Chapter 21 Class Notes
Chapter 21 Class Notes Acc 302
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This 6 page Class Notes was uploaded by Lauren95 on Wednesday April 6, 2016. The Class Notes belongs to Acc 302 at Pace University taught by Reisig in Spring 2016. Since its upload, it has received 11 views. For similar materials see Intermediate Accounting II in Accounting at Pace University.
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Date Created: 04/06/16
Chapter 21 – Leases (Major Chapter on the Final exam) Leases are when one company rent something (asset) from another It is referred to as a rental transaction – they sign a rental agreement also known as a lease. The person or company that owns the asset and collects rent on that asset is known as the lessor. The person or company that is doing the purchasing is known as the lessee. Operating Leases: Lessee : Lessor: Rent Expense Cash Cash Rent Revenue(income) OR OR Prepaid Rent Pay rent early Cash Cash Unearned rent When you receive: Unearned Rent Rent income(revenue) Capital Leases: Lessee: o If the purpose of your transaction is to get the future benefit without owning it Capital Lease o Treat it as if you own asset even if you legally don’t o Ignore rent – don’t treat asset as if you are renting it o Should show up in Property, Plant, and Equipment side of the balance sheet. o 4 Criteria for capital leases: *Use in order* o Only need to meet the requirements of one. (1) Transfer of Ownership Transfer of title Ownership of asset at end of lease (2) Bargain Purchase Option Lessee can purchase at a bargain price from lessor for significantly less. Leads to lessee owning the asset in the end. (3) If lease term is 75% or more than life of asset Lessee will get most of the benefits of owning the asset (4) Present value (todays worth) of minimum lease payments if 90% or more of FMV of assets. Treat as if we bought the asset o Like we bought today – Use PV tables o Have to figure out PV and minimum lease. Leased Equipment Obligations – C/L We depreciate the equipment: When we borrow we pay interest: Dep exp Obligation – C/L A/Dep Int Exp Cash In capital lease there is no rent expense. Act like you own the asset. Ordinary Annuity vs Annuity Due o Ordinary annuity is when the payment occurs at the end of the period. o Annuity due is when the payment occurs at the beginning of the year. Use the incremental borrowing rate unless you know the lessor interest rate and it is lower, then use the lessor interest rate. Criteria for Depreciation: o If you met criteria 1+2 above – Use life of asset o If you did not meet criteria 1+2 above – life of lease Example: Read through lease and this is what was discovered: (1) --------- Transfer (2) --------- Bargain (3) 5 year lease, 5 year life (4) FMV = 100,000 -Payments are due at the beginning of each year. (After reading this you can conclude that you need to use they annuity due table. ) -Payments $25,981. 82 each year -Includes insurance on assets of $2,000 year executory costs -Incremental bargaining rate = 11% / year -Lessors implicit rate 10% Gross payments – Executive costs = 25,981.82 – 2,000 = 23,981.82 *Only do this because insurance costs was included in the gross payment (4) PV of an annuity due: Payment 23,981.82 x 4.16986 (Get from table) PV min payment 100,000 FMV Asset 100,000 *PV is 100% of FMV asset = capital lease contract 1/1/16 Leased Equipment 100,000 Obligation – C/L 100,000 1/1/16 Date Payment Int Principle Obligation 1/1/16 ----- ------ -------- 100,000 1/1/16 23981.62 0 23981.62 76018 1/1/17 23981.62 7602 16380 59638 1/1/18 23981.62 5964 18018 59638 1/1/19 23981.62 4162 19820 21800 1/1/20 23981.62 2180 21800 0 1/1/16 Obligation – C/L 23928 Insur exp 2,000 Cash 25982 12/31/2016 Interest exp 7602 Interest Pay 7602 12/31/16 Depreciation Exp 20,000 (100,000-0)/5 = (Cost – Salv)/Life A/Dep 20,000 1/1/17 Obligation – C/L 16380 Int Pay 7602 Insurance 2000 Cash 25982 12/31/17 Interest exp 5964 Int Pay 5964 12/31/17 Depreciation Exp 20,000 (100,000-0)/5 = (Cost – Salv)/Life A/Dep 20,000 Bargain Purch Option – lessee will take advantage o Minimum payment will be different $5000 bargain purch 23981.62 5,000 We will pay this 5 times x 4.16986 x .62092 We will pay this only once 100,000 3105 $103,105 *Amortization table starts at $103105 also add an extra line for the onetime payment (the extra line is below) Date Payment Int Principle Obligation 12/31/20 5000 X X X Guarantee Residual Value (salvage value) o The asset will be $X at the end of the lease. Still has some value to it. It’s a guarantee, treat as if it’s a bargain purchase agreement. Add into minimum lease payments. o Exclude unguaranteed residual values – not included *problems will tell you o Any residual value it is in the depreciation equation: Cost – Salv = Cost – guarantee residual Life Life Lessor: o Act as if they are selling or sold the asset. o Record “Interest income” Off balance sheet financing: o Companies had a lot of liabilities o This led to misleading statements, so they had to find a way to record these rental assets. o Decided to reduce those liabilities. In order to do that they created leases. The leases were to ensure the assets they were renting were showing up on the asset side of the balance sheet. Lessor does exactly the opposite of the lessee. o Act as if they sell it. o Record “interest income” Has a choice between leases: o Operating – the lease has not been transferred o Capital – the lease is being transferred Treat as you sold the asset. But you haven’t collected money yet – “lease receivable” Interest is also included – “interest income” Capital Lease Criteria: (1) Transfer of Ownership Transfer of tite Ownership of asset at end of lease (2) Bargain Purchase Option Lessee can purchase at a bargain price from lessor for significantly less. Leads to lessee owning the asset in the end. (3) If lease term is 75% or more than life of asset Lessee will get most of the benefits of owning the asset (4) Present value (todays worth) of minimum lease payments if 90% or more of FMV of assets. Treat as if we bought the asset o Like we bought today – Use PV tables o Have to figure out PV and minimum lease. There is additional criteria: (1) Collectability Certain o Confident they will collect all money. o Reasonably assured (2) No further costs to be incurred by lessor o Have to be finished with asset o Both of these criteria have to be met o Completely ignore the incremental late because you only know the lessor rate. Always use the lessor rate More than one Capital Lease: o Direct Finance Lease No dealer profit Ex: Equipment – company doesn’t want to do anything but sells it. Bank goes to the factory and pay the price. No profit. 1 type of income o Sales Type Lease There is a dealers profit Ex: Car leases – profit involved Two types of income Include profit in journal entry o Dealers profit = FMV vs. Cost FMV $100,000 Pay $25,981.62 S/L method Cost $100,000 Insurance $2,000 Lessors rate 10% 5 years term Pay at the beginning 5 years life 1/1/16 Date Pay Int (10%) Recovery Net Investment 1/1/16 100,000 1/1/16 23,982 --- 23,982 76018 1/1/17 23,982 7602 16,380 59,638 1/1/18 23,982 5964 18,018 41,620 1/1/19 23,982 4162 19,820 21,800 1/1/20 23,982 2180 21800 0 119,908 119,908 100,000 1/1/16 Cash 25,982 Lease Rec 23,982 (1/5 Lease Rec) Insurance Exp 2,000 12/31/16 Unearned int 7602 Int Inc 7602 Sales Type Lease: FMV $100,000 Cost $85,000 *Treat like you sold the asset COGS 85,000 (Inventory (asset) – COGS when sold) Lease Rec 119,908 Sales 100,000 (FMV) Equip 85000 (@ Cost) Unearned Int 19,908 *Record deal or profit Complications: Bargain Purchase – add to PV minimum payment Guarantee Residual Value – Include to PV Unguaranteed Residual Value - Include to PV o Getting asset back either way so you have to include that in PV calculation.
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