Stock Market Brief Deck for "this does not happen often".pdf
2012-10-24 Accounting for Leases
1. Accounting for
Leases - Basics
and Updates
Angelo Hermosura, Audit Manager
October 24, 2012
Thrive. Grow. Achieve.
2. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
• EVALUATION WHETHER AN ARRANGEMENT CONTAINS A LEASE
• LEASE DEFINITION (FASB ASC 840)
• LEASE CLASSIFICATION CRITERIA
COURSE • OPERATING LEASE
OBJECTIVES/ • LEASE MODIFICATIONS
SUMMARY
• LEASEHOLD IMPROVEMENTS IN AN OPERATING LEASE
• CAPITAL LEASE
• DEVELOPMENTS IN LEASE ACCOUNTING
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3. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
ARRANGEMENTS THAT QUALIFY AS LEASES
• The purchaser has the ability or right to operate the asset
• The purchaser has the ability or right to control physical access to the asset
• It is remote that one or more parties other than the purchaser will take than a minor
EVALUATION amount of the output or other utility that will be produced or generated by the asset
WHETHER AN
ARRANGMENT ARRANGEMENTS THAT DO NOT QUALIFY AS LEASES
CONTAINS A • Agreements that are contracts for services that do not transfer the right to use the
LEASE asset from one contracting party to the other.
• Assets are not the subject of a lease if fulfillment of the arrangement is not
dependent on the use of the specified asset in an arrangement.
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4. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
WHAT IS A LEASE?
An agreement conveying the right to use property, plant, or equipment (land and/or
depreciable assets) usually for a stated period of time.
LEASE
DEFINITION
UNDER FASB
ASC 840
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5. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
OPERATING LEASE VERSUS CAPITAL LEASE
A lessee and a lessor
shall consider whether
a lease meets ANY of
the following criteria:
LEASE
CLASSIFICATION
OPERATING LEASE
CRITERIA
NO
Present Value of
Transfer of Bargain Purchase Lease Term is = or > 75%
Minimum Lease
of Asset’s Estimated
Payments is = or > 90% of
Ownership Option Economic Life
Fair Value of Asset
YES YES YES YES
CAPITAL LEASE
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6. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
DEFINITION OF TERMS:
1) Transfer of Ownership – transfer of title at the end of the lease or shortly after the
lease term
2) Bargain Purchase Option – Option to purchase the asset for a price that is
LEASE sufficiently lower than the expected fair value of the asset at the time the option
becomes exercisable
CLASSIFICATION
CRITERIA 3) Lease Term – Fixed non-cancelable lease term plus “periods covered by renewal
options” subject to certain qualifications
4) Estimated Economic Useful Life – Estimated remaining period during which the
asset is expected to be economically usable, with normal repairs and maintenance
5) Minimum Lease Payments – Payments that the lessee is obligated to make or can
be required to make in connection with the leased property excluding contingent
rentals and executory costs but including payment called for by the bargain
purchase option
6) Fair Value of Asset – The price for which the leased property could be sold in an
arms-length transaction between unrelated parties.
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7. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
EXAMPLE – DETERMINATION OF OPERATING LEASE VERSUS CAPITAL LEASE
On August 31, 2012 (lease commencement date), BB & Co. (Lessee) entered into an
arrangement with Company B (Lessor) to use Company B’s photocopying machine
for an annual payment of $1,143 for a period of 3 years (noncancelable), due at the
beginning of the lease commencement date. The annual payment of $1,143
includes an annual fixed maintenance fee of $143. The machine’s estimated useful
LEASE life at the lease commencement date was 5 years. Based on BB’s research, the fair
value of the machine is approximately $3,200. Assume that the incremental
CLASSIFICATION borrowing rate applicable is 5%.
CRITERIA Test of Criteria:
1) Transfer of Ownership?
NO
2) Bargain Purchase Option?
NO
3) Lease Term is 75% or more of machine’s useful life?
NO , only 60% (3 years divided by 5 years)
4) Present value of all minimum lease payments is 90% or more of machine’s fair value?
NO (see next slide for the calculation)
CONCLUSION: OPERATING LEASE
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8. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
EXAMPLES – DETERMINATION OF OPERATING VERSUS CAPITAL
LEASE
Example 1, Test of Criteria (continued)
The following is the calculated present value of the total minimum lease payments:
LEASE
CLASSIFICATION
Total Payment Maintenance Yearly Minimum Lease Payments
CRITERIA
$ 1,143 $ 143 $ 1,000
$ 1,143 $ 143 $ 1,000
$ 1,143 $ 143 $ 1,000
$ 3,429 $ 429 $ 3,000
PV of Minimum Lease Payments =PV(0.05,3,-1000,1) $2,859.41
Divided by: Fair Value of Machine 3,200.00
% of PV over Fair Value 89%
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9. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
LEASE EXPENSE RECOGNITION
• Rent payments are charged to expense over the lease term
• Rent expense is recognized on a straight-line basis unless another systematic and rational
basis is representative of the time pattern in which use benefit is derived from the asset.
OPERATING
LEASES
RENT ESCALATIONS
(LESSEES)
•Scheduled rent increases as part of minimum lease payments
•Factors such as time value of money, anticipated inflations or expected future revenues to
allocate scheduled rent increases is inappropriate
LEASE INCENTIVES
•Payments made to or on behalf of the lessee
•Losses incurred by the lessor as a result of assuming a lessee’s preexisting lease with a
third party
•Recognized as reductions of rental expense on a straight-line basis over the term of the
lease
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10. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
SUB-LEASE
• If sublease arrangement does not relieve the original lessee of the primary obligation under the
original operating lease, the sublessor shall account for the original and sublease as operating
leases.
• Loss should be recognized by the sublessor, if costs expected to be incurred under the sublease
arrangement exceed the anticipated revenue.
OPERATING
LEASES
(LESSEES)
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11. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
EXAMPLE – STRAIGHT LINE CALCULATION
On September 1, 2012, the ABC Corp. entered into a noncancelable lease agreement for 2
years with EFG Corp. for an equipment which will economically last for 7 years. Monthly
payments of $1,500 is required commencing on September 1, 2012. Monthly payments
starting January 2013 increases by 10% and another 10% increase by January 2014. However,
ABC Corp. was provided with 3 months of free rent from September 2012 through October
OPERATING 2012. ABC Org.’s year-end is December 31.
LEASE
ABC Corp. has a previous lease agreement with a third party. EFG Corp. assumed the
(LESSEES) remaining payments required on this previous lease totaling $3,000 on behalf of ABC Corp.
Assume that after all the analysis made by ABC Corp., the lease was determined to be
classified as an operating lease.
Instruction: Prepare the entries in 2012 to record the above transactions.
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13. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
EXAMPLE – STRAIGHT LINE CALCULATION (CONTINUED)
ENTRIES:
1) Loss on Pre-Existing Lease $3,000
Incentive from Lessor $3,000
OPERATING To record the incentive on the pre-existing lease assumed by the lessor.
LEASES
(LESSEES)
2) Incentive from Lessor $500 ($3,000/24 x 4 months)
Rent Expense $500
To record the lease incentive as reduction in rent expense over the lease term.
3) Rent Expense $6,220
Cash $3,000
Deferred Rent - current $1,140
Deferred Rent - noncurrent $2,080
To record the rent expense in 2012 (4 months).
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14. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
LEASEHOLD IMPROVEMENTS IN AN OPERATING LEASE
• Amortized over the shorter of the useful life of the assets or the term that includes the required lease periods and
renewals that are deemed to be reasonably assured.
• Allowance for leasehold improvement as lease incentives – recognized as reduction in rent expense
EXAMPLE:
Lessee A enters into a lease (accounted for as an operating lease) with Lessor B for a 5-year term at a yearly rental of
$1,000 with renewal term of another 5 years which is reasonably assured. In order to induce Lessee A to enter into the
OPERATING lease, Lessor B agrees to provide upfront funding of up to $500 for leasehold improvements. Lessee A spends $700 on
leasehold improvements that are based on Lessee A’s unique specifications. Leasehold improvements economic life is
LEASE – 15 years.
ENTRIES
LEASEHOLD
IMPROVEMENTS To record the lease incentive:
(LESSEES) Cash
Lease Incentive Obligation
$500
$500
To record the leasehold improvement:
Leasehold Improvements $700
Cash $700
To record the rent expense and amortization of lease incentive obligation on a yearly basis:
Rent expense $950
Lease incentive Obligation ($500/10 years) $ 50
Cash $1,000
To record the amortization of leasehold improvements on a yearly basis:
Amortization expense – Leasehold Improvements $70
Accumulated amortization – Leasehold Improvements $70
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15. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
LEASE MODIFICATIONS - ILLUSTRATIVE EXAMPLE:
Entity A leases an asset under an operating lease for use in its operations for a period of 8 years.
Before the expiration of the original lease term, the lessee and lessor agree to modify the lease by
shortening the lease term and increasing the payments over the shortened lease period. The
modifications did not change the lease classification and no other changes were made to lease.
LEASE
Assumed that starting in year 3, Entity A’s lease term was shortened from 8 to 5 years and the lease
MODIFICATIONS payments increased from $5,000 per year to $7,000 per year. Based on comparable market rents, the
asset can be leased between $4,500 and $5,500 per year.
Question:
1) How should the lease modification be accounted for.
Answers:
1) The lease modification represents a termination penalty because the lease term was significantly
shortened and the amended lease payment was significantly higher than comparable market rent.
2) The amount that should be charged to operations is as follows:
Modified Lease Payments per year $7,000
Less: Original Lease Payments per year $5,000
Increase in Lease Payments per year $2,000
Multiply by: Shortened period (remaining) 3 (5 years less 2 years gone)
Amount to be charged to operations $6,000
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16. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
FOR ALL OPERATING LEASES:
• Rental expense for each period for which an income statement is presented
• Separate amounts for minimum rentals, contingent rentals and sublease rentals
• Rental payments under leases with terms of a month or less that were not renewed need
OPERATING not be included.
LEASES –
DISCLOSURE FOR OPERATING LEASES WITH INITIAL OR REMAINING NONCANCELABLE LEASE TERMS
IN EXCESS OF ONE YEAR:
REQUIREMENTS
(LESSEES) • Future minimum rental payments required as of the date of the latest balance sheet
presented, in the aggregate and for each of the five succeeding fiscal years
•Total minimum rentals to be received in the future under noncancelable subleases as of the
date of the latest balance sheet presented.
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17. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
EXAMPLE DISCLOSURE:
On May 1, 2009, Top 3% & Co. (the Company), entered into a five-year equipment lease that expires in May 2014 and
requires a monthly rental payment of $646. In November 1, 2009, the Company also entered into another five-year
equipment lease that extends through May 2014 and requires a monthly rental payment of $3,418. Rent expense totaled
$41,212 and $26,839 for the years ended September 30, 2011 and 2010.
The Company leases office and maintenance facilities from a limited partnership that is wholly owned by the
stockholders of the company. The lease extends through March 2013. Rent expense totaled $312,000 for each of the
years ended September 30, 2011 and 2010, which represents annual rent paid to the related party in each fiscal year.
OPERATING
Rent expense for all leases totaled $353,312 and $338,839 for the years ended September 30, 2011 and 2010.
LEASES –
DISCLOSURE As of September 30, 2011, future minimum lease payments required under these leases are as follows:
REQUIREMENTS For the year ending September 30,
(LESSEES) 2012 $ 378,029
2013 180,165
2014 48,770
2015 42,766
Total $ 649,730
The Company subleases office and maintenance facilities to a corporation that is wholly owned by the stockholders The
subleases commenced on July 1, 2009, and expire on December 31, 2012. The payments under these subleases totaled
$120,000 per year.
As of September 30, 2011, future minimum lease payments to be received under these leases are as follows:
For the year ending September 30,
2012 $120,000
2013 30,000
Total $150,000
Total rent income on the subleases amounted to $120,000 for each of the years ended September 30, 2011 and 2010.
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18. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
CAPITAL LEASE - RECOGNITION
• The lessee shall recognize a capital lease as an asset and an obligation
• Contingent rentals shall be included by a lessee in the determination of income as
accruable
CAPITAL LEASE
• Capital lease asset and capital lease obligation equivalent to the present value at the
(LESSEES) beginning of the lease term of minimum lease payments during the lease term excluding
executory costs
• If the present value of the minimum lease payments exceeds the fair value of the leased
property at lease inception, the amount measured initially as the asset and obligation should
be the fair value (fair value should consider escalations in minimum lease payments, if any)
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19. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
EXAMPLE
The lease has a fixed noncancelable term of 30 months, with a rental of $135 payable at the
beginning of each month. The lessee guarantees the residual value at the end of the 30-month
lease term in the amount of $2,000. The lessee is to receive any excess of sales price of property
over the guaranteed amount at the end of the lease term. The lessee pays executory costs (not
included in the $135). The rentals specified are deemed to be fair rentals (as distinct from bargain
rentals), and the guarantees of the residual value are expected to approximate realizable values.
CAPITAL LEASE
(LESSEES) The lessor's cost of the leased property (automobile) is $5,000, the fair value of the leased
property at inception of the lease (1/1/2012) is $5,000, and the estimated economic life of the
leased property is 5 years.
The residual value at the end of the lease term is estimated to be $2,000. The lessee depreciates
its owned automobiles on a straight-line basis. The lessee's incremental borrowing rate is 10.5
percent per year. There were no initial direct costs of negotiating and closing the transaction. At
the end of the lease term the asset is sold for $2,100.
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20. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
EXAMPLE (CONTINUED)
Calculation of Minimum Rental Payments
Minimum rental payments over the lease term ($135 x 30 months) $4,050
Add: Lessee’s guarantee of the residual value at the end of the lease term $2,000
Total minimum lease payments $6,050
CAPITAL LEASE
(LESSEES) Calculated present Value using incremental borrowing rate of 10.5% per year.
Rental payments $3,580
Add: Residual guarantee by lessee $1,540
Total present value $5,120
Note: Present Value is 102% of the fair value ($5,120 divided by $5,000)
Question: Which amount should be used to capitalize the leased asset: $5,120 or $5,000
Answer: $5,000 – because fair value of the leased asset is lower than the present value of total
minimum lease payments (per FASB ASC 840-30-30-1 to 4)
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21. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
EXAMPLE (CONTINUED)
ENTRIES
To record the capital lease at fair value:
Leased property under capital leases (asset) $5,000
Obligations under capital leases (liability) $5,000
CAPITAL LEASE To record first month’s rental payment:
(LESSEES) Obligations under capital leases $135
Cash $135
To record the interest expense at the end of the first month:
Interest expense $ 49
Accrued interest on obligations under capital lease $ 49
NOTE: In the second month, the $135 payment will be allocated between principal and interest.
To record the depreciation expense of the leased property:
Depreciation expense – leased property $100 ($5,000-$2,000 divided by 30)
Leased Property under Capital Leases $100
To record the sale of the leased property:
Cash $ 100
Obligations under capital leases $2,000
Leased Property under Capital Leases $2,000
Gain on disposition of leased property $ 100
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22. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
DISCLOSURE REQUIREMENTS
• Gross amount of assets recorded under capital assets as of the date of each
balance sheet presented (by major classes according to nature or function)
• Future minimum lease payments as of the date of the latest balance sheet
CAPITAL LEASE presented, in the aggregate and for each of the five succeeding fiscal years
DISCLOSURE
- with separate deductions from the total for amount representing executory costs included in the
REQUIREMENTS amount of minimum lease payments and for the amount of imputed interest necessary to reduce the net
(LESSEE) minimum lease payments to present value
• Total minimum sublease rentals to be received in the future under
noncancelable subleases as of the date of the latest balance sheet presented
• Total contingent rentals actually incurred for each period for which an
income statement is presented
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23. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
ILLUSTRATIVE SAMPLE DISCLOSURE
The following is a schedule by years of future minimum lease payments under
capital leases together with the present value of the net minimum lease
payments as of December 31, 1976.:
CAPITAL LEASE
DISCLOSURE
REQUIREMENTS
(LESSEE)
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24. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
LEASE PROJECT (FOR LESSEES)
• Right of Use Model
• Balance sheet to have the right to use asset and liability to make payments
DEVELOPMENTS • Income Statement to have amortization and interest expenses
IN ACCOUNTING
FOR LEASES
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25. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
FOUR APPROACHES IN LEASE ACCOUNTING
• Front loaded interest and amortization expenses
• Straight-line expense pattern – consumption and payments are even
DEVELOPMENTS • Expense pattern based on how the lessee consumes or uses the asset
IN ACCOUNTING
FOR LEASES • Straight-line expense over the lease term
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26. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
TIMEFRAME
• Updated exposure draft to be available later in 2012
• Comment period is likely to be 120 days (depending on extent of change)
DEVELOPMENTS • Final standard expected to be released in 2013
IN ACCOUNTING
FOR LEASES • Effective date to be determined
• Deferral for nonpublic companies for another 1 or two years is likely
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27. ACCOUNTING FOR LEASES – BASICS
AND UPDATES
RECOMMENDED PREPARATIONS
• Perform an inventory of all leases
• Assess the impact of the proposed standard to financial covenants
DEVELOPMENTS • Assess the impact on cost recovery arrangements (most particularly on
IN ACCOUNTING NFP’s)
FOR LEASES
• Discuss with auditors these potential impacts
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