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1、Leases,15,McGraw-Hill/Irwin,Copyright 2011 by the McGraw-Hill Companies,Inc.All rights reserved.,Accounting by the Lessor and Lessee,A lease is an agreement in which the lessor conveys the right to use property,plant,or equipment,usually for a stated period of time,to the lessee.,Lessor=Owner of pro
2、perty,Capital Leases and Installment Notes Compared,Matrix,Inc.acquires equipment from Apex,Inc.by paying$193,878 every six months for the next three years.The interest rate associated with the agreement is 9%.Lets look at the arrangement as an installment note payable and as a capital lease agreeme
3、nt.First,lets prepare an amortization schedule for the payments.,Inception of the Agreement,At inception January 1,Installment NoteEquipment1,000,000Notes payable 1,000,000Capital LeaseLeased Equipment1,000,000Lease payable 1,000,000,Classification Criteria,Ownership transfers to the lessee at the e
4、nd of the lease term,or.A bargain purchase option(BPO)exists,or.The non-cancelable lease term is equal to 75%or more of the expected economic life of the asset,or.The PV of the minimum lease payments(MLP)is 90%or more of the fair value of the asset.,A capital lease must meet one of four criteria:,Op
5、erating Lease,Capital Lease,Classification Criteria,A bargain purchase option(BPO)gives the lessee the right to purchase the leased asset at a price significantly lower than the expected fair value of the property and the exercise of the option appears reasonably assured.,The lease term is normally
6、considered to be the non-cancelable term of the lease plus any periods covered by bargain renewal options.If the inception of the lease occurs during the last 25%of an assets economic life,this criterion does not apply.,For the lessee,a capital lease is treated as the purchase of an asset the lessee
7、 records both an asset and liability at inception of the lease.,Additional Lessor Conditions,Lessor=Owner of the property subject to the lease.,The four conditions discussed apply to both the lessee and lessor.However,the lessor must meet two additional conditions for the lease to be classified as e
8、ither a direct financing or sales-type lease:The collectibility of the lease payments must be reasonably predictable.If any costs to the lessor have yet to be incurred,they are reasonably predictable.Performance by the lessor is substantially complete.,U.S.GAAP vs.IFRS,Lease classification rules.Sam
9、e as IFRS.75%or more of assets life.“Substantially all means 90%or more.Title transfers.,Lease accounting under U.S.GAAP and IFRS provides a good general comparison of“rules-based accounting”as U.S.GAAP often is described and“principles-basedaccounting”which often is the description assigned to IFRS
10、.,Situations that normally would lead to classification as a finance lease are:Contains a BPOTerm is“major portion”of assets life.PV of MLP greater than“substantially all”of the fair value of the asset.Other circumstances impact classification.,Operating Leases,Criteria for a capital lease not met.,
11、Lease agreement exists.,Record lease as an Operating Lease.,CapitalLease,Operating Leases,On January 1,2011,Sans Serif Publishers,Inc.,a computer services and printing firm,leased a color copier from CompuDec Corporation.The lease agreement specifies four annual payments of$100,000 beginning January
12、 1,2011,the inception of the lease,and at each January 1 thereafter through 2014.The useful life of the copier is estimated to be six years.Before deciding to lease,Sans Serif considered purchasing the copier for its cash price of$479,079.If funds were borrowed to buy the copier,the interest rate wo
13、uld have been 10%.,San Serif Publishers,Inc.(Lessee)Prepaid rent100,000Cash 100,000CompuDec Corporation(Lessor)Cash100,000Unearned rent revenue 100,000,At End of the Four Payment Dates,Leasehold Improvements,Sometimes a lessee will make improvements to leased property that reverts back to the lessor
14、 at the end of the lease.Like other assets,leasehold improvement costs are allocated as depreciation expense over its useful life to the lessee,which is to be the shorter of the physical life of the asset or the lease term.,Capital Leases Lessee and Lessor,The amount recorded(capitalized)is the pres
15、ent value of the minimum lease payments.However,the amount recorded cannot exceed the fair value of the leased asset.,In calculating the present value of the minimum lease payments,the interest rate used by the lessee is the lower of:Its incremental borrowing rate,orThe implicit interest rate used b
16、y the lessor.,Capital Leases Lessee and Lessee,When the lessor is a manufacturer or dealer,the fair value of the property at the inception of the lease is likely to be its normal selling price.,If the lessor is not a manufacturer or dealer,the fair value of the leased asset typically is the lessors
17、cost.,Capital Leases Lessee and Lessor,On January 1,2011,Sans Serif Publishers,Inc.,leased a copier from First Lease Corp.First Lease purchased the equipment from CompuDec Corporation at a cost of$479,079.The lease agreement specifies annual payments beginning January 1,2011,the inception of the lea
18、se,and at each December 31 thereafter through 2015.The six year lease term ending December 31,2016,is equal to the estimated useful life of the copier.First Lease routinely acquires electronic equipment for lease to other firms.The interest rate In these financing arrangements is10%.Since the lease
19、term is equal to the expected useful life of the copier(75%),the transaction must be recorded by the lessee as a capital lease.We believe the collectibility of the lease payments is reasonably certain and any costs to the lessor that are yet incurred are reasonably predictable,this qualifies also as
20、 a direct financing lease to First Lease.To achieve its objectives,First Lease must(a)recover its$479,079 investment as well as(b)earn interest revenue at a rate of 10%.So,the lessor determined that annual rental payments would be$100,000.,$479,079 4.79079*=$100,000 rental payments.*PV of an annuity
21、 due of$1:n=6,I=10%$100,000 4,79079*=$479,079 lessees cost,Capital Leases Lessee and Lessor,Direct Financing Lease(January 1,2011),San Serif Publishers,Inc.(Lessee)Leased equipment(PV of payments)479,079Lease payable(PV of payments)479,079First Lease Corp.(Lessor)Lease receivable(PV of payments)479,
22、079Inventory of equipment(Lessors cost)479,079,First Lease Payment(January 1,2011),San Serif Publishers,Inc.(Lessee)Lease payable100,000Cash 100,000First Lease Corp.(Lessor)Cash100,000Lease receivable 100,000,Capital Leases Lessee and Lessor,Amortization Schedule for the Lease,$379,079 10%=$37,908,$
23、100,000-$37,908=$62,092,$379,079-$62,092=$316,987,Capital Leases Lessee and Lessor,Second Lease Payment(December 31,2011),San Serif Publishers,Inc.(Lessee)Interest expense37,908Lease payable62,092Cash 100,000First Lease Corp.(Lessor)Cash100,000Lease receivable 62,092Interest revenue 37,908,Depreciat
24、ion Recorded at(December 31,2011),San Serif Publishers,Inc.(Lessee)Depreciation expense 79,847Accumulated depreciation 79,847($479,079 6=$79,847 Assuming straight-line method.),Capital Leases Lessee and Lessor,Depreciation PeriodThe lessee normally should depreciate a leased asset over the term of t
25、he lease.However,if ownership transfers or a bargain purchase option is present(i.e.,either of the first two classification criteria is met),the asset should be depreciated over its useful life.,Sales-Type Leases,If the lessor is a manufacturer or dealer,the fair value of the leased asset generally
26、is higher than the cost of the asset.,At inception of the lease,the lessor will record the Cost of Goods Sold as well as the Sales Revenue(PV of payments).,In addition to interest revenue earned over the lease term,the lessor receives a manufacturers or dealers profit on the“sale”of the asset.,Sales
27、-Type Leases,On January 1,2011,Sans Serif Publishers,Inc.,leased a copier from CompuDec Corp.at a price of$479,079.The lease agreement specifies annual payments of$100,000 beginning January 1,2011(the inception of the lease),and at each December 31 thereafter through 2015.The six year lease term end
28、ing December 31,2016,is equal to the estimated useful life of the copier.CompuDec manufactured the copier at a cost of$300,000.CompuDecs interest rate for financing the transaction is10%.,Sales-Type Leases,Lease Classification,The lease term(6-years)is equal to 100%of the useful life of the copier,a
29、ndFair market value is difference from cost of the leased asset.CompuDec is certain about the collectibility of the lease payments,andNo costs are to be incurred by CompuDec relating to the lease agreement,SOThe lease agreement is classified as a Sales-Type lease from the viewpoint of CompuDec(lesso
30、r)and a capital lease from the viewpoint of Sans Serif Publishers(lessee).,Sales-Type Leases:Lessee,At inception of the Lease January 1,2011CompDec Corp.(Lessor)Lease receivable479,079Cost of goods sold300,000Sales revenue 479,079Inventory of equipment 300,000Receipt of the First Lease Payment Janua
31、ry 1,2011CompDec Corp.(Lessor)Cash100,000Lease receivable 100,000,Bargain Purchase Optionsand Residual Value,A bargain purchase option(BPO)is a provision of some lease contracts that gives the lessee the option of purchasing the leased property at a bargain price.The expectation that the option pric
32、e will be paid effectively adds an additional cash flow to the lease for both the lessee and the lessor.As a result:,LESSEE adds the present value of the BPO price to the present value of periodic rental payments when computing the amount to be recorded a leased asset and a lease liability.LESSOR,wh
33、en computing periodic rental payments,subtracts the present value of the BPO price from the amount to be recovered(fair value)to determine the amount that must be recovered from the lessee through the periodic rental payments.,Bargain Purchase Option(BPO),On January 1,2011,Sans Serif Publishers,Inc.
34、,leased a color copier from CompuDec Corporation at a price of$479,079.The lease agreement specifies annual payments beginning January 1,2011,the inception of the lease,and at each December 31 there after through 2015.The estimated useful life of the copier is seven years.On December 31,2016,at the
35、end of the six year lease term,the copier is expected to be worth$75,000,and Sans Serif has the option to purchase it for$60,000 on that date.The residual value after seven years is zero.CompuDec manufactured the copier at a cost of$300,000 and its interest rate for financing the transaction is10%.,
36、Bargain Purchase Option(BPO),Exercise of BPO at the end of the lease term:$54,542 10%=$5,458*$60,000 BPO payment-$5,458=$54,542,Bargain Purchase Option(BPO),End of Lease December 31,2016Sans Serif Publishers,Inc.(Lessee)Depreciation expense($479,079 7)68,440Accumulated depreciation68,440Interest exp
37、ense 5,458Lease payable 54,542Cash(BPO payment)60,000CompDec Corporation(Lessor)Cash60,000Lease receivable 54,582Interest revenue 5,458,Refer the amortization schedule and computations on the previous screen,Residual Value,The residual value of leased property is an estimate of what its commercial v
38、alue will be at the end of the lease term.,On January 1,2011,Sans Serif Publishers,Inc.,leased a color copier from CompuDec Corporation at a price of$479,079.The lease agreement specifies annual payments beginning January 1,2011,the inception of the lease,and at each December 31 thereafter through 2
39、015.The estimated useful life of the copier is seven years.At the end of the six year lease term,ending December 31,2016,the copier is expected to be worth$60,000.CompuDec manufactured the copier at a cost of$300,000 and its interest rate for financing the transaction is10%.,Effect on the Lessee of
40、a Residual Value,Guaranteed Residual Value,Sometimes 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.This not only reduces the lessors risk but also provid
41、es incentive for the lessee to exercise a higher degree of care in maintaining the leased asset to preserve the residual value.,PV factor of an annuity due of$1:n=6,i=10%,PV factor of$1:n=6,i=10%,Effect on the Lessee of a Residual Value,Unguaranteed Residual Value,A lease agreement may be silent as
42、to the question of residual value.This is referred to as an unguaranteed residual value.In the case of unguaranteed residual value,the lessee is not obligated to make any payments other than the periodic rental payments.As a result,the present value of the minimum lease payments recorded as a leased
43、 asset and a lease liability is simply the present value of periodic rental payments($445,211).The same is true when the residual value is guaranteed by a third-party guarantor such as an insurance company.,Effects on the Lessor of a Residual Value,Guaranteed Residual Value,When the residual value i
44、s guaranteed,the lessor as well as the lessee views it as a component of minimum lease payments.In fact,even if it is not guaranteed,the lessor still expects to receive it in the form of property,or cash,or both.,Residual Value Guaranteed,Lets use our previous example of a sales-type lease and repla
45、ce the bargain purchase option with a guaranteed residual value.,Sales-Type Lease January 1,2011San Serif Publishers,Inc.(Lessee)Leased equipment479,079Lease payable 479,079CompDec Corporation(Lessor)Lease receivable479,079Cost of goods sold300,000Sales revenue 479,079Inventory of equipment 300,000,
46、Residual Value Guaranteed,First Lease Payment January 1,2011San Serif Publishers,Inc.(Lessee)Lease payable92,931Cash92,931CompDec Corporation(Lessor)Cash92,931Lease receivable 92,931,Residual Value Guaranteed,December 31,2015San Serif Publishers,Inc.(Lessee)Depreciation expense68,847Accumulation dep
47、reciation68,847Interest expense13,407Lease payable79,524Cash92,931CompDec Corporation(Lessor)Cash92,931Interest revenue13,407Lease receivable 79,524,See amortizationschedule,Treatment of Residual Value,Executory Costs,One of the responsibilities of ownership that is transferred to the lessee in a ca
48、pital lease is the responsibility to pay for maintenance,insurance,taxes,and any other costs associated with ownership.These are referred to as executory costs.,The lessee records executory costs as incurred:,Sans Serif Publishers,Inc.(Lessee)Maintenance expense2,000Cash2,000,Discount Rate,One rate
49、is implicit in the lease agreement.This is the effective interest rate the lease payments provide the lessor over and above the price at which the asset is sold under the lease.It is the desired rate of return the lessor has in mind when deciding the size of the lease payments.Usually the lessee is
50、aware of the lessors implicit rate or can infer it from the assets fair value.When the lessors implicit rate is unknown,the lessee should use its own incremental borrowing rate.This is the rate the lessee would expect to pay a bank if funds were borrowed to buy the asset.,Lessors Initial Direct Cost
