【正文】 M11—Lease 1 Study Notes FAR M11 (Lease) A lease is a contract between a lessor (the owner of an asset) and a lessee (the person who is going to use the asset) that conveys the right to use specific property for a stated period of time in exchange for a stated payment. Accounting for the lease transaction is based on “substance over form”. The following are the types of the leases from accounting perspective Lessor Lessee ? Operating lease ? Nonoperating lease Sales type lease Direct financing lease ? Operating lease ? Capital lease Operating lease If the lease is classified as an operating lease, the lessee is going to treat the lease payments as rent expense. and the lessor is going to treat it as rental ine and there is no interest in an operating lease . For CPA exam purpose, the operating lease is relatively simple from accounting perspective. Most CPA exam questions concentrate on how to calculate the rent expense especially in some special situations. The general rule is that the amount of rent expense that should be recognized in each period of the lease is the same. This means that the rent expense amount will be the same for each month, quarter or year. Rent expense needs to be equal each month in order to match revenues and expenses properly. Accounting by lessee ? Free rent: lease rent expense is recognized evenly ? Lease bonus: is considered an asset and amortized straight line over the lease term ? Leasehold improvements is reported as part of the fixed assets and amortized over the shorter of lease term or useful life ? Refundable security deposit are receivable vs. nonrefundable deposit are prepaid assets to be amortized in the future ? Early termination costs must be recognized immediately at fair value by lessee upon termination of the lease agreement. (ceaseuse date) Accounting by lessor ? Initial direct costs (finder’s fees, appraisal fees, document processing fees, negotiation fees and any other direct costs incurred to set up the lease agreement) are capitalized and amortized on straight line going forward by the lessor ? Depreciate the assets ? Executor costs (taxes, insurance and maintenance) are recognized as incurred ? Lease bonus is unearned revenue and amortized over the life of the lease ? Rent received in advance is unearned revenue ? Termination costs should be measured and recognized at fair value at the date the lease agreement is terminated Lessee Lessor Initial direct costs N/A Assets Lease bonus Prepaid assets Unearned revenue M11—Lease 2 Refundable Security deposit Receivables liabilities Nonrefundable security deposit Prepaid assets Unearned revenue Leasehold improvements Capitalized as PPE and amortize over the shorter of (1) remaining lease term (2) useful life of the improvement N/A Early termination costs Early termination costs must be recognized immediately at fair value by lessee upon termination of the lease agreement Early termination costs should be measured and recognized at fair value at the date the lease agreement is terminated Disclosures for operating lease ? A general description of the leasing arrangements ? Minimum lease payments for each of the next 5 years and in the aggregate beyond 5 years. Capital lease A lease where the rights and risks of ownership have transferred from the lessor to the lessee, it is considered really like a “purchase” of the asset in substance, though in legal form it is a lease. So the lessee should recognizes both an asset and a liability at the present value of the minimum lease payments not to exceed the fair market value. The lessor will account for such a lease as either an operating lease, saletype lease or a direct financing lease. Accounting by lessee for capital lease If the lease term meets one of the four criteria, the lessee accounts for the lease as capital lease as if he OWNS the asset. 1) The lease transfer ownership of the asset to the lessee at the end of the lease term 2) The lease includes written bargain purchase option M11—Lease 3 3) The present value of the minimum lease payments is equal to 90% or more of the FMV of the asset at inception and the lease is not executed in the last 25% of the original useful life. 4) The lease term is equal to 75% or more of the estimated economic useful life of the asset at inception and the lease is not executed in the last 25% of the original useful life. If the lease qualifies for a capital lease, the lesee should Day 1 Accounting (1) Record the leased assets on the balance sheet at the lower of ? FMV ( a new implicit interest rate must be calculated) ? PV of the minimum lease payments (discussed in details below) The Minimum Lease Payments include all amounts that the lessee is obligated to pay to the lessor over the life of the lease. The main items that are included in the MLP are: 1) the annual (or monthly) lease payment 2) the required purchase price or bargain purchase option included in the lease, and 3) Any amount of residual value that is guaranteed by the lessee (or by a party that is related to the lessee). Guaranteed residual value is considered part of the minimum lease payments and is reflected in the lessor’s lease receivable account and the lessee’s lease payable account. The present value of the unguaranteed residual value should be included in the lessor’s investment in the lease unless the lease transfers title to the leased assets or there is a bargain purchase option. Executory costs, maintenance costs and any taxes on the leased item are not included in the calculation of the PV of the MLP. Any amounts paid by the lessee for these items will be expensed as they are incurred. (2) Record the lease liabilities on the balance by present value the future payment