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2012-10-24 Accounting for Leases
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2012-10-24 Accounting for Leases

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    Mr. Bernard butty
    Email: leasebutty.bg@gmail.com
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  • A RELIABLE AND A GENUINE PROVIDER THAT CAN DELIVER BANK GUARANTEE AND OTHER FORM OF BANKING INSTRUMENTS FOR LEASE WHICH ARE MAINLY FRESH CUT.

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    Email: mklease.broker@gmail.com
    Skype ID: mklease.broker
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  • 1. Accounting for Leases - Basics and Updates Angelo Hermosura, Audit Manager October 24, 2012Thrive. Grow. Achieve.
  • 2. ACCOUNTING FOR LEASES – BASICS AND UPDATES • EVALUATION WHETHER AN ARRANGEMENT CONTAINS A LEASE • LEASE DEFINITION (FASB ASC 840) • LEASE CLASSIFICATION CRITERIACOURSE • OPERATING LEASEOBJECTIVES/ • LEASE MODIFICATIONSSUMMARY • LEASEHOLD IMPROVEMENTS IN AN OPERATING LEASE • CAPITAL LEASE • DEVELOPMENTS IN LEASE ACCOUNTING Page 2
  • 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 minorEVALUATION amount of the output or other utility that will be produced or generated by the assetWHETHER ANARRANGMENT ARRANGEMENTS THAT DO NOT QUALIFY AS LEASESCONTAINS A • Agreements that are contracts for services that do not transfer the right to use theLEASE 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. Page 3
  • 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.LEASEDEFINITIONUNDER FASBASC 840 Page 4
  • 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:LEASECLASSIFICATION OPERATING LEASECRITERIA 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 Page 5
  • 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 isLEASE sufficiently lower than the expected fair value of the asset at the time the option becomes exercisableCLASSIFICATIONCRITERIA 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. Page 6
  • 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 usefulLEASE 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 incrementalCLASSIFICATION 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 Page 7
  • 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:LEASECLASSIFICATION Total Payment Maintenance Yearly Minimum Lease PaymentsCRITERIA $ 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% Page 8
  • 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.OPERATINGLEASES 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 Page 9
  • 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.OPERATINGLEASES(LESSEES) Page 10
  • 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 OctoberOPERATING 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. Page 11
  • 12. ACCOUNTING FOR LEASES – BASICS AND UPDATES EXAMPLE – STRAIGHT LINE CALCULATION (CONTINUED) Monthly Rent 1,500 Lease incentive 3,000 Rent Increase starting Jan. 2013 10% Straight-Line Monthly Rent 1,555 Month # Monthly Payment Straight-Line Rent Deferred Rent Cumulative Deferred Rent Sep-12 1 - 1,555 1,555 1,555 Oct-12 2 - 1,555 1,555 3,110 Nov-12 3 1,500 1,555 55 3,165 Dec-12 4 1,500 1,555 55 3,220OPERATING Jan-13 5 1,650 1,555 (95) 3,125LEASES Feb-13 6 1,650 1,555 (95) 3,030 Mar-13 7 1,650 1,555 (95) 2,935(LESSEES) Apr-13 8 1,650 1,555 (95) 2,840 May-13 9 1,650 1,555 (95) 2,745 Jun-13 10 1,650 1,555 (95) 2,650 Jul-13 11 1,650 1,555 (95) 2,555 How much is Aug-13 12 1,650 1,555 (95) 2,460 Sep-13 13 1,650 1,555 (95) 2,365 current portion Oct-13 14 1,650 1,555 (95) 2,270 of deferred rent? Nov-13 15 1,650 1,555 (95) 2,175 Dec-13 16 1,650 1,555 (95) 2,080 Jan-14 17 1,815 1,555 (260) 1,820 Feb-14 18 1,815 1,555 (260) 1,560 Mar-14 19 1,815 1,555 (260) 1,300 Apr-14 20 1,815 1,555 (260) 1,040 May-14 21 1,815 1,555 (260) 780 Jun-14 22 1,815 1,555 (260) 520 Jul-14 23 1,815 1,555 (260) 260 Aug-14 24 1,815 1,555 (260) (0) TOTAL 37,320 37,320 Page 12
  • 13. ACCOUNTING FOR LEASES – BASICS AND UPDATES EXAMPLE – STRAIGHT LINE CALCULATION (CONTINUED) ENTRIES: 1) Loss on Pre-Existing Lease $3,000 Incentive from Lessor $3,000OPERATING 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). Page 13
  • 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 theOPERATING 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 isLEASE – 15 years. ENTRIESLEASEHOLDIMPROVEMENTS 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 Page 14
  • 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 leaseMODIFICATIONS 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 Page 15
  • 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 needOPERATING 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. Page 16
  • 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. Page 17
  • 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 accruableCAPITAL 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) Page 18
  • 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 lessors 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 lessees 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. Page 19
  • 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 $6,050CAPITAL 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) Page 20
  • 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) $5,000CAPITAL 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 Page 21
  • 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 sheetCAPITAL LEASE presented, in the aggregate and for each of the five succeeding fiscal yearsDISCLOSURE - with separate deductions from the total for amount representing executory costs included in theREQUIREMENTS 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 Page 22
  • 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 LEASEDISCLOSUREREQUIREMENTS(LESSEE) Page 23
  • 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 paymentsDEVELOPMENTS • Income Statement to have amortization and interest expensesIN ACCOUNTINGFOR LEASES Page 24
  • 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 evenDEVELOPMENTS • Expense pattern based on how the lessee consumes or uses the assetIN ACCOUNTINGFOR LEASES • Straight-line expense over the lease term Page 25
  • 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 2013IN ACCOUNTINGFOR LEASES • Effective date to be determined • Deferral for nonpublic companies for another 1 or two years is likely Page 26
  • 27. ACCOUNTING FOR LEASES – BASICS AND UPDATES RECOMMENDED PREPARATIONS • Perform an inventory of all leases • Assess the impact of the proposed standard to financial covenantsDEVELOPMENTS • Assess the impact on cost recovery arrangements (most particularly onIN ACCOUNTING NFP’s)FOR LEASES • Discuss with auditors these potential impacts Page 27