Business
Lease Accounting
Lease accounting refers to the process of recording and reporting lease transactions in a company's financial statements. It involves classifying leases as either operating or finance leases and recognizing the associated assets and liabilities. The goal is to provide a clear picture of a company's lease-related financial obligations and the impact of leases on its financial position.
Written by Perlego with AI-assistance
Related key terms
1 of 5
9 Key excerpts on "Lease Accounting"
eBook - PDF- Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield(Authors)
- 2020(Publication Date)
- Wiley(Publisher)
Daniel has asked you to conduct some research on these items related to lease capitalization criteria. Instructions Access the IFRS authoritative literature at the IFRS website. When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following questions. (Provide par- agraph citations.) a. What is included is the measurement of (1) the lease liability and (2) the right-of-use asset? b. Besides the non-cancelable term of the lease, what are other con- siderations in determining the “lease term”? c. When should a lessee account for a lease modification? What pro- cedures are followed? Global Accounting Insights LEARNING OBJECTIVE 7 Compare the accounting procedures for leases under IFRS and U.S. GAAP. Leasing is a global business. Lessors and lessees enter into arrangements with one another without regard to national boundaries. Although U.S. GAAP and IFRS accounting guidance for leasing is not identical, both the FASB and the IASB decided that prior Lease Accounting did not provide the most useful, trans- parent, and complete information about leasing transactions. In response, the FASB and IASB worked together on a Lease Accounting project. The FASB issued an update to its Codification, adding section 842, Leases (ASC 842), in February 2016. Many of the requirements in the new FASB standard are the same as those in IFRS 16. The main differences between U.S. GAAP and IFRS under the new rules are in relation to the lessee accounting model. Specifically, U.S. GAAP still maintains a distinction between finance leases and operating leases in the financial statements for lessees. As a result, lessees account for some leases using the finance lease method, while accounting for operating leases (leases that convey right of use but not ownership) is based on a straight-line lease expense approach. 21-70 CHAPTER 21 Accounting for Leases Relevant Facts Following are the key similarities and differences between U.S.
eBook - PDFFinancial Accounting Theory and Analysis
Text and Cases
- Richard G. Schroeder, Myrtle W. Clark, Jack M. Cathey(Authors)
- 2019(Publication Date)
- Wiley(Publisher)
1 Some lease agreements are in-substance long-term installment purchases of assets that have been structured to gain tax or other benefits to the parties. Because leases can take different forms, accountants must examine the underlying nature of the original transaction to determine the appropriate method of accounting for these agreements. Stated differently, the financial effects of leases should be reported in a manner that describes the intent of the lessor and lessee (i.e. the substance of the agreement) rather than the form of the agreement. Accounting for Leases Two methods for allocating lease revenues and expenses to the periods covered by the lease agreement have emerged in accounting practice. One method, a capital lease, is based on the view that the lease constitutes an agreement through which the lessor finances the acquisition of assets by the lessee. Consequently, capital leases are in-substance installment purchases of assets. The other method is an operating lease and is based on the view that the lease constitutes a rental agreement between the lessor and lessee. Two basic questions have been associated with accounting for leases. 1. What characteristics of the lease agreement imply that a lease should be reported in the balance sheet as an asset accompanied by an associated liability? 2. If none exits, should the lessee be allowed to report lease payments as rent expense? The accounting profession first recognized the problems associated with leases in Accounting Research Bulletin (ARB) No. 38. This release recommended that if a lease agreement were in sub- stance an installment purchase of property, the lessee should report it as an asset and a liability. As with many of the ARBs, the recommendations of this pronouncement were largely ignored in practice, and the lease disclosure problem remained an important accounting issue. In 1964, the APB issued Opinion No. 5, “Reporting of Leases in Financial Statements of Les- sees” (superseded).
eBook - PDFFinancial Accounting Theory and Analysis
Text and Cases
- Richard G. Schroeder, Myrtle W. Clark, Jack M. Cathey(Authors)
- 2022(Publication Date)
- Wiley(Publisher)
1 Some lease agreements are in-substance long-term installment purchases of assets that have been structured to gain tax or other benefits to the parties. Because leases can take different forms, accountants must examine the underlying nature of the original transaction to determine the appropriate method of accounting for these agreements. Stated differently, the financial effects of leases should be reported in a manner that describes the intent of the lessor and lessee (i.e., the substance of the agreement) rather than the form of the agreement. Accounting for Leases Two methods for allocating lease revenues and expenses to the periods covered by the lease agreement have emerged in accounting practice. One method, a capital lease, is based on the view that the lease constitutes an agreement through which the lessor finances the acquisition of assets by the lessee. Consequently, capital leases are in-substance installment purchases of assets. The other method is an operating lease and is based on the view that the lease constitutes a rental agreement between the lessor and lessee. Two basic questions have been associated with accounting for leases. 1. What characteristics of the lease agreement imply that a lease should be reported in the balance sheet as an asset accompanied by an associated liability? 2. If none exits, should the lessee be allowed to report lease payments as rent expense? The accounting profession first recognized the problems associated with leases in Accounting Research Bulletin (ARB) No. 38. This release recommended that if a lease agreement were in sub- stance an installment purchase of property, the lessee should report it as an asset and a liability. As with many of the ARBs, the recommendations of this pronouncement were largely ignored in practice, and the lease disclosure problem remained an important accounting issue. In 1964, the APB issued Opinion No. 5, “Reporting of Leases in Financial Statements of Lessees” (superseded).
- Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield(Authors)
- 2019(Publication Date)
- Wiley(Publisher)
21-1 CHAPTER 21 Accounting for Leases Student Practice and Solutions Manual Chapter 21 Review LEARNING OBJECTIVES 1. Understand the environment related to leasing transactions. 2. Explain the accounting for finance leases. 3. Explain the accounting for operating leases. 4. Discuss the accounting and reporting for special features of lease arrangements. *5. Describe the lessee’s accounting for sale-leaseback transactions. *6. Describe the lessor’s accounting for a direct financing lease. *7. Apply lessee and lessor accounting to finance and operating leases. *8. Compare the accounting for leases under GAAP and IFRS. Many businesses lease substantial portions of the property and equipment they use in their business organization as an alternative to ownership. Because leasing provides some finan- cial, operating, and risk advantages over ownership, it has become the fastest growing form of capital investment. This increased significance of lease arrangements in recent years has intensified the need for uniform accounting and complete informative reporting of leasing transactions. Chapter 21 presents a discussion of the accounting issues related to leasing arrangements from the point of view of both the lessee and the lessor. LO 1: Understand the environment related to leasing transactions. The Leasing Environment A lease is a contractual agreement between a lessor and a lessee that gives the lessee the right to use specific property, owned by the lessor, for a spec- ified period of time. In return for this right, the lessee agrees to make rental payments over the lease term to the lessor. Advantages of Leasing In discussing the advantages of leasing arrangements, advo- cates point out that leasing allows for the lessee: (a) 100% financing, (b) protection against obsolescence, (c) flexibility, and (d) less costly financing. For the lessor, it allows: (a) profitable interest margins, (b) sales stimulation, (c) tax benefits, and (d) return of high residual value.
eBook - ePub- Obioma A. Ebisike(Author)
- 2019(Publication Date)
- Wiley(Publisher)
It is important to note, however, that the lease standard allows lessees to make an accounting policy election not to recognize right-of-use assets and lease liabilities for short-term leases. A short-term lease is defined as a lease that has a lease term of 12 months or less and does not include a purchase option that the lessee is reasonably certain to exercise. If a lessee were to make this election, then it should recognize lease expense on a straight-line basis over the lease term.LESSEE MEASUREMENT AND RECORDING OF OPERATING AND FINANCE LEASES
From the perspective of a lessee, a lease is classified as either an operating or finance lease. The difference between the two has already been discussed in the previous chapter, but in this chapter we discuss how these two leases are recorded by a lessee.For operating leases, a lessee is required to:2- Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position.
- Recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a straight-line basis.
- Classify all cash payments within operating activities in the statement of cash flows.
For finance leases, a lessee is required to:3- Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position.
- Recognize interest on the lease liability separately from amortization of the right-of-use asset in the statement of comprehensive income.
- Classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows.
CONTRACTS WITH MULTIPLE COMPONENTS
Before discussing further, let's define a lease and what constitutes a lease. ASC 842 defines a lease as a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. It describes control over the use of the identified asset as when the lessee has both (i) the right to obtain substantially all of the economic benefits from the use of the assets and (ii) the right to direct the use of the asset.
eBook - PDF- Paul Gee(Author)
- 2006(Publication Date)
- Butterworth-Heinemann(Publisher)
These leases will usually be finance leases. (2) Companies which operate a business which involves the renting-out of assets for varying periods of time, usually to more than one customer (usually operating leases). (3) Companies which are manufacturers or dealer lessors who use leasing to market their products. This could relate to either a finance lease or operating lease according to the criteria in SSAP 21. (b) Accounting Approach (1) In the case of an operating lease, the lessor retains both the legal title and the risks and rewards of ownership of the asset. The risks of ownership include the possibility of reduced demand for the lease of the asset as well as the risk of obsolescence. An operating lease asset should be capitalized and depreciated. (2) In the case of a finance lease, the substance of the transaction is similar to that of a secured loan receivable. Consequently, the asset is treated as a finance lease receivable. 14.11 Lessor Accounting – Operating Leases (a) Accounting Treatment (1) Assets held for use in operating leases should be classified as fixed assets, being depreciated over their useful lives. (2) Rental income should be recognized on a straight-line basis over the period of the lease. This applies even if the payments are not made on a straight- line basis. However, the standard does permit another systematic and rational basis to be used if this is more representative of the time pattern in which the benefits are receivable. Turnover should comprise the aggregate rentals receivable in respect of the accounting period. UK GAAP for Business and Practice 253 (b) Lessor Profit and Loss Account Using format 2, the relevant profit and loss extract would appear as follows: £ £ X Turnover X Staff costs X Depreciation X Other operating charges X Interest payable X (X) Profit on ordinary activities before tax X (c) Manufacturer/Dealer Lessor Suppose a manufacturer/dealer enters into an operating lease.
eBook - PDF- Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield(Authors)
- 2022(Publication Date)
- Wiley(Publisher)
Learning Objectives Review 20-51 Learning Objectives Review ➊ Describe the environment related to leasing transactions. A lease is a contract that conveys the right to control the use of identi- fied property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. Advantages to Lessee Advantages to Lessor 1. 100% financing. 1. Profitable interest margins. 2. Less obsolescence. 2. Stimulation of product sales. 3. Flexibility. 3. Efficient tax sharing. 4. Tax benefits. 4. Residual value profits. Leases are classified as finance or operating. Leases should be classi- fied as finance if they meet any of the following criteria. • The lease transfers ownership of the property to the lessee. • The lease contains an option to purchase the underlying asset that the lessee is reasonably certain to exercise. • The lease term is a major part (75%) of the remaining economic life of the underlying asset. • The present value of the lease payments equals or exceeds sub- stantially all (90%) of the underlying asset’s fair value. • The lessor does not have an alternative use for the asset at the end of the lease. Lessors evaluate the same tests as lessees to determine the classifica- tion of a lease as sales-type or operating. ➋ Explain the accounting for finance leases. For a finance/sales-type lease, the lessee records a right-of-use asset and related liability at the commencement of the lease. The lessee rec- ognizes interest expense on the lease liability over the life of the lease using the effective-interest method and records amortization expense on the right-of-use asset. The lessor determines the lease payments, based on the rate of return—the implicit rate—needed to justify leas- ing the asset, taking into account the credit standing of the lessee, the length of the lease, and the status of the residual value (guaranteed versus unguaranteed).
eBook - PDF- Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield, Irene M. Wiecek, Bruce J. McConomy(Authors)
- 2019(Publication Date)
- Wiley(Publisher)
The minimum lease payments in this case are allocated based on the relative fair values of the land and the building. If title is not expected to be transferred, the accounting depends on the fair value (FV) of the land rela- tive to the building. If the FV of the land is minor, the land and building are treated as a single unit when classifying the lease. If the FV is significant, the land and building are considered separately, with the land portion classified as an operating lease. 25 Allocating based on the value of leasehold interests is not the same thing as based on relative fair values of the underlying assets. Because the land will revert to the lessor and maintain its value, unlike the building, the rental payments charged for the land will not be based on recovering its full fair value. 20-56 CHAPTER 20 Leases Review and Practice Summary of Learning Objectives 1. Understand the importance of leases from a busi- ness perspective. Leases represent a significant source of financing for companies. One of the issues identified by the IASB, prior to the adoption of IFRS 16, was a lack of transparency in financial reporting of leases, leaving us- ers like financial analysts to guess the extent of debt and leverage of many companies. Accounting for leases is not just an accounting is- sue, but one of importance to users of financial statements, including financial institutions and leasing companies. 2. Explain the conceptual nature, economic substance, and advantages of lease transactions. A lease is a contract between two parties that gives the lessee the right to use property that is owned by the lessor. In situations where the les- see obtains the use of the majority of the economic benefits inherent in a leased asset, the transaction is similar in substance to acquiring an asset. Therefore, the lessee recognizes the asset and associated li- ability and the lessor transfers the asset under Lease Accounting.
eBook - PDF- Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield(Authors)
- 2019(Publication Date)
- Wiley(Publisher)
21-34 CHAPTER 21 Accounting for Leases assets. On the solvency side, the debt to equity ratio will increase, and the interest coverage ratio will decrease. In addition, recent studies indicate that using only note disclosures to deter- mine lease obligations have understated their numerical impact. 19 One thing is certain—the grossing up of the assets and liabilities related to lease arrange- ments will have significant consequences on the organizational, operational, and contractual side. Examples are: 1. States often levy taxes based on property amounts, which will now be higher. 2. Performance metrics to evaluate management may have to change for companies, particularly when growth rates in assets are used or returns on assets are used to measure performance. 3. Companies may have contracts with the government for which reimbursement is based on rent expense, which may change the compensation agreement. 4. Debt covenants might require revisions. Given the pervasiveness and magnitude of the changes, it is not surprising that the FASB is permitting an extended implementation window to allow companies and users of financial statements to adapt to the new standard. 19 Pepa Kraft, “Rating Agency Adjustment to GAAP Financial Statements and Their Effect on Ratings and Credit Spreads,” The Accounting Review (March 2015), Vol. 90, No. 2, pp 641–674. In addition, a study by J.P. Morgan showed significant variation in the range of analysts’ estimates of the underlying lease obligations under the new rules. See P. Elwin and S. C. Fernandes, “Leases on B/S from 2017? Retailers and Transport Will Be Hit Hard in Leverage Terms,” Global Equity Research, J.P. Morgan Securities (May 17, 2013). Evolving Issue Bring It On! As discussed in the opening story, the Lease Accounting rules will bring a significant amount of lease-related assets and liabilities onto lessee balance sheets. Recent estimates for the largest 100 U.S. com- panies put the number at over $539 billion.
Index pages curate the most relevant extracts from our library of academic textbooks. They’ve been created using an in-house natural language model (NLM), each adding context and meaning to key research topics.
