LeaseQuery. Your Easy Button For Lease Accounting. LeaseQuery.com

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1 LeaseQuery Your Easy Button For Lease Accounting

2 Capital Lease Accounting Under Current Accounting Standards Part 1 of 2

3 What To Expect What is a Capital Lease? Part 1 Four Criteria Strong-form or Weak-form? Free Lease Accounting Tools Part 2 Example

4 What is a Capital Lease? A lease in which the lessee records the leased asset as if it purchased the asset using funding provided by the lessor.

5 First Criterion Ownership of the underlying asset transfers to the lessee after the lease term

6 Second Criterion There is a bargain purchase option, meaning that the lessee has an option to buy the underlying asset after the lease term at a price that s substantially below its fair market value

7 Third Criterion The lease term is 75% or greater than the useful life of the underlying asset

8 Fourth Criterion The present value of the minimum lease payments is at least 90% of the fair value of the asset

9 Strong or Weak-Form? At LeaseQuery, we call capital leases that meet criterion 1 or 2 Strong-Form and leases that meet criterion 3 or 4 Weak-Form

10 Major Difference between Strong and Weak-Form In a strong-form lease, the underlying assets are depreciated over the useful life of the asset as if it were owned while for weak-form leases the assets are depreciated over the lease term

11 LeaseQuery Your Easy Button For Lease Accounting

12 Capital Lease Accounting Under Current Accounting Standards Part 2 of 2

13 Example Assume a company (lessee) signs a lease for a forklift with the following predicates: Fair value of the forklift is $16,000 Lease term is 3 years Monthly payments of $500/month paid in advance; $50 of the monthly payment is related to maintenance Interest rate a bank would charge this company for a $16,000 loan over 3 years is 4% Useful life of the forklift is 5 years At the end of the lease term, the company can purchase the forklift for $1,000, which is the estimated fair value at the end of the lease. Free Tool Use our free (click me) tool to help determine if this is a Capital or Operating lease

14 Capital vs Operating Lease Test At the end of the lease term, the company can purchase the forklift for $1,000, which is the estimated fair value at the end of the lease. The above information answers no to both criterion one and two, therefore this is not a strong-form capital lease and we must continue testing

15 Capital vs Operating Lease Test Lease term is 3 years Useful life of the forklift is 5 years Monthly payments of $500/month paid in advance; $50 of the monthly payment is related to maintenance **NOTE** Use payment of $450 instead of $500 because $50 of the payment is related to maintenance and deemed executory cost

16 Capital vs Operating Lease Test Interest rate a bank would charge this company for a $16,000 loan over 3 years is 4% Fair value of the forklift is $16,000

17 Capital vs Operating Lease Test After submitting all of the information; open the PDF summary to see the results As you can see, we have a capital lease because of the fourth test which shows that the present value of the minimum lease payments are greater than or equal to 90% of fair value of the asset

18 Journal Entries To Be Recorded To record the initial value of the lease, we need the present value of the minimum lease payment In the Free Tools section of our site; download the Present Value Calculation Tool to compute PV of the minimum lease payments. Enter the appropriate data and refresh the sheet to see amount to be booked, the entry will look like below:

19 Journal Entries To Be Recorded Two entries need to be recorded monthly The first entry will be to reduce the Capital Lease Liability, book Maintenance Expense, and record Cash Payment. Because the first cash payment is made at the beginning of the lease term, there is no interest to be recorded(1a), the subsequent month s entry will look like the second entry shaded light blue(2a) Monthly Entry 1: 1A: 2A:

20 Journal Entries To Be Recorded The second entry to be made monthly will be Depreciation Expense, which is straight lined from the present value of the minimum lease payments over the term of the lease 15, Months = **Note** This lease is a weak-form capital lease which means we depreciate over the term of the lease(36 months) instead of useful life(60 months) Monthly Entry 2:

21 Summary Capital vs Operating Lease Test Four Criteria Strong-form or Weak-form Journal Entries to be Recorded PV of Minimum Lease Payments Depreciation Expense Calculation