REVISED LEASING EXPOSURE DRAFT

LEASING JOHN C. FUSCO, JR. CPA, MT 1

REVISED LEASING EXPOSURE DRAFT

REVISED EXPOSURE DRAFT ON LEASING (ED2)

ISSUED MAY 16, 2013DEVELOPED AND PRESENTED BY:

JOHN C. FUSCO, JR. CPAMACE

OCTOBER 17, 2013


AT THIS POINT THE NEW METHODS ARE LIKELYTO BECOME AN ACCOUNTING STANDARD

UPDATE (ASU) ARE THERE ARGUMENTS AGAINST IT?

Yes, but the economists and non-accountants have won the battle accountants have fought

for years.STATED OBJECTIVE OF THE ED

Establish principles that Lessees and Lessors should apply to report useful information to users of financial statements about the amount, timing and uncertainty of cash flows arising from a lease.


WHY IS THE NEW METHODOLOGY IMPORTANT?Most businesses of some size, and not too large

either, have leases. Some companies have many leases on their books. Think about it, most companies have:

Office/Building lease(s) Vehicle leases (cars and trucks) Computer leases Phone equipment lease Other equipment leases


APLICABILITY OF NEW RULESAny entity that enters into a lease and

reports in accordance with GAAP, is subject to the new accounting for leases, except:

Short Term leases – leases of less than 12 months total.

Leases of intangible assets Leases of minerals etc. (non-

regenerative resources) Leases of Biological assets including

timber


WHAT IS THE NEW MODEL?The core principle involved is that an

entity should recognize assets and liabilities arising from a lease.

Lessee accounting requires reporting a “Right-of-Use asset and a lease obligation

Lessor accounting requires application of the “receivable and residual” method


WHY THE CHANGE?Many users of financial statements

(mostly analysts) say that the bright line classification of lease as capital and operating fails to meet the users needs because they do not always provide a faithful representation of leasing transactions because they do not require lessees to recognize assets and liabilities arising from operating leases.


QUESTION When we are finished with today’s

presentation ask yourself:

WHAT ARE WE GAINING WITH THE NEW MODEL AS TO INFORMNG USERS OF THE FINANCIAL STATEMENTS ABOUT THE AMOUNT, TIMING AND UNCERTAINTY OF CASH FLOWS ARISING FROM LEASES?


EXAMPLES3 YEAR COPIER LEASE $400/MONTHOPERATING LEASE UNDER CURRENT RULESTWO COMPANIESCOMPANY J AND COMPANY F SAME LEASE TERMS/ SAME EQUIPMENT/ FROM THE SAME LESSORRESULTRENT EXPENSE $4,800/YEAR FOR THREE YEARSFOR BOTH COMPANIES


NEW METHODYEAR Co. J

(6%)CO. F(8%) CO. J CO. F

ASSET ASSET LIABILITY LIABILITYInitial 13,148 12,765 13,148 12,7651 8,766 8,510 9,025 8,8442 4,383 4,255 4,648 4,5983 0 0 0 0


INCOME STATEMENT EFFECTYEAR CO. J CO. F CO. J CO. F CO. J CO. F

INT INT Amort. Amot. Total Total

1 677 880 4,383 4,255 5,061 5,1342 422 554 4,383 4,255 4,805 4,8093 152 202 4,383 4,255 4,535 4,457

Total 1,251

1,636 13,148

12,765

14,400

14,400


WHAT WE HAVE TO DOWe need to classify our leases as: TYPE A LEASES – a lease that is expected to

consume MORE than an INSIGNIFICANT portion of the economic benefits embedded in the underlying asset. (things like equipment, aircraft, cars and trucks); so in plain English the lease is for a significant part of the assets useful life.

Notwithstanding the above requirements, if a lessee has a significant economic incentive to exercise an option to purchase the underlying asset, it is classified as a Type A lease.


TYPE B LEASES – leases are classified as TYPE B if either of the following criteria are met:

Lease term is for an insignificant portion of the total economic life of the underlying asset.

OR Present value of lease payments is

insignificant relative to the Fair Value of the underlying asset at commencement date.


TYPE B EXCEPTIONIf the underlying asset is property it is

classified as Type B property unless one of the following criteria are met:

The lease term is for the major part of the remaining economic life of the underlying asset.

OR The present value of the lease

payments accounts for substantially all of the Fair Value of the underlying asset at commencement date.


ED 2 EXAMPLE OF TYPE –B EXCEPTION Lessee enters into a 15-year lease of an office building,

which has a remaining economic life of 40 years at the commencement date.

The lease calls for payments of $30,000 per year, the present value of which is $300,000 using the lessee incremental borrowing rate.

The fair value of the property at the commencement date is $400,000.

Lessee determines the lease is a Type-B lease because:a. The underlying asset is propertyb. Lease term is not for a major part of the remaining

economic life of the property (37.5% )c. The PV of the lease payments does not account for

substantially all of the Fair value of the property. (75% - 300,000/400,000)

Your thoughts on the above?


RECOGNITION – TYPE A LEASE BY LEASEELessee would : Recognize a right-of-use asset and a

lease liability at the present value of lease payments.

Recognize the unwinding of the discount on the lease liability as interest separately from the amortization of the right-of-use asset.


REGONITION OF TYPE B LEASES BY LESSEEFor most leases of property (that is land

and/or building or part of a building) the lessee would:

Recognize a right-of-use asset and a lease liability, initially measured at the present value of lease payments.

Recognize a single lease cost, combining the unwinding of the discount on the lease liability with the amortization of the right-of-use asset, on a straight-line basis.


LESSORS MEASUREMENT OF TYPE A LEASESFor most leases of assets other than property, a

lessor would classify the lease as a Type A Lease and do the following:

Derecognized the underlying asset and recognize a right to receive lease payments (the lease receivable) and a residual asset representing the rights the lessor retains relating to the underlying asset.

Recognize the unwinding of the discount on both the receivable and the residual asset as interest income over the lease term.

Recognize any profit relating to the lease at the commencement date.


LESSOR REOGNITION OF TYPE B LEASESFor most leases of property, lessor would

apply an approach similar to existing operating lease accounting in which the lessor would:

Continue to recognize the underlying asset.

Recognize lease income over the lease term typically on a straight-line basis.


WHAT IS IN THE LEASE PAYMENTSBoth lessee and lessor would: Exclude most variable lease payments Include payments to be made in

optional periods only if the lessee has a significant economic incentive to exercise an option to extend or not to exercise an option to terminate.


SIGNIFICANT ECONOMIC INCENTIVEAt commencement date an entity assesses

whether the lessee has a significant economic incentive to exercise an option considering all relevant factors, such as:

a. Contractual terms and conditions of the optional periods compared with current market rates such as:

1. The amount of lease payments in any optional period

2. The amount of any variable lease payments or other contingent payments.

3. The terms and conditions of any options that are exercisable after initial optional period such as a purchase option.


SIGNIFICANT ECONOMIC INCENTIVE (CONTINUED)b. Significant leasehold improvements

that are expected to have significant economic value for the lessee when the option to extend or terminate the lease or purchase the asset becomes exercisable.

c. Costs relating to the termination of the lease and signing a new lease.

d. The importance of that underlying asset to the lessee’s operations.


IDENTIFYING A LEASEBasic definition: a contract that conveys the

right to use an asset (the underlying asset) for a period of time for consideration.

At inception of a contract, an entity shall determine whether the contract is or contains a lease by addressing both of the following:

Whether fulfillment of the contract depends on the use of an identified asset

Whether the contract conveys the right to control the use of the identified asset for a period of time.


FULFILLMENT Asset would usually be specifically

identified in the contract. However, even the asset is specifically

identified fulfillment does not depend on the use of an identified asset, if the lessor has the substantive right to substitute the asset throughout the term of the contract.


CONTROLLING THE USEContract gives lessee the right to control

the use of the identified asset if throughout the term of the contract the lessee has the right to do both of the following:

a. Direct the use of the identified asset.b. Derive the benefits from the use of the

identified asset. Let’s look at some examples from ED2

of using the criteria to determine if a contract contains a lease.


IDENTIFYING A LEASECONTRACT FOR RAIL CARS-EXAMPLE 1 Contract between the lessee (Customer) and a

freight carrier (Carrier) for use of 10 rail cars of a particular specification that are owned by the carrier and contracted for 5 years.

Contract specifies the type of car. Customer determines when, where and which goods are transported using the cars.

When cars are not in use, they are kept at Customer’s premises and Customer can use them for any purpose (such as storage) if it so chooses.

If a particular car needs service or repair Carrier is required to substitute an equivalent car of the same type. Except in case of default, Carrier can not retrieve the cars during the 5 years of the contract.


CONTRACT FOR RAIL CARS-EXAMPLE 1 (CONTINUED) Carrier is required to provide and engine and

driver when requested by Customer. If Carrier is unable to provide Customer can use another Carrier’s service.

Carrier can transport Customer’s goods along with other Customer’s goods on trains up to 100 cars..

RESULT: The contract contains a lease, Customer had the right to use 10 cars for 5 years. Contract also contains a nonlease service component that relates to the use of an engine and driver. Contract does not convey the right to use an identified engine.


CONTRACT FOR RAIL CARS-EXAMPLE 1 (CONTINUED) ANALYSIS Customer has the right to control use of

the cars because of both of the following:A. Customer has the ability to drive the use of

the cars. Customer determines how, when, and for what purpose the cars are used, not only when they are being used to transport Customer’s goods but throughout the term of the contract.

B. Customer has the ability to derive the benefit from use of the cars. The cars are available for Customer’s use throughout the term of the contract, including when they are not being used to transport Customer’s goods.


CONTRACT FOR RAIL CARS-EXAMPLE 1A Contract between Customer and carrier requires

carrier to transport a specified quantity of goods in accordance with a stated timetable for a period of five years.

The timetable and quantity of goods specified is the equivalent of the Customer having the use of 10 rail cars for 5 years.

Contract states the nature and quantitiy of goods to be transported but does not include specific details of the cars or engine to be used.

Carrier had a large pool of similar cars and can choose which cars to use and engines to use to fulfill Customer’s requests.

RESULT: The contract does NOT contain a lease.


CONTRACT FOR RAIL CARS-EXAMPLE 1A ANALYSIS The contract does not contain a lease

because:1. Fulfillment of the contract does not

depend on the use of 10 identified rail cars or an identified engine.

2. Carrier has substantive substitution rights,

3. Carrier can choose any cars without Customer’s consent.

4. There are no economic barriers that prevent Carrier from using any cars and engines in fulfillment of the contract.


CONTRACT FOR COFFEE SERVICE Customer (the lessee) enters into a contract for

coffee services for two years with Suplier (lessor) Supplier puts 25 coffee machines in customer’s

premise that are tailored for use with consumables provided by Supplier. The coffee machines function only with consumables provided by Supplier and have no use to Customer other than when they are used in conjunction with those consumables.

Supplier is responsible for repairs and maintenance of the coffee machines.

Customers staff operate the machines, selecting the coffee they wish to drink and the machines deliver the coffee.

RESULT: The contract does not contain a lease.


CONTRACT FOR COFFEE SERVICE (ANALYSIS) Although fulfillment of the contract may depend on the use

of the machines, the contract does not give the Customer the right to control the use of the machines.

Customer does not have ability to derive benefits from the use of the machines on their own; the machines function only with the consumables supplies by Supplier. Machines are incidental to the delivery of coffee services to the Customer over the two year term of the contract.

Developer’s Note: Most of these type contracts require a certain quantity of consumables to be purchased by the Customer or the Supplier pulls the machines out. For instance , typical machine today would be a Keurig that uses K-cups that are available from many sources. The Supplier will insist on purchase only from them and remove the machines if they even suspect the Customer has used consumables from another source. So, you have a service contract not a lease.


CONTRACT FOR FIBER-OPTIC CABLE – PART A Customer (lessee) enters into a 15 year

contract to use 3 specified, physically distinct dark fibers withina larger cable connecting Hong Kong to Tokyo.

Customer makes all the decisions about the use of the fibers by connecting each end of the fibers to its electronic equipment (that is the Customer “lights’ the fibers).

If the fibers are damaged, Supplier is responsible for repairs and maintenance.

RESULT: The contract contains a lease.


CONTRACT FOR FIBER-OPTIC CABLE – PART A (ANALYSIS) Why does this contract contain a lease? One reason is that

fulfillment depends on use of the fibers that are explicitly specified in the contract and are physically distinct from other fibers within the cable.

The Customer has the right to control the use of the dark fibers because of the following:a. Customer has the ability to direct the use of the dark fibers.

Customer determines how, when and to what purpose the fibers are used. Accordingly, Customer makes the decisions about the use of the fibers that most significantly affect the economic benefits derived from use throughout the term of the contract.

b. Customer has the ability to derive the benefit from use of the dark fibers. The fibers are available for Customer’s use throughout the 15 year term of the contract, they can not be used by any other party unless Customer agrees to such use. The contract also contains a non-lease service component for repairs and maintenance of the fibers.


CONTRACT FOR FIBER-OPTIC CABLE – PART B Customer enters into a 15 year contract for the

right to use a specified amount of capacity within a cable connecting Hong Kong to Tokyo.

The specified amoutis equivant to Customer having the use of the full capacit yof 3 fiber strands within the cable (the cable contains 15 fibers with similar capacities)

Supplies makes decisions about the transmission of data (that is, Supplier lights the fibers and makes decisions about which fibers are used to transmit Customer’s traffic).

RESULT: the contract does not contain a lease.


CONTRACT FOR FIBER-OPTIC CABLE – PART B (ANALYSIS) The contract does not contain a lease

because:1. Supplier makes all the decisions about

transmission of Customer’s data, which requires only a portion of the capacity of the cable.

2. That capacity portion ids not physically distinct from the remaining capacity of the cable.

3. Customer has contracted for the right to capacity within a cable. It does not have the right to use an identified asset.


COMMENCEMENT DATE OF THE LEASEDate on which the lessor makes an

underlying asset available for use by a lessee.


LEASE TERM The noncancellable period of the lease,

together with both of the following:a. Periods covered by an option to extend

the lease if the lessee has a significant economic incentive to exercise that option.

b. Periods covered by an option to terminate the lease if the lessee has a significant economic incentive not to exercise the option.


LEASE PAYMENTSPayments made by lessee to a lessor relating to the right

to use the underlying asset during the lease term, consisting of the following:

a. Fixed payments, less any lease incentives received or receivable from the lessor.

b. Variable lease payments that depend on an index or rate or are in substance a fixed payment

c. The exercise price of a purchase option if the lessee has significant economic incentive to exercise that option.

d. Payments for penalties for terminating the lease if the lease term reflects the lessee exercising the option to terminate.

e. Non lease components are not includedf. Residual value guarantees are included.


LESSEE’S INCREMENTAL BORROWING RATEThe rate of interest that the lessee would

have to pay to borrow over a similar term, and with similar security, the funds necessary to obtain an asset of similar value in a similar economic environment.

NOTE: Private companies can elect to use the risk-free rate. Some treasury rates recently:

2year – 0.27%; 5 year – 0.77%; 10 year- 1.86%


INITIAL DIRECT COSTSLessors have always needed to record

“initial direct costs” and amortize them over the life of the lease.

Now lessees must also include initial direct costs in the right-of-use asset at commencement of the lease.

Initial direct costs are defines as:Costs that are directly attributable to

negotiating and arranging a lease and would not have been incurred without entering into the lease.


COSTS INCLUDED IN INITIAL DIRECT COSTSFor both lessees and lessors such items as: Commissions Legal fees Evaluating the prospective lessee’s

financial condition Evaluating and recording guarantees,

collateral, and other security contracts Negotiating lease terms and conditions Payments made to existing tenants to

obtain the lease


COSTS THAT ARE NOT INITIAL DIRECT COSTS1. General overhead, including for example

depreciation, occupancy and equipment costs, unsuccessful origination efforts, and idle time

2. Costs related to activities performed by the lessor for advertising, soliciting potential lessees, servicing existing leases, or other ancillary activities.

Question: What about the controllers time reviewing,

negotiating and setting up the lease on the books?


NON-LEASE COMPONENTSIf there are “observable” standalone prices

for each component of the contract, lessee shall allocate the consideration to each component on the basis of the relative standalone price of each. Standalone price is the price at which a lessee would purchase the component separately.

After that allocation the remaining amounts are considered lease components.

This is likely in a maintenance contract included with your lease payment.


RECORDING LEASESLESSEEFacts: 10 yr. lease, option for 5 more yrs. No

incentive to exercise so use 10 yr. as term.Borrowing rate 5.87% Initial direct costs $15,000Lease payments $50,000/yr initial term; $55,000/yr

extended term Paid beginning of yearPV of 10, $50,000 payments at 5.87% $342,017

Pays first year at commencementAt commencement recordDR Right-of-use (342,017+50,000+15,000) =

407,017CR Lease Liability 342,017CR Cash (50,000+15,000) 65,000


End of first year Type A lease:Interest (5.87*342,017)20,076 Lease liability 20,076

Amortization (402,017/10) 40,702 Right-of-use 40,702

Balances end of first yearRight-of-use (407017-40,702) = 366,315Lease liability (342,017+20,076) = 362,093


SAME FACTS TYPE B LEASE Total lease cost: 10x50,000 = 500,000 + 15,000 = 515,000 Lease expense per year = 51,500

(515,000/10) Entry:Lease expense 51,500 Lease liability 20,076

Right-of-use (51,500-20,076) 31,424

Next years payment beginning of year:Lease liability 50,000 Cash 50,000


PURCHASE OPTIONLessee enters into a 5-year lease of

equipment with annual end of year lease payments of $59,000, no initial direct costs, option to purchase for $5,000 at end of fifth year. Residual value of equipment at end of 5 years is $75,000, therefore, significant economic incentive to exercise the option. The fair value of the equipment at commencement date is $250,000. The rate implicit in the lease, that is the rate that makes the PV of payments including the option to equal the FV is 6.33%.


ACCOUN TING FOR THIS LEASECommencement date:Right-of-use 250,000 Lease liability 250,000Right-of-use amortized over life of equipment

7yrs rather than shorter life of lease.First year entry:Interest expense (250,000*6.33%) 15,825 Lease liability

15,825Amortization (250,000/7) 35,714 Right-of-use

35,714


END OF FIRST YEARRight-of-use asset (250,000-35,714)=

214,286

Lease liability (250,000+15,825 – 59,000) = 206,825

The $59,000 is the payment that was recoded as debiting Lease Liability and crediting cash at end of year.


END OF YEAR 5Right of use asset (250,000-35417X5) =

71,430Liability remaining is $5,000 the purchase

option which is then paid.The Right-of-use asset gets reclassified to

Property, Plant & equipment as follows:PP&E 71,430 Right-of-use 71,430Then the lessee depreciates this amount

over the remaining two years.


VARIABLE PAYMENTS BASED ON INDEX Lease term = 10 Years Annual payments = $100,000 paid

beginning of year Increase each year by increase in CPI for

last 12 months At commencement CPI = 125 end of

year 1 = 128 Lessee Borrowing rate = 8% First payment made at commencement

PV of remaining payments = 624,689


ENTRIES TYPE B CONTRACTRight-of-use (624,689+100,000) 724,689 Lease liability 624,689

Cash 100,000

Lease cost is $1,000,000 (100,000*10)

therefore entry for first year is:Lease expense 100,000 Lease liability (8%*624,689) 49,975 Right of use (100,000-49,975) 50,025


END OF YEAR 1With increase in CPI payments for the second

year as 100,000 * 128/125 = 102,400Adjust lease liability equal to difference

between PV of revised and the original payments. PV 9 payments at 2,400 at 8% = 16,192, entry

Right-of-use 16,192 Lease liability 16,192End of second year makes paymentLease liability 102,400 Cash 102,400


CPI PLUS PERFORMANCESame facts as previous example but lessee also

must pay 2% of sales of $1,200,000 or $24,000

Therefore expense for the year will be $124,000 (100,000 + 24,000) entry would be

Lease expense 124,000 Lease liability (8%*624,689) 49,975 Right-of-use (100,000-49,975) 50,025 Accrued variable lease payment 24,000


LESSEE PRESENTATIONBALANCE SHEET (STATEMENT OF FINANCIAL

POSITION):1. Right-of-use assets separately from other

assets2. Lease liabilities separate from other

liabilities3. Right-of-use assets arising from Type A

leases separately from right-of-use assets arising from Type B leases

4. Lease Liabilities arising from Type A leases separately from Lease Liabilities arising from Type B leases


If above not on Balance Sheet then Lessee does both of the following;

a. Present right-of-use assets within the same line item as the corresponding underlying assets would be presented if they were owned

b. Disclose which line items in the statement of financial position include right-of-use assets and lease liabilities.

STATEMENT OF COMPREHENSIVE INCOMEc. Type A leases the unwinding of the discount on the

lease liability separately from the amortization of the right-of-use asset

d. Type B leases the unwinding of the discount on the lease liability together with the amortization of the right-of-use asset


STATEMENT OF CASH FLOWSa. Repayments of principal portion of

lease liability from Type A leases in Financing Activities

b. Unwinding of the discount on Type A leases as interest.

c. Payments arising from Type B leases in Operating Activities

d. Variable lease payments and short-term lease payments not included in lease liability in Operating Activities


LESSEE DISCLOSUREGeneral information about company’s leases and

the significant judgments made in applying these rules along with the amounts recognized in the financial statements relating to those leases.

Level of detail should satisfy the disclosure objective which is to enable users to understand the amount, timing, and uncertainty of cash flows arising from leases. Disclosure should be quantitative and qualitative. It should be aggregated or disaggregated so that useful information is not obscured by including a large amount of insignificant detail or by aggregating items that have different characteristics.


Disclose the following:a. Information about the nature of leases,

including:1. A general description of these leases,

including2. The basis and terms and conditions, on which

variable lease payments are determined.3. The existence and terms and conditions , of

options to extend or terminate. Should disclose narrative disclosure about the options that are recognized as part of right-of-use and lease liability and those that are not.

4. The existence and terms and conditions, of residual value guarantees


5. The restrictions or covenants imposed by leases and information about sub-leases.

Information about leases that have not yet commenced but that create significant rights and obligations

Information about determinations of whether a contract contains a lease, allocation between lease and non-lease components and determination of the discount rate.


Disclose reconciliation of opening and closing balances of lease liabilities separate for A an B Type leases, including

a. Liabilities created due to leases commencing or extended

b. Liabilities extinguished due to leases being terminated

c. Remeasurements relating change in an index or rate used to determine lease payments

d. Cash paide. Foreign currency translation gains and lossesf. Effects of business combinationsGOOD NEWS-NONPUBLIC COMPANIES CAN ELECT

NOT TO DISCLOSE THE ITEMS ON THIS SLIDE


TRANSITIONSpecific reliefs are permitted as follows:1. Lessees and lessors need not include initial

direct costs in the measurement of right-of-use asset or lease receivable

2. An entity can use hindsight, such as in determining whether a contract contains a lease, in classifying a lease, or in determining lease term if lease contains options.

3. Lessees and lessors need only go back and adjust leases for the earliest comparative year presented rather than follow the rule of Topic 250 requiring going back as far as possible where information is available.


LEASES PREVIOUSLY CLASSIFIED AS CAPITAL LEASESThe carrying amount just prior to the

earliest comparative year presented becomes the right-of-use asset and lease liability and the leases are all considered Type A.

Subsequent to the transition measure the right-of-use asset and the lease liability as required by the subtopic when adopted.


LESSEE OPERATING LEASE TO TYPE A LEASE5 Year lease for a vehicle at transition they are one year into

the lease.Lease payments at end of year remaining payments 1 at

$31,000 and 3 at $33,000Borrowing rate at earliest comparative period 6%Lease liability PV of 1 pay @31,000 and 3@33,000 at 6% is

$112,462Determining the Right-of-use asset – two stepsStep 1 – Determine the commencement date lease liability by

taking the four remaining payments average $32,500 PV 5 year annuity at 32,500 = 136,902 the commencement date lease liability .

Step 2 – Estimates the right-of-use asset as $109,522 (136,522*4/5 year term) The difference between the right-of-use asset and lease liability at beginning of year 2 of the lease is an adjustment to opening retained earnings


ENTRIESRight-of-use 109,522Retained earnings 2,940 Lease liability

112,462Entity also had accrued rent for expense

recorded but not yet paid of $1,200 so another entry removes that amount:

Accrued Rent 1,200 Right-of-use 1,200


LESSEE OPERATING TO TYPE B LEASEAssume numbers are the same as previous

example only the underlying asset is land, therefore, it is a Type B lease.

Only entries needed are:Right-of-use 109,522Retained earnings 2,940 Lease liability

112,462

Accrued rent 1,200 Right-of-use 1,200


LESSOR ACCOUNTING At commencement date the lease receivable should

include: a. Fixed payments less any incentives payable to the

lessee b. Variable lease payments that depend on an index or rate

initially measured at the index or rate at commencement date.

c. Variable lease payments that are in-substance fixed payments

d. Lease payments structured as residual value guarantees e. The exercise price of purchase option if lessee has

significant economic incentive to exercise f. Payments for penalties for termination if term reflects

lessee exercising such option


LESSOR ACCOUNTING TYPE A LEASE CARRYING VALUE EQUALS FAIR VALUEAsset: Vehicle Term: 3 years Payments: $2,400/annual end of yearInitial Direct Costs: $200Carrying Amount and Fair Value of Vehicle:

$10,000Residual Value after 3 years: $4,500LLessee’s Options: Purchase at market after

initial term or extend 2 years at same payments

Economic Life of Vehicle: 7 YearsLessor concludes no economic incentive for

lessee to exercise either option


Rate Implicit in Lease (makes PV of payments and Value at end of term equal – 6.87%

Lease receivable: $6,513 PV 3 payments of $2,400 at 6.87% plus initial direct costs of $200

Gross residual Value: $3,687, expected value at end of term discounted at 6.87%

No difference in carrying value nor fair value so entry is as follows:

Lease receivable 6,513Residual value 3,687 Vehicle 10,000 Cash for initial direct costs 200


Imputed interest rate that will bring lease receivable to zero is 5.18% which is used to calculate interest earnings during lease term

At end of year 1: Cash 2,400 Lease receivable 2,400 Lease receivable 338

(5.18%*6,513) Residual asset 253 (6.87%*3,687) Interest income (338+253) 591


End of year 1:Lease receivable (6,513-2400+338)

4,451Residual asset (3,687+253)

3,940At end of the term:Lease receivable is reduced to -0-Gross residual asset becomes 4,500Interest on lease receivable is 687Interest income on residual asset 813Total interest income 1,500


End of term reclassifies residual asset to inventory:

Inventory 4,500 Residual asset 4,500Assume lessor sells the vehicle for $5,000Cash 5,000 Inventory 4,500 Gain on sale of inventory 500


ISSUESAddition of a great number of assets and

liabilities changes the usual measurements of company liquidity and solvency.

Lenders, governmental units and other users need to be aware of these changes

Transition to putting all info on thebooks needs to be carried out in an organized manner

Systems may have to be changed or modified greatly to accommodate these rules.

Related party transactions based on legal rights rather than in-substance rights.

Right-of-use asset, what exactly is it?


BIGGEST ISSUE

MATERIALITY


THANK YOU

Documents

REVISED LEASING EXPOSURE DRAFT