328
Balance
75,185
65,920
55,544
43,922
30,905
16,327
-1
page19
Record First Lease Payment
interest expense ($75,185 x 12%) $9,022
lease obligation
9,265
cash
$18,287
Interest rate implicit in the lease unless the
lessee’s incremental borrowing rate is both
known by the lessor and is lower.
page20
Lessor Capital Lease Types

Direct financing leases



PV of minimum lease payments equals the FMV of
the leased asset
No “profit” is recorded; considered to be a
financing arrangement.
Sales-type leases


PV of minimum lease payments less the FMV of
the leased asset equals the “dealer profit”
Profit is recognized as revenue at the inception of
the lease
page21
Initial Direct Costs

Includes costs directly associated with
negotiating a particular lease



amounts paid to third parties (e.g. lawyer’s fees,
appraisal fees, finders fees)
amounts incurred internally (e.g. time spent
negotiating lease terms, preparing and
processing documents)
Excludes indirect costs (e.g. allocated
portion of general advertising, administration
costs or overhead)
page22
Accounting for
Initial Direct Costs

Operating -

Sales-type -

Direct financing-
defer and allocate over lease term
in proportion to rental income
expense in same period as
profit on sale recognized
add to gross investment in the
lease
amortize over lease as a yield
adjustment

page23
Example - Direct Financing
3 year lease
 $20,000 payments due at end of year
 implicit interest rate = 10%
 FMV (lessor’s cost of asset) = $49,737
 initial direct costs = $1,000

page24
Net Investment in Lease
What is the PV of the MLP (without initial direct costs)?
20,000 x PVIFA(n=3,r=10%)
=$49,737 = cost (this is a direct financing lease)
Do initial direct costs affect this calculation?
Yes, they are added and a new interest rate is found.
page25
Impute New Effective Yield
Why add to the initial direct costs?
We want the interest rate the equates the net
investment to the cash flows
$49,737 = -$1,000 + $20,000 PVa (n=3,r=??)
$50,737 = $20,000 x PVa (n=3,r=?)
2.53685 = PVa (n=3,r=?)
by trial and error: r=8.89%
page26
Ignoring Initial Direct Costs
payment
opening
yr. 1
20,000
yr. 2
20,000
yr. 3
20,000
total interest income
interest principal
(10%)
4,974
15,026
3,471
16,529
1,818
18,182
10,263
balance
49,737
34,711
18,182
(0)
page27
Including Initial Direct Costs
payment
interest principal
opening
(8.89%)
yr. 1
20,000
4,511
15,489
yr. 2
20,000
3,134
16,866
yr. 3
20,000
1,619
18,381
total interest income
9,263
Reduction in income = 10,263 - 9,263
= 1,000
= initial direct costs
balance
50,737
35,248
18,381
0
page28
Amort. of Initial Direct Costs
yr. 1
yr. 2
yr. 3
total
interest interest
at 10% at 8.89%
4,974
4,511
3,471
3,134
1,818
1,618
10,263
9,263
amortization
463
337
200
1,000
page29
Journal Entry
Entries to record lease:
deferred initial direct costs
cash (etc.)
1,000
lease receivable
60,000
unearned interest income
leased asset
1,000
10,263
49,737
page30
Journal Entries
Entries to record first payment and
amortization of income and costs
cash
lease receivable
unearned interest income
interest income
20,000
20,000
4,974
initial direct expense amortization 463
deferred initial direct costs
4,974
463
page31
Sale/leaseback
Seller/lessee
Should the gain
or loss on sale be
recognized when
asset “sold” to
lessor?
Leaseback:
seller retains
use of the asset
Sale:
Legal title
Transfers
Buyer/lessor
Account for lease
according to
classification tests.
page32
Sale/leaseback- operating lease
Lessee Retains Right To Use Asset


defer gains only (losses are recognized
immediately)
amortize to rent expense over lease term in
proportion to rental payments
Why do you think we defer any gains?
Owners would strike deals where they “sold” the
asset for an inflated price and booked a huge gain on
sale and in return they promised to make
unreasonably large lease payments in the future
page33
Sale/leaseback -- capital lease
Lessee Retains Right To Use Asset


defer gains only (losses are recognized
immediately)
amortize to depreciation expense over
lease term in proportion to
amortization of leased asset
page34
“Minor leaseback”



Lessee Loses Most Rights To Use Asset
Defined as PV of rental payments is
10% or less of asset’s fair value
Recognize gain or loss on sale
immediately
page35