Chapter 15 Leases 15-1

Transcription

1 Chapter 15 Leases 1. Why Leasing sometimes makes more sense 2. The accounting issues in recording a lease transaction 3. The types of contractual provisions in lease 4. The lease classification: capital vs. operating 5. Lessee accounting: operating and capital 6. Lessor accounting: operating and capital 7. Leases disclosures 8. International accounting for leases 9. The sale-leaseback transaction 15-1

2 Which Company Owns the Largest Number of Commercial Aircraft in the World? However, General Electric owns over 1,800 aircraft that it leases to more than 225 customer airlines in over 70 countries. 15-2

3 Introduction A lease is a contract specifying the terms under which the owner of property, the lessor, transfers the right to use the property to a lessee. A major challenge for the accounting profession has been to establish standards that prevent companies from using the legal form of a lease to avoid recognizing future payment obligations as a liability. 15-3

4 1. Describe the circumstances in which leasing makes more business sense than does outright sale and purchase Economic Advantages to Leasing Over Purchasing 1. No down payment 2. Avoid risks of ownership 3. Flexibility For the Lessee For the Lessor 1. Increased sales 2. Ongoing business relationship with lessee 3. Residual value retained 15-4

5 2. The accounting issues in recording a lease transaction Simple Example Owner Company owns a piece of equipment with a market value of $10,000 and an estimated useful life of five years. User Company wishes to acquire the equipment. User Company can borrow $10,000 from the bank at 10% interest. Payments for principal and interest would be five equal annual installments of $2,

6 Simple Example Alternatively, User Company can lease the equipment from Owner Company for five years and make five annual rental payments of $2,638. User will still use the equipment for five years and will still make payments of $2,638 per year. The primary difference is that now Owner is not just selling the equipment but is also substituting for the bank in providing financing. (continued) 15-6

7 Simple Example On the date the lease is signed, should Owner Company recognize an equipment sale? The key accounting issues for the lessor are: Has effective ownership of the equipment been passed from Owner to User? Is the transaction complete, meaning does Owner have any significant responsibilities remaining in regard to the equipment? Is Owner Company reasonably certain the five annual payments can be collected from User Company? (continued) 15-7

8 Simple Example Question: On the date the lease is signed, should User recognize the lease equipment as an asset and the obligation to make the lease payment as a liability? Answer: The answer hinges on whether effective ownership, as opposed to legal ownership, of the equipment changes hands when Owner and User sign the lease agreement. The economic substance of the lease is that the lease signing is equivalent to the transfer of effective ownership, and the fact that Owner retains legal title of the equipment during the lease period is a mere technicality. 15-8

9 Capital vs. Operating Lease Capital leases are accounted for as if the lease agreement transfers ownership of the asset from the lessor to lessee. Operating leases are accounted for as rental agreements, with no transfer of effective ownership associated with the lease. 15-9

10 Why Leasing Over Purchasing? Keeping the asset off the balance sheet improves financial ratio measures of efficiency. Keeping the liability off the balance sheet improves measures of leverage. For companies that lease a large portion of the assets they use, the accounting standards associated with leasing are the most critical standards that they apply

11 3. Outline the type of contractual provisions typically included in lease agreements Cancellation Provisions Some leases are noncancelable, meaning that these lease contracts are cancelable only on the outcome of some remote contingency or that the cancellation provisions and penalties of these leases are so costly to the lessee that cancellation will not occur. All cancelable leases are accounting for as operating leases. Some, but not all noncancelable leases are accounted for as capital leases

12 Bargain Purchase Option If the specified purchase option price is expected to be considerably less than the fair value at the date the purchase option may be exercised, the option is called a bargain purchase option. By definition, a bargain purchase option is one that is expected to be exercised. Noncancelable leases with BPO are accounted for as capital leases

13 Lease Term The lease term is the time period from the beginning to the end of the lease. The beginning of the lease term occurs when the leased property is transferred to the lessee. The end of the lease term is more flexible because many leases include provisions allowing the lessee to extend the lease period. (continued) 15-13

14 Lease Term The end of the lease term is at the end of the fixed noncancelable lease period plus all renewal option periods that are likely to be exercised. A bargain purchase option is one with such an attractive lease rate, or other favorable provision, that at the inception of the lease, it is likely that the lease will be renewed beyond the fixed lease period

15 Residual Value The market value of the leased property at the end of the lease term is referred to as its residual value. Some lease contracts require the lessee to guarantee a minimum residual value. If the market value falls below the guaranteed residual value, the lessee must pay the difference. (continued) 15-15

16 Residual Value If there is no bargain purchase option or guarantee of the residual value, the lessor reacquires the property. If the actual amount of the residual value is unknown until the end of the lease term, it must be estimated at the inception of the lease. The residual value under these circumstances is referred to as an unguaranteed residual value

17 Minimum Lease Payments The rental payments required over the lease term plus any amount to be paid for the residual value are referred to as the minimum lease payments. Lease payments sometimes include charges for items such as insurance, maintenance, and taxes on the leased property. These are referred to as executory costs and they are not included as part of the minimum lease payment. (continued) 15-17

18 Minimum Lease Payments Dorney Leasing Co. owns and leases road equipment for three years at $3,000 per month. Included in the lease payment is $500 per month for executory costs to insure and maintain the equipment. At the end of the 3-year period, Dorney is guaranteed a residual value of $10,000 by the lessee. (continued) 15-18

19 Minimum Lease Payments Minimum lease payments: Rental payments exclusive of executory costs ($2,500 36) $ 90,000 Guaranteed residual value 10,000 Total minimum lease payments $100,000 How did Dorney decide that a $2,500 monthly lease payment would be sufficient if 12% is the interest rate? 15-19

20 Nature of Leases The implicit interest rate is the rate used by the lessor in calculating the desired lease payment. For purposes of computing the present value of the minimum lease payments, the lessee uses the lower of the implicit interest rate used by the lessor and the lessee s own incremental borrowing rate. The lessee s incremental borrowing rate is the rate at which the lessee could borrow the amount of money necessary to purchase the leased asset, taking into consideration the lessee s financial situation and current conditions in the marketplace

21 4. Apply the lease classification criteria in order to distinguish between capital and operating leases 15-21

22 General Classification Criteria Lessee and Lessor The four general criteria that apply to all leases for both the lessee and lessor relate to transfer of ownership, bargain purchase option, economic life, and fair value. 1. The lease transfers ownership of the leased asset to the lessee by the end of the lease term. 2. The lease contains a bargain purchase option making it reasonably assured that the property will be purchased by the lessee at a future date. 3. The lease term is equal to 75% or more of the estimated economic life of the leased property. 4. The present value of the minimum lease payments at the beginning of the lease equals or exceeds 90% or more of the fair market value of the leased asset

23 IASB Approach IAS 17, Accounting for Leases, states simply: A lease is classified as a finance (i.e., capital) lease if it transfers substantially all the risks and rewards incident to ownership. This type of standard places the responsibility of distinguishing the type of lease on the accountant. (continued) 15-23

24 IASB Approach IAS 17 gives the following examples of situations that would normally lead to a lease being classified as a finance lease : a) The lease transfers ownership of the asset to the lessee at the end of the lease term. b) The lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable. (continued) 15-24

25 IASB Approach c) The lease term is for the major part of the economic life of the asset even if title is not transferred. d) At the inception of the lease the present value of the minimum lease payments amount to at least substantially all of the fair value of the leased asset. Note the similarity between the IAS 17 guidelines and those of the FASB. They are the same in spirit

26 Revenue Recognition Criteria Lessor In addition to meeting one of the four general criteria, a lease must meet two additional revenue recognition criteria to be classified by the lessor as a capital lease: 1. Collection of the minimum lease payments must be reasonably predictable. 2. Any unreimbursable costs yet to be incurred by the lessor under the terms of the lease are known or can be reasonably estimated at the lease inception date

27 15-27

28 5. Properly account for both capital and operating leases from the standpoint of the lessee (asset user) Accounting for Leases Lessee All leases as viewed by the lessee may be divided into two types: operating leases and capital leases. If the lease meets any one of the four, it is treated as a capital lease. Otherwise, it is an operating lease. Accounting for operating leases involves the recognition of rent expense over the term of the lease

29 Accounting for Leases Lessee Accounting for a capital lease essentially requires the lessee to report on the balance sheet the present value of the future lease payments, both as an asset and a liability. The asset is amortized as though it had been purchased by the lessee

30 Accounting for Operating Lease Lessee The lease terms for manufacturing equipment are $40,000 a year on a year-to-year basis. The entry to record the lease payment for the year would be as follows: Rent Expense 40,000 Cash 40,

31 Operating Leases with Varying Lease Payments The terms of the lease for an aircraft by International Airlines provide for payments of $150,000 a year for the first two years of the lease and $250,000 for each of the next three years. The total lease payments would be $1,050,000, or $210,000 a year on a straightline basis. The required entries in the five years are shown on Slide (continued) 15-31

32 Operating Leases with Varying Lease Payments The required entries in the first two years would be as follows: Rent Expense 210,000 Cash 150,000 Rent Payable current liability 60,000 The entries for each of the last three years are as follows: Rent Expense 210,000 Rent Payable 40,000 Cash 250,

33 Accounting for Capital Leases Lessee Marshall Corporation Lessee Lease period: 5 years, beginning January 1, Noncancelable. Rental amount: $65,000 per year payable annually in advance; includes $5,000 to cover executory costs. Estimated economic life of equipment: 5 years. Expected residual value of equipment at end of lease period: None. (continued) 15-33

34 Accounting for Capital Leases Lessee Marshall Corp. Entries on January 1, 2013 Leased Equipment 250,192 Obligations under Capital Leases 250,192 To record the lease. PMT = $60,000; N = 5; I = 10% Lease Expense 5,000 Obligations under Capital Leases 60,000 Cash 65,000 To record the first lease payment (including executory costs of $5,000)

35 Accounting for Capital Leases Lessee The term lease expense is used to record the executory costs related to the leased equipment, such as insurance and taxes. When a lease is capitalized, the asset is included on the balance sheet and written off over time. The word amortization, instead of depreciation, is typically used when describing the systematic expensing of the cost of a leased asset. (continued) 15-35

36 Accounting for Capital Leases Lessee Marshall Corp. Entries on December 31, 2013 If normal company depreciation policy for this type of equipment is used, the amortization entry for 2013 is shown below: Amortization Expense on Leased Equipment 50,038 Accumulated Amortization on Leased Equipment 50,038 (continued) $250,192/

37 (continued) 15-37

38 Accounting for Capital Leases Lessee Entries on December 31, 2013 Prepaid Executory Costs 5,000 Obligations under Capital Leases 40,981 Interest Expense 19,019 Cash 65,000 ($250,192 $60,000) 0.10 (continued) 15-38

39 Accounting for Capital Leases Lessee The December 31, 2013, balance sheet of Marshall Corporation would include information concerning the leased equipment and related obligations

40 Accounting for Capital Leases Lessee As the amount of interest expense declines each period, the total expense will be reduced and, for the last two years, will be less than the $65,000 payments (See Slide 15-37). The total amount debited to expense over the life of the lease will be the same regardless of whether the lease is accounted for as an operating lease or a capital lease. (continued) 15-40

41 15-41

42 Accounting for Leases with a Bargain Purchase Option Frequently, the lessee is given the option of purchasing the property in the future at what appears to be a bargain price. The present value of the bargain purchase option is part of the minimum lease payments and should be included in the capitalized value of the lease. (continued) 15-42

43 Accounting for Leases with a Bargain Purchase Option Lessee Lease period: 5 years, beginning January 1, 2013, noncancelable. Rental amount: $65,000 per year payable annually in advance; includes $5,000 to cover executory costs. Estimated economic life of equipment: 5 years. Expected residual value of equipment at end of lease period: None

44 Accounting for Leases with a Bargain Purchase Option These are the same facts as the previous illustration. However, we ve added a bargain purchase option of $75,000 exercisable after five years. The economic life of the equipment is expected to be ten years. Notice in Slide that the present value of the bargain purchase amount of $75,000, or $46,569, increases the present value of the minimum lease payments

45 Accounting for Leases with a Bargain Purchase Option Minimum Lease Payments Present value of five payments at the beginning of each year for five years: PMT = $60,000, N = 5, I = 10% $250,192 Present value of the bargain purchase option of $75,000 at the end of 5 years: FV = $75,000, N = 5, I = 10% 46,569 Present value of minimum lease payments $296,761 (continued) 15-45

46 (continued) 15-46

47 Accounting for Leases with a Bargain Purchase Option Entries on December 31, 2017 Obligations under Capital Leases 68,182 Interest Expense 6,818 Cash 75,000 To record exercise of bargain purchase option. Equipment 148,381 Accumulated Amortization on Leased Equipment 148,380 Leased Equipment 296,761 To transfer remaining balance in leased asset account to equipment

48 Accounting for Leases with a Bargain Purchase Option If the equipment is not purchased and the lease is permitted to lapse, the following entry is required on December 31, 2017: Loss from Failure to Exercise Bargain Purchase Option 73,381 Obligation under Capital Leases 68,182 Interest Expense 6,818 Accumulated Amortization on Leased Equipment 148,380 Leased Equipment 296,

49 Accounting for Purchase of Asset During Lease Term On December 31, 2015, rather than making the lease payment due, the lessee purchased the leased property in the Marshall Corporation example for $120,000. At that date, the remaining liability recorded on the lessee s books is $114,545 and the net book value of the recorded leased asset is $100,078 [capitalized value of $250,192 less $150,114 amortization ($50,038 3)]. (Slides 15-37) (continued) 15-49

50 Accounting for Purchase of Asset During Lease Term Given the facts in Slide 15-49, the entry to record the purchase on the lessee s books would be as follows: Interest Expense 10,413 Obligation under Capital Leases 104,132 Equipment 105,533 Accumulated Amortization on Leased Equipment 150,114 Leased Equipment 250,192 Cash 120,000 [$100,078 + ($120,000 $114,545)] 15-50

51 Treatment of Leases on Lessee s Statement of Cash Flows Operating leases present no special problems to the lessee in preparing a statement of cash flows. For capital leases by the lessee the amortization of leased assets would be treated the same as depreciation. The portion of the cash payment allocated to interest expense would require no adjustment under the indirect method and would be reported as part of the cash payment for interest expense under the direct method. (continued) 15-51

52 Treatment of Leases on Lessee s Statement of Cash Flows The portion of the cash payment allocated to the lease liability would be reported as a financing outflow under either method. The impact of a capital lease on the lessee s statement of cash flows is summarized in Exhibit 15-6 on Slide (continued) 15-52

53 15-53

54 Treatment of Leases on Lessee s Statement of Cash Flows In 2013, Marshall Corporation s income before any lease-related expenses is $200,000. Net income for the year is computed as follows: Income before lease-related expenses $200,000 Lease-related interest expense (19,019) Lease-related amortization expense (50,038) Net income $130,943 (continued) 15-54

55 Treatment of Leases on Lessee s Statement of Cash Flows The statement of cash flows for Marshall Corporation for 2013, displaying only the lease-related items and using the indirect method to report cash flow from operating activities, would appear as follows: 15-55

56 Treatment of Leases on Lessee s Statement of Cash Flows In addition, the supplemental disclosure to the statement of cash flows would include the following two lease-related items: Significant noncash transaction: During 2013 the company leased equipment under a capital lease arrangement. The present value of the minimum future payments under the lease was $250,192 on the lease-signing date. Cash paid for interest was $19,

57 6. Properly account for both capital and operating leases from the standpoint of the lessor (asset owner) Accounting for Leases Lessor Direct financing leases involve a lessor who is primarily engaged in financing activities, such as a bank or finance company. The lessor views the lease as an investment. Sales-type leases involve manufacturers or dealers who use leases as a means of facilitating the marketing of their products

58 Accounting for Leases Lessor A sales-type lease generates two different types of revenue: 1) An immediate profit or loss, which is the difference between the cost of the property being leased and its sales price, or fair value, at the inception of the lease. 2) Interest revenue earned over time as the lessee makes the lease payments that pay off the lease obligation plus interest

59 Initial Direct Costs For either an operating, direct financing, or sales-type lease, a lessor may incur certain costs, referred to as initial direct costs, in connection with obtaining the lease. These costs include the costs to negotiate the lease, perform the credit check on the lessee, and prepare the lease documents. (continued) 15-59

60 15-60

61 Accounting for Operating Leases Lessor Universal Leasing Co. (Lessor) Minimum payment (in advance) including $5,000 executory cost $65,000/year Lease period (beginning Jan. 1, 2013) 5 years Economic life of asset 10 years Estimated residual value at end of lease $0 Implicit rate 10% Incremental borrowing rate 10% Cost to lessor $400,000 Initial direct costs $15,000 (continued) 15-61

62 Accounting for Operating Leases Lessor Universal Leasing Co. (Lessor) The entries to record the payment of the initial direct costs and the receipt of the lease payment on January 1, 2013 would be as follows: Deferred Initial Direct Costs 15,000 Cash 15,000 Cash 65,000 Rent Revenue 60,000 Executory Costs 5,000 (continued) 15-62

63 Accounting for Operating Leases Lessor Universal Leasing Co. (Lessor) To record the amortization of direct costs over five years and the depreciation of equipment over ten years using the straight-line basis: Amortization of Initial Direct Costs 3,000 Deferred Initial Direct Costs 3,000 Depreciation Expense on Leased Equipment 40,000 Accumulated Depreciation on Leased Equipment 40,

64 Accounting for Direct Financing Leases Refer to Slides for details concerning Marshall Corporation s leasing arrangement with Universal Leasing Company. The cost of the equipment to Universal was the same as the fair value, $250,192 and Equipment Purchased for Lease was charged when the equipment was acquired. (continued) 15-64

65 Accounting for Direct Financing Leases Receivable Recorded at Gross Amount To record initial lease on January 1, 2013: Lease Payments Receivable 300,000 Equipment Purchased for Lease 250,192 Unearned Interest Revenue 49,808 To record first payment on January 1, 2013: Cash 65,000 Lease Payment Receivable 60,000 Executory Costs 5,000 (continued) 15-65

66 (continued) 15-66

67 Accounting for Direct Financing Leases To record receipt of the second payment: Cash 65,000 Lease Payment Receivable 60,000 Deferred Executory Costs (a liability) 5,000 Unearned Interest Revenue 19,019 Interest Revenue 19,

68 Accounting for Direct Financing Leases The asset portion of the balance sheet of the lessor at December 31, 2013, will report the lease receivable as follows: 15-68

69 Lessor Accounting for Direct Financing Leases with Residual Value Assuming the same facts as the last illustration, except that the asset has a residual value at the end of the 5-year lease of $75,000. The cost to Universal Leasing Company was again the same as its fair value, $296,761. The fair value in this example is different from the fair value in the previous example because, in the previous example, the asset was assumed to be worthless at the end of the lease term. (continued) 15-69

70 Lessor Accounting for Direct Financing Leases with Residual Value Receivable Recorded at Net Amount To record initial lease on January 1, 2013: Lease Payments Receivable 296,761 Equipment Purchased for Lease 296,761 To record first payment on January 1, 2013: Cash 65,000 Lease Payment Receivable 60,000 Executory Costs 5,000 (continued) 15-70

71 Lessor Accounting for Direct Financing Leases with Residual Value To record payment on December 31, 2013: Cash 65,000 Lease Payments Receivable 36,324 Deferred Executory Cost 5,000 Interest Revenue 23,676 To record recovery of the leased asset at the end of the lease term on December 31, 2017: Equipment 75,000 Lease Payment Receivable 68,182 Interest Revenue 6,

72 Accounting for Sales-Type Leases Lessor In a sales-type lease, an immediate profit or loss arises from the difference between the sales price of the leased property and the lessor s cost to manufacture or purchase the asset. If there is no difference between the sales price and the lessor s cost, the lease is not a salestype lease. The lessor will also recognize interest revenue over the lease term for the difference between the sales price and the gross amount of the minimum lease payments

73 Accounting for Sales-Type Leases Lessor (1) Minimum lease payments (2) Fair value of leased asset (3) Cost or carrying value of leased asset to lessor Financial Revenue (Interest) Manufacturer s or Dealer s Profit (Loss) (continued) 15-73

74 Accounting for Sales-Type Leases Lessor American Manufacturing Co. (Lessor) Fair value of equipment $250,192 Lease period (beginning Jan. 1, 2013) 5 years Economic life of asset 10 years Estimated residual value at end of lease $0 Implicit rate 10% PV of future lease payments $250,192 Cost to lessor $160,000 Direct costs incurred $15,000 (continued) 15-74

75 Accounting for Sales-Type Leases Lessor (1) Minimum lease payments: ($65,000 $5,000) 5 $300,000 (2) Fair value of equipment $250,192 (3) Cost of leased equipment to lessor, plus initial direct costs $175,000 $49,808 (Interest Revenue) $75,192 (Mfr. s Profit) (continued) 15-75

76 Accounting for Sales-Type Leases Lessor American Manufacturing Co. (Lessor) To record entries on January 1, 2013: Lease Payments Receivable 250,192 Sales 250,192 Cost of Goods Sold 175,000 Finished Goods Inventory 160,000 Deferred Initial Direct Costs 15,000 Cash 65,000 Lease Payments Receivable 60,000 Executory Costs 5,

77 Accounting for Sales-Type Leases BPO or Guaranteed R/V The minimum lease payments will include the following if they are part of the agreement: a lump sum (from a bargain purchase option) at the end of the lease term OR a guaranteed residual value. The receivable is increased by the present value of the future payment, and sales are increased by the present value of the additional amount. (continued) 15-77

78 Accounting for Sales-Type Leases BPO or Guaranteed R/V Using the data from Exhibit 15-5, American Manufacturing offers a bargain purchase option of $75,000 at the end of five years

79 Accounting for Sales-Type Leases BPO or Guaranteed R/V American Manufacturing Co. (Lessor) To record entries on January 1, 2013: Lease Payments Receivable 296,761 Sales 296,761 Cost of Goods Sold 175,000 Finished Goods Inventory 160,000 Deferred Initial Direct Costs 15,000 Cash 65,000 Lease Payments Receivable 60,000 Executory Costs 5,

80 Accounting for Sales-Type Leases Unguaranteed Residual Value When a sales-type lease does not contain a bargain purchase option or a guaranteed residual value, but the economic life of the leased asset exceeds the lease term, the residual value will remain with the lessor. This is called an unguaranteed residual value. (continued) 15-80

81 Accounting for Sales-Type Leases Unguaranteed Residual Value To record entries on January 1, 2013: Lease Payments Receivable 250,192 Sales 250,192 Cost of Goods Sold ($175,000 $46,569) 128,431 Finished Goods Inventory ($160,000 $46,569) 113,431 Deferred Initial Direct Costs 15,000 Lease Payments Receivable 46,569 Finished Goods Inventory 46,

82 Accounting for Sales-Type Leases Unguaranteed Residual Value Gross profit on the transaction is the same regardless of whether the residual value is guaranteed or unguaranteed

83 Third-Party Guarantees of Residual Value When a lease is used to increase sales, the seller wants to account for the lease as a sales-type lease. On the other hand, the buyer would prefer to account for the lease as an operating lease to keep the obligation off the balance sheet. A third-party guarantee of residual value is a clever trick that companies have devised to get around accounting rules. How do they do it? (continued) 15-83

84 Third-Party Guarantees of Residual Value The lessor includes a guaranteed residual value with the calculation so that present value of the minimum lease payments meet the 90% of fair value criterion. This allows the lessor to treat the lease as a sales-type lease. The lessee pays an insurance company or investment firm to guarantee the residual value. This allows the lessee to remove the guaranteed residual value from the calculation, dropping the amount below 90%. This allows the lessee to account for the lease as an operating lease

85 Sale of Asset During Lease Term If the leased asset in Exhibit 15-8 below is sold on December 31, 2015, for $140,000 before the $60,000 rental payment is made (the Lease Payments Receivable balance is $104,132) 15-85

86 Sale of Asset During Lease Term a gain of $25,455 would be reported. The following journal entry would be recorded on December 31, 2015, to record the sale: Cash 140,000 Interest Revenue 10,413 Lease Payments Receivable 104,132 Gain on Sale of Leased Asset 25,

87 Treatment of Leases on Lessor s Statement of Cash Flows In 2013, American Manufacturing s income before any lease-related items is $200,000. Net income for the year can be computed as follows: Income before lease-related items $200,000 Lease-related sales 250,192 Lease-related cost of goods sold (175,000) Leased-related interest revenue 19,019 Net income $294,211 (continued) 15-87

88 15-88

89 Treatment of Leases on Lessor s Statement of Cash Flows For 2013, American Manufacturing s cash flow from operations, using the indirect method, would appear as follows: Operating activities: Net income $294,211 Less: Increase in lease payments receivable ($250,192 $60,000 $40,981) (149,211) Plus: Decrease in finished goods inventory 175,000 Net cash flow from operating activities $320,

90 7. Prepare and interpret the lease disclosure required of both lessors and lessees Disclosure Requirements for Leases The required information supplements the amounts recognized in the financial statements and usually is included in a single note to the financial statements. The information listed on Slides and is required for all leases that have initial or remaining noncancelable lease terms in excess of one year

91 Disclosure Requirements for Leases Lessee 1. Gross amount of assets recorded as capital leases, along with related accumulated amortization. 2. Future minimum rental payments required as of the date of the latest balance sheet presented in aggregate and for each of the five succeeding fiscal years. 3. Rental expense for each period for which an income statement is presented. 4. A general description of the lease contracts, including information about restrictions on such items as dividends, additional debt, and further leasing. 5. For capital leases, the amount of imputed interest necessary to reduce the lease payments to present value

92 15-92

93 15-93

94 15-94

95 15-95

96 8. Compare the treatment of accounting for leases in the United States with the requirements of international accounting standards International Accounting of Leases IAS 17 relies on the exercise of accounting judgment to distinguish between operating and capital leases. A proposal, titled Accounting for Leases: A New Approach, notes that current lease accounting standards fail in their objective of requiring companies to recognize significant rights and obligations as assets and liabilities in the balance sheet

97 International Accounting of Leases This proposal suggests that the lease accounting rule be simplified as follows: All lease contracts are to be accounted for as capital leases

98 9. Record a sales-leaseback transaction for both a seller-lessee and a purchaserlessor Sale-Leaseback Transactions (Sale at a Gain) On January 1, 2013, Hopkins Inc. sells equipment having a carrying value of $750,000 to Ashcroft Co. for $950,000 and immediately leases back the equipment. Terms of the lease are: 1. The term of the lease is 10 years, noncancelable. A down payment of $200,000 is required plus equal lease payments of $107,107 at the beginning of each year. The implicit rate is 10%

99 Sale-Leaseback Transactions (Sale at a Gain) 2. The equipment has a fair value of $950,000 and an expected life of 20 years. Straightline depreciation is used. 3. Hopkins has an option to renew the lease for $10,000 per year for 10 years, the rest of its economic life. Title passes at the end of the lease. (continued) 15-99

100 (continued)

101 Sale-Leaseback Transactions (Sale at a Gain)