Capital Leases, ASC 840

Leases
SFAS 13, November 1976
“Accounting for Leases”

Lease classification criteria
(A) Ownership transfer
–> Ownership is transferred by the end of the lease term
(B) Bargain purchase option
-> Lessee has an option purchase at the price lower than the fair value
(C) Lease term: 75% rule
–> Lease term ≥ 75% of economic life of the leased property
(D) Minimum lease payment: 90% rule
–> Present value of minimum lease payments > 90% of fair value of the leased property

Additional criteria for lessor
(E) Collectibility of minimum lease payment
–> reasonably predictable
(F) No important uncertainties
–> about the additional costs to be incurred by lessor
–> when such costs are not reimbursable

Capital lease by lessee
1. A lease meets any of (A), (B), (C), (D)
2. The leased property is recognized as an asset by lessee

Capital lease by lessor
A lease is classified as one of the following
(1) sales-type lease
(2) direct financing lease
(3) leveraged lease

Sales-type lease
1. A lease satisfies any of (A), (B), (C), (D) and both of (E), (F)
2. The lessor gets manufacturer’s or dealer’s profit or loss

Direct financing lease
1. A lease satisfies any of (A), (B), (C), (D) and both of (E), (F)
2. The lessor does not get manufacturer’s or dealer’s profit
3. A lease does not meet the leveraged lease criteria

Leveraged lease
1. A lease satisfies any of (A), (B), (C), (D) and both of (E), (F)
2. The lessor does not get manufacturer’s or dealer’s profit
3. A lease meets all of (G), (H), (I)

Leveraged lease combines two transactions into one
Transaction 1: lessor borrows money and purchases the leased property
Transaction 2: lessor leases the property to lessee

Manufacturer’s or dealer’s profit or loss
–> when fair value ≠ carrying amount of the leased property
–> profit when fair value > carrying amount
–> loss when fair value < carrying amount

Leveraged lease criteria
(G) A lease involves at least three parties
–> a lessee, a lessor (equity participant), a long-term creditor
(H) Financing by long-term creditor
–> provides substantial leverage to the lessor
–> is nonrecourse as to the lessor’s general credit
(I) Lessor’s net investment
–> declines during early periods
–> rises during later periods

Capital lease accounting by lessee
–> Recognize the leased property as an asset
–> and recognize a liability for lease payment

Accounting by lessor
1. Sales-type lease
–> The lessor records the lease same as a sale of the property
–> Sales, cost of goods sold, lease receivable, unearned income are recognized by the lessor

2. Direct financing lease
–> Asses is derecognized from the lessor’s records
–> Lease receivable, unearned income are recognized by the lessor

3. Leveraged lease
–> The lessor recognizes the following:
(a) rentals receivable
(b) unearned and deferred income
(c) residual value of leased property
(d) investment tax credit, if applicable

 

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