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Introduction

This course emphasizes accounting by lessees: however, there are many parallels between lessee and lessor accounting.
Where appropriate, the modules are organized into A and B parts that describe the lessee's accounting and the lessor's
accounting, respectively. In all of the two-part modules, the description of the lessor's accounting in part B is abbreviated and
relies on the more complete description of the lessee's accounting presented in part A.
A lease contract gives the lessee (leaseholder) certain rights related to the leased property and imposes an obligation to pay for
these rights. The rights of the lessee are less than those obtained from the purchase of the property. Generally accepted
accounting principles establish criteria for determining whether a lease agreement transfers sufficient rights to give the
transaction the substance of an outright purchase. If the accounting criteria are met, the lease is described as a capital lease,
and the leased asset and the lease obligation are reported in the lessee's balance sheet. In effect, the lease is reported in the
same manner as an installment purchase of the leased asset. If the accounting criteria are not met, the lease is described as
an operating lease and is reported as an executory contract (that is, a simple rental arrangement) in the periods that
performance occurs.

Introduction
The flexibility that lease agreements provide with respect to property rights and financial obligations results in continued growth
in the volume of lease transactions. Consider the following:

Leases may provide financing of 100 percent of the asset's cost.

Leases may limit the lessee's exposure to losses due to obsolescence.

A company that is not able to benefit from the tax depreciation of a new asset because of net operating loss
carryforwards can indirectly obtain this benefit via reduced lease payments to a lessor that can benefit from the
depreciation of the asset.

Sale-leaseback transactions are a source of financing that can provide off-balance-sheet leverage as well as significant
tax advantages.

Leases can provide a means of reducing the alternative minimum tax (AMT).

There is almost infinite flexibility in the assignment of the risks and rewards of ownership and in structuring the financing
obligation.

Many lessee companies prefer the off-balance-sheet financing aspect of operating leases. To the extent that a company's
balance sheet appears to have too much debt or it is close to defaulting on existing debt covenants, operating leases may
provide a financing mechanism that does not cause further deterioration in critical debt-equity ratios. Although one may
question the real benefits of off-balance-sheet financing, many lessees carefully structure lease agreements to avoid meeting
the accounting requirements for capital lease treatment.

Introduction
Accounting for lease agreements is often complicated by differences between their legal form and their economic substance. If
sufficient property rights are transferred, the economic substance of a lease is the same as a legal purchase. But how is the
determination made that a lease agreement transfers sufficient property rights to the lessee to justify reporting the lease as if a
purchase has occurred? US generally accepted accounting principles (GAAP) provides specific criteria (often referred to as
"bright-line" tests) to identify the critical point at which a lease must be reported as a capital lease. Nonetheless, US GAAP
does not ensure that companies with substantially identical lease agreements will report these lease agreements identically. In

fact, the criteria are such that companies wishing to avoid capital lease accounting while obtaining most of the benefits of
ownership generally are able to do so.
FASB Accounting Standards Codification (ASC) 840, Leases, provides the authoritative guidance for all lease transactions. As
previously noted, the FASB and the IASB are continuing work on a joint project on leases. The objective of the accounting for
leases project is to comprehensively reconsider the guidance in FASB ASC 840 and IAS 17, Leases, along with subsequent
amendments and interpretations, to ensure that financial statements provide useful, transparent, and complete information
about leasing transactions to investors and other users of financial statements. The Boards began deliberations of lease
accounting issues in 2007. They published a discussion paper for public comment in March, 2009 that explores these issues
and describes both Board's preliminary views.
An exposure draft (ED) on a proposed new, converged leasing standard has been issued but was met with significant
resistance. Almost all companies will be significantly impacted because of the widespread use of leases. Most notably, the new
leasing model proposes to bring virtually all leases onto the balance sheet. For both lessees and lessors, this is a major
change, as operating leases would be rendered obsolete. As of March 2013, the FASB and IASB are in the process of redeliberating the proposed guidance with an aim to re-expose a new ED in the second quarter of 2013. One "Big Four" public
accounting firm has gone on record that they do not believe any new guidance will be effective before 2016.

Introduction
The new standard will likely require a right-of-use approach, which requires the reporting of the rights and obligations conveyed
by all leases, including short-term leases, on the balance sheet. In addition, it is likely that there will be no grandfathering of
existing leases, which means companies will need to reassess all existing leases, with the exception of certain capital leases, if
the new guidance is adopted.
For lessors, the likely outcome is a performance obligation approach, which will keep the leased asset on the lessor's balance
sheet. The lessor would also recognize a receivable for the rental payments that will be received over the lease term and a
corresponding liability for the obligation to provide use of the leased asset to the lessee. The practical effect of this approach is
a gross up of the balance sheet. The FASB and IASB are still evaluating this proposed presentation and may consider whether
the performance obligation should be netted against the leased asset or the receivable. In addition, they are also considering
how upfront recognition of manufacturer or dealer profit might fit into the performance obligation approach.

For lessees, the days of debating whether a lease is a capital or operating lease appear to be nearing an end, as lessees would
be required to recognize an asset and a corresponding liability for all leases. Companies that are lessees should be mindful of
how this change may impact financial ratios, debt covenants, and perhaps their overall business model.

Applicability of the FASB Pronouncements
FASB ASC 840 applies to financial reporting of leases by both lessors and lessees.
A lease is an agreement that conveys the right to use property, plant, or equipment usually for a stated period of time.
Significantly, this definition does not include agreements that convey the right to use only intangible assets or services.
However, agreements that include substantial services or intangibles in addition to plant, property, or equipment are considered
leases for the purposes of financial reporting.
The standards do not apply to

Lease agreements that convey rights to explore for or to extract natural resources, including oil, gas, minerals, and
timber; or

Licensing agreements for motion pictures, plays, manuscripts, patents, copyrights, and other intangibles.

Module 1A—Lessee's Classification of Leases
Lessees must classify leases as either operating or capital. Operating leases are accounted for as rental agreements in a
manner similar to that of other executory contracts. Capital leases are accounted essentially as if an installment purchase of the
leased asset has occurred.

FASB ASC 840, Leases, identifies four criteria for classifying leases. If one or more of these criteria are satisfied by a lease
agreement at its inception, it is classified as a capital lease. All other leases are classified as operating leases. Once classified,
there are no further changes in classification unless the terms of the lease are modified. A lease of personal property meeting
any of the following criteria at its inception is a capital lease:
a. Ownership is transferred to the lessee by the end of the lease term.
b. A bargain purchase option for the leased property is available to the lessee. A bargain purchase option is as an option to
purchase the property at a price low enough relative to its fair value to provide reasonable assurance that the lessee will
exercise the option.
c. The term of the lease equals or exceeds 75 percent of the remaining estimated economic life of the leased property,
except that this criterion is not applicable if the beginning of the lease term falls within the last 25 percent of the total
estimated economic life.
d. The present value of the minimum lease payments, excluding any portion representing executory costs, equals or
exceeds 90 percent of the fair value of the leased property to the lessor. Like the second criterion, this criterion is not
applicable if the beginning of the lease term falls within the last 25 percent of the total estimated economic life.
The (a) and (b) criteria are straightforward and do not cause significant problems in practice, even though judgment is required
to determine whether a purchase option qualifies as a bargain. The (c) and (d) criteria are difficult to apply, and they will be
discussed in detail.

Criterion (c): Comparing the Lease Term to the Economic Life of the Property
Two measurements are required to determine whether the lease term exceeds 75 percent of the economic life of the leased
property:

The term of the lease Once the measurements are made. a simple comparison is required to determine whether the term of the lease exceeds 75 percent of the remaining estimated economic life of the asset. Note again that this criterion is not applied if the leased property is in the last 25 percent of its total economic life at the inception of the lease.  Periods for which bargain renewal options apply. Criterion (c): Comparing the Lease Term to the Economic Life of the Property The term of the lease includes:  The fixed non-cancelable term of the lease.  Periods for which failure to renew results in a penalty high enough that renewal is reasonably assured. The economic life of the leased asset 2. and it includes use by parties other than the lessee. The economic life is not limited by the lease term. . The economic life of a leased asset is defined as the remaining period during which the asset will be economically useful for the purpose for which was intended at the inception of the lease. A bargain renewal option allows the lessee to extend the lease at a rental amount sufficiently less than a fair rental amount to provide reasonable assurance of renewal.1. The estimate of economic life assumes that normal repairs and maintenance will be performed.

 Periods for which ordinary renewal options apply and for which it is expected that either (1) a guarantee by the lessee of the lessor's debt related to the property will be in effect. .  The lease is cancelable with the permission of the lessor.  The lease is cancelable if the lessee enters into a new lease with the lessor.  The lease is cancelable but the lessee is subject to such a large penalty that continuation of the lease is reasonably assured. or (2) a loan by the lessee to the lessor related to the property will exist. but not beyond the date that a bargain purchase option is exercisable. The implicit assumption is that a lessee will agree to let the lessor force extension of the lease term only if it wants to lease the property for the longer period. Criterion (c): Comparing the Lease Term to the Economic Life of the Property A noncancelable lease is one that is not cancelable by the lessee.  Periods for which ordinary renewal options apply preceding the exercise date of a bargain purchase option. In addition. and  Periods for which the lessor may force renewal or extension of the lease term. a lease is considered noncancelable even when the following conditions are present:  The lease is cancelable upon the occurrence of some remote contingency.

and the lease must be classified as a capital lease. The machine is expected to have a fair value of $15.000 in four years when the option is exercisable. Criterion (c): Comparing the Lease Term to the Economic Life of the Property Example 1 Applying the 75 Percent of Estimated Economic Life Criterion A company agrees to a noncancelable lease contract for a new machine. This exceeds the 75 percent threshold. The economic life of the machine is estimated to be five years. companies wanting to avoid the 75 percent of economic life threshold for capital lease classification are often able to do so because of the subjectivity inherent in the estimation of the property's economic life. The lease requires monthly payments for a threeyear term. Nonetheless.The FASB has foreclosed most opportunities to structure leases so that the lease term. as measured in the context of the capital lease criterion. At its option the lessee may renew the lease for an additional year after which it has the option to purchase the machine for $500. Does the lease agreement meet the (c) criterion for classification as a capital lease? Applying the 75 Percent of Estimated Economic Life Criterion Noncancelable lease term Ordinary renewal period prior to bargain purchase option Lease term 3 years + 1 year 4 years The lease term is 80 percent (4 years/5 years) of the estimated economic life. is less than the actual term. There is no need to examine the other three criteria because capital lease .

000. Fair value of the leased property to the lessor at the inception of the lease . The same logic underlies the inclusion of periods subject to bargain renewal options or high penalties for failure to renew. Criterion (d) is by far the most complex to apply. Of the 4 criteria. the ordinary renewal term preceding the option date must be added to the noncancelable term. $500. the 90 percent recovery criterion most often causes a lease to be classified as a capital lease. Criterion (d): Comparing the Present Value of the Minimum Lease Payments to the Fair Value of the Leased Property A lease is classified as a capital lease if the present value of the minimum lease payments. Specifically it will renew the lease to take advantage of the bargain purchase option. Amounts and timing of the minimum lease payments less executory costs 2. Solution Explanation A bargain purchase option exists because the option price. Like criterion (c). is substantially below the estimated fair market value of the machine. excluding any portion related to executory costs. $15. In this situation. equals or exceeds 90 percent of the fair value of the leased property to the lessor.classification is required if any of the four are met. Three measurements are required: 1. criterion (d) is not applied if the property is in the last 25 percent of its total economic life at the inception of the lease. Discount rate for calculating the present value of the minimum lease payments 3.

The fair rental value of the machine during the renewal period would be $800 per month. The lessee has the option to renew the lease for $500 per month for an additional three years. Example 2 Applying the 90 Percent Recovery Criterion A company agrees to a noncancelable lease contract for a new machine. The lease requires $1. The normal selling price of the new machine is $40.453 . examine the following example of the application of the present value criterion. Does the lease agreement meet the criterion (d) for classification as a capital lease? Applying the 90 Percent Recovery Criterion Present value of minimum lease payments (12 percent discount rate): 36 payments @ $950 $28.888 36 payments @ $450 9.565 Net present value $38. The lease agreement indicates that $50 of each lease payment is payment for maintenance and repairs during the term of the lease and that the lessor's implicit interest rate used to determine the amount of the lease payments is 12 percent.000 payments at the beginning of each month for a three-year term. Before considering the intricacies of these measurements.000. Criterion (d): Comparing the Present Value of the Minimum Lease Payments to the Fair Value of the Leased Property 5.4.

Contingent rentals generally are excluded from the minimum lease payments. If the present value of the lease payments is less than 90 percent of the fair value. Because of the variety of lease agreements. Minimum Lease Payments The minimum lease payments are those payments the lessee is obligated to make. There is a presumption that renewal is reasonably assured because of the bargain offered by the renewal option. Guarantees of the lessor's debt and obligations to pay executory costs are excluded from the minimum lease payments. and all other amounts are excluded. maintenance. the FASB provides detailed guidance with respect to each of the measurements. and fair market value of the leased property will be discussed in detail. and taxes related to the leased property.000 × 90% = $36.90% of fair value of property: $40. The normal sales price is a measure of the fair value of the leased property. the minimum rental payments and the amount of the bargain purchase option comprise the minimum lease payments. so the lease must be classified as a capital lease. If a lease contains a bargain purchase option. the lease may still qualify as a capital lease because it meets one of the other criteria. Executory costs paid by the lessor and included in the lease payments include the lessor's profit on those costs. The measurement of the minimum lease payments. Minimum rental payments do not include . whether paid by the lessor or the lessee. discount rate. Solution Explanation The minimum lease payments include both the noncancelable rental payments and the bargain renewal payments.000 The net present value of the lease minimum lease payments exceeds 90 percent of the fair value of the property (96 percent) at the inception of the lease. plus any payments it can be required to make in connection to the leased property. Executory costs are costs such as insurance.

payments contingent on increases in the cost or value of the property during construction or contingent on the volume of future use of the property. the maximum guarantee. Discount Rate The discount rate for calculating the present value of the minimum lease payments is the lesser of the interest rate implicit in the lease (as computed by the lessor) or the lessee's incremental borrowing rate. If the lessee has guaranteed the difference between a stated amount and the amount realized by the lessor. A penalty is not included in the minimum lease payments if the lease term has been extended because the presence of the penalty provides reasonable assurance that the lease will be extended. that is. the guaranteed amount is set equal to the stated amount.  Any residual value of the property guaranteed by the lessee or a related party. However. . Conceptually. the minimum lease payments include  The minimum rental payments during the term of the lease. The implicit interest rate is the rate that causes the present value of the minimum lease payments and any unguaranteed residual value to equal the fair value of the property. this is the calculation that the lessor made to determine the amount of the lease payments. the purchase amount is considered to be a guaranteed residual value. If it is not practical to determine the lessor's implicit interest rate. contingent rentals based on an existing index or rate such as the consumer price index or the prime interest rate are included based on the level of the index or rate at the inception of the lease. If a lease does not contain a bargain purchase option. and  A penalty payment that the lessee must make or can be required to make upon failure to renew or extend the lease. the lessee's incremental borrowing rate must be used as the discount rate. When the lessor can require the lessee to purchase the property.

As result. a high interest rate is preferable because it results in a lower present value for the minimum lease payments. FASB ASC 840. .These leases normally arise when a manufacturer or dealer uses lease agreements as a mechanism for selling products. Leases. and lessees routinely maintain that it is not practical to determine the lessor's implicit rate unless it is disclosed by the lessor.The lessee's incremental borrowing rate is the rate at which the lessee could borrow funds to purchase the leased property. does not explicitly require the lessee to estimate the lessor's implicit interest rate. and may willingly refuse to disclose their implicit rate. Module 1B—Lessor's Classification of Leases Lessors must classify leases into one of four categories: 1. the fair value of the property should be modified to reflect any changes in market conditions. Fair Value of Leased Property The fair value of the leased property at the inception of the lease is the amount for which the property could be sold in an arm'slength transaction. Direct financing leases . When there is a significant period of time between acquisition of the asset and the inception of the lease. A narrow interpretation of the standard is common in practice. Lessors are aware of this situation. For other lessors. Sales-type leases . the fair value ordinarily is the normal selling price reflecting any discounts and all market conditions at the inception of the lease. 2. the lessee may prefer to not know the lessor's implicit rate because it might be lower than the lessee's incremental borrowing rate. A secured borrowing rate may be used if the lessor would have used a secured loan to acquire the leased property. which allows the lessee to use its own incremental borrowing rate to discount the minimum lease payments. For a lessee that is attempting to avoid classifying a lease as a capital lease.These leases normally arise when a financial institution uses lease agreements as an alternative to making a direct loan that would be used by a borrower to purchase rather than lease the property. When the lessor is the manufacturer or dealer. the fair value is ordinarily the cost of the leased asset.

Module 1A describes the detailed procedures for applying the four criteria. Operating leases are accounted for as rental agreements in a manner similar to that of other executory contracts. In addition to these four criteria. Once classified. or leveraged): .3. A bargain purchase option is included. 4. there are no further changes in classification unless the terms of the lease are modified. direct financing lease. equals or exceeds 90 percent of the fair value of the leased property to the lessor. excluding any portion representing executory costs. or a leveraged lease.Leveraged leases are similar to direct financing leases except that they involve a third party that shares the risk with the financial institution. Leveraged leases . c. The first three categories are differing forms of capital leases that are accounted for as if either an installment sale of the leased property or a financing transaction has occurred. a lease agreement for personal property must meet at least one of four criteria: a. The term of the lease equals or exceeds 75 percent of the remaining estimated economic life of the leased property. Operating leases . Ownership is transferred.Operating leases are ordinary rental agreements. Module 1B—Lessor's Classification of Leases To be classified as a sales-type lease. All leases that are not properly classified as one of the other three categories are classified as operating leases. d. b. The present value of the minimum lease payments. These are the same criteria used by lessees. lessors apply two additional criteria to determine whether a lease is a capital lease (sales-type. direct financing.

and the lease must not qualify as a leveraged lease. the property is being sold for a profit or a loss. A lessor classifies a lease as a capital lease only when both of these criteria are met. the fair value of the leased property at the inception of the lease must be different from its cost (or carrying amount.e. In addition. The renewal of either a sales-type or a direct financing lease during the lease term is classified as a direct financing lease. the fair value of the leased property at the inception of the lease must be equal to its cost (or carrying amount. Normally this type of lease is undertaken by financial institutions as an alternative to a loan collateralized by the property. That is. or executory costs is not considered to be evidence that a lease agreement fails to meet these two criteria. the renewal continues to be classified as sales-type lease. for example. Collectability of the minimum lease payments is reasonably predictable. No important uncertainties exist with respect of unreimbursable costs. if different). the consolidated financial statements must report the leases as sales-type leases. Normally this type of lease is recorded by manufacturers or dealers in the property who use lease transactions as an alternative to outright sales. there is no profit or loss at the inception of the lease. which may be incurred by the lessor. Sales-Type Leases A sales-type lease meets at least one of the (a) through (d) criteria. If a manufacturer sells its leases to a financing subsidiary that. Thus. In addition. In this case. future warranty costs. Routine estimation of uncollectible accounts. and both (e) and (f). accounts for the leases as direct financing leases. f. except when a sales-type lease is renewed within the final few months of its term. and both (e) and (f). it is solely a financing transaction. in turn. warranty costs. if different). rather. Direct Financing Leases A direct financing lease meets at least one of the (a) through (d) criteria. Leveraged Leases .

The lessor's net investment declines during the early years of the lease and then rises in later years. including the equality of the fair value of the leased property at the inception of the lease and the property's cost. modifies the application of the four capital lease criteria for leases of real estate. h. Leases. and a lessor (the equity participant). Module 2A—Lessee's Classification of Real Estate Leases Because of the relatively long economic lives of real estate. Leases of real estate and personal property 4.A leveraged lease is a form of direct financing lease. Leases of land and buildings 3. and the long-term creditor may have recourse to the leased property and unremitted rental payments. a long-term creditor. The financing provided by the long-term creditor is nonrecourse with respect to the general credit of the lessor. Real estate leases are divided into four categories: 1. leveraged leases must meet three additional criteria: g. In addition to meeting the criteria for a direct financing lease. The financing provides substantial leverage to the lessor. More than one cycle of this type may occur. The agreement involves at least three parties: a lessee. Leases of land 2. Leases that meet the criteria for a sales-type lease are classified as sales-type leases and never as leveraged leases. Leases of a part of a building . The net investment is defined as the lessor's investment in the lease less deferred taxes arising from temporary differences between tax and financial income related to the lease. i. FASB ASC 840. and it must satisfy the same criteria described previously.

Apply the transfer of ownership and the bargain purchase option criteria [(a) and (b)]. A bargain purchase option is defined as an option to purchase at a price low enough relative to the fair value of the property to provide reasonable assurance that the lessee will exercise its option. Thus. the risks and benefits of ownership are not transferred to the lessee unless title to the land will eventually be obtained. b. 2. Implicitly. the economic life and 90 percent recovery criteria [(c) and (d)] are not applicable.Leases of Land For leases that involve only land. The steps are as follows: 1. When neither the (a) nor the (b) criteria is met. If either of the criteria is met. If the fair value of the land is less than 25 percent of the total fair value of the leased property. the lessee classifies a lease of land as capital only if either (a) or (b) criterion is met at the inception of the lease. the land and buildings will be capitalized separately. A bargain purchase option for the leased property is available to the lessee. the property is evaluated as a single unit (assumed to be a building) for the purpose of applying the economic life and fair value of the property criteria. the lease is classified as a capital lease if either the (c) or (d) criterion is met: . Thus. the lease is classified as a capital lease. These two criteria are identical with those for classification of leases of personal property: a. Leases of Land and Buildings Classification of a lease of both land and buildings is a multi-step process. Ownership is transferred to the lessee by the end of the lease term. the lessee compares the fair value of the land to the fair value of all of the leased property. However.

(cont. The remaining of the minimum lease payments are attributed to the building. and the land element is classified as an operating lease.) If the fair value of the land is 25 percent or more of the total fair value of the leased property. the lessee compares the fair value of the land to the fair value of all of the leased property. The term of the lease equals or exceeds 75 percent of the remaining estimated economic life of the leased building. When neither the (a) nor the (b) criteria is met. equals or exceeds 90 percent of the fair value of the leased property to the lessor. except that this criterion is not applicable if the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the building. The present value of the minimum lease payments. The steps are as follows: (cont. the entire lease (building and land elements) is treated as a single operating lease. If the building element of the lease meets neither the (c) nor (d) criterion. Leases of Land and Buildings Classification of a lease of both land and buildings is a multi-step process. the minimum lease payments are separated into the part related to the land and the part related to the building. the building element is classified as a capital lease. If the building element of the lease meets either criterion (c) or (d). excluding any portion representing executory costs.c. This criterion is not applicable if the beginning of the lease term falls within the last 25 percent of the total estimated economic life. Leases of Land and Buildings . This is done by determining the fair value of the land and applying the lessee's incremental borrowing rate to determine the amount of the minimum lease payments applicable to the land. d.) 2.

The lease contains a 5-year renewal option with a penalty clause.000. for example. The lessee's incremental borrowing rate is 10 percent and the lessor's implicit interest rate for the lease is not known by the lessee.000 penalty. The fair value of the land and the building is estimated to be $300. The two elements are classified by applying the appropriate criteria for personal property and real estate as described previously. This poses a problem in applying the 90 percent recovery criterion. The lease requires annual payments of $100. The lessee estimates the portions of the lease payments applicable to the real estate and personal property elements.Example 3 Classification of a Lease Including Land and Buildings A company agrees to a noncancelable lease contract for a plant facility. it must pay a $300.000 and $750. Is the lease classified as an operating or a capital lease? Leases of Real Estate and Personal Property A lease that includes both real estate and personal property is accounted for as though it were two separate leases.153 at the beginning of each year for a 20-year period. respectively. The building's estimated economic life is 35 years. a lease of a floor of an office building or a store unit in a retail mall. Leases of a Part of a Building Leases may involve leased property that is part of a larger unit of real estate. Note that the criteria related to the transfer of ownership and for a bargain purchase option will almost never be met because the lease does not involve the . If the lessee fails to renew.

the lease is classified by applying the criteria for real estate leases as described above. Leases of Land Sales-type leases are leases that transfer ownership of the land [criterion (a)] and give rise to a manufacturer's or dealer's profit (or loss). leveraged. 2. or operating lease. Leases of land and buildings 3. the lease is classified by applying only criterion (c). The estimated economic life of the building is used as the economic life of the property unit being leased. Leases of land 2. Leases of real estate and personal property 4. If the fair value of the leased property is not objectively determinable. The classification of real estate leases generally parallels that for personal property (see Module 1B). For a lease of part of a larger unit of real estate. Leases of a part of a building These four types of leases have differing criteria for classifying a lease as a sales-type. direct financing. FASB ASC 840. . Module 2B—Lessor's Classification of Real Estate Leases For the purpose of classifying real estate leases. lessors separately analyze four types of leases: 1. Leases requires the following classification steps: 1. Note that criteria (e) and (f) do not apply.whole property unit. If the fair value of the leased property is objectively determinable.

All leases that do not meet the criteria for a capital lease described below are classified as operating leases.Direct financing leases are leases other than leveraged leases that meet either criteria (a) or (b) (ownership is transferred. and (i) as described in Module 1B. Leases of Land and Buildings . or a bargain purchase option exists) and both criteria (e) and (f) (that is. (h). This type of lease is accounted for as a single unit. and no important uncertainties exist with respect of unreimbursable costs to be incurred by the lessor) and do not give rise to a manufacturer's or a dealer's profit (or loss). predictable.  Leveraged leases meet the criteria described above for direct financing leases plus criteria (g). Leveraged leases meet the criteria described above for direct financing leases plus criteria (g). collectibility of the minimum lease payments is reasonable. Operating leases include all other leases. and (i) as described in Module 1B. Leases of Land and Buildings Classification of a lease of both land and buildings is a multi-step process. (h).  Direct financing leases include leases other than leveraged leases that meet either criteria (a) or (b) and both criteria (e) and (f) and do not give rise to a manufacturer's or a dealer's profit (or loss). even those that give rise to a manufacturer's or dealer's profit (or loss) but do not meet criterion (a). The first step is to apply the transfer of ownership and bargain purchase option criteria [(a) and (b)] as follows:  Sales-type leases include leases that meet criterion (a) and give rise to a manufacturer's or dealer's profit (or loss).

If the fair value of the land is less than 25 percent of the total fair value of all leased property.When neither the (a) nor (b) criterion is met. and both criteria (e) and (f) are met. and (i) also are met in which case the lease is a leveraged lease. If the building cannot be classified as either a direct financing lease or a leveraged lease. the lease is classified in the normal manner for a real estate lease. The remainder of the minimum lease payments are attributed to the building. the lease is a direct financing lease unless (g). (h). the building and the land are treated as a single operating lease. the lease is a direct financing lease unless (g). If either the cost or the fair value cannot be objectively determined. the lessor classifies the lease as an operating lease. If no manufacturer's or dealer's profit (or loss) exists. and (i) also are met in which case the lease is a leveraged lease. This is done by determining the fair value of the land and applying the lessee's incremental borrowing rate to determine the amount of the minimum lease payments applicable to the land. the lessor follows essentially the same procedure as was described for the lessee in Module 2A. the land and the building must be considered separately for classifying the lease. If the building element meets either criteria (c) or (d) and both (e) and (f) and no manufacturer's or dealer's profit (or loss) exists. (h). If the fair value of the land is greater than 25 percent of the total fair value of all leased property. Leases of Both Real Estate and Equipment The portions of the minimum lease payments related to the personal property and the real estate must be estimated so that the equipment lease and the real estate portions of the lease can be classified as though they were separate lease agreements. The land is accounted for separately as an operating lease. Module 3A—Lessee's Accounting for Leases Operating Leases . Leases of Part of a Building If the cost and the fair value of the portion of the building that has been leased can be objectively determined. and either criteria (c) or (d) are met. the property is evaluated as a single unit for applying criteria (c) and (d).

Thus. a scheduled rent increase occurring because the lessee will gain access to and control over additional leased property is expensed over the period that the lessee has control of the additional leased property. FASB ASC 840 guidance indicates that the physical use of the property is the basis for expense recognition on other than a straight-line basis.FASB ASC 840. and (2) increases or decreases that are dependent on future events such as interest rates or sale volume. anticipated inflation. not actual usage. requires that rental expense for operating leases be recognized over the lease term as it becomes payable. Expected changes in rental payments that are dependent on future events are considered contingent rentals and are recognized as they become probable and estimable. The use of factors such as the time value of money. For example. or expected future revenues to allocate expected increases in the minimum lease payments are not permitted because they do not relate to the time pattern of the physical access of the property.A company agrees to a noncancelable lease contract for one floor of a building. rental expense shall be recognized on a straight-line basis unless some other rational and systematic basis better represents the time pattern of benefit derived from the use of the leased asset. In the case of unequal lease payments. Operating Leases Example 4 Recognition of Operating Lease Expense Part A . a distinction is made between (1) scheduled rent increases that are not dependent on future events. a lessee that has control of all of the leased property at the inception of the lease but agrees to rent increases that reflect expected increases in the physical use of the leased property must recognize the additional rent expense on a straight-line basis over the lease term. When the minimum lease payments are not level. Contingent lease payments that are not included in the minimum lease payments are expensed when they become payable. Otherwise. scheduled increases shall be recognized on a straight-line basis over the lease term. Leases. Scheduled increases are part of minimum lease payments and must be recognized on a straight-line basis unless there is evidence that the increased payments reflect changes in physical control or access to the property. The lease requires lease . The interpretation of use is that access to or control of the leased property is the relevant variable.

The first lease payment is due two years from the inception of the lease. Part D . Capital Leases FASB ASC 840 requires that the lessee record a capital lease as an asset and an obligation equal to the present value of the minimum lease payments during the lease term.000 at the beginning of each month for a 15-year period. The discount rate used to calculate the present value is the same rate used to apply the 90 percent recovery criterion for lease capitalization.000. The old lease has three years remaining. . How is lease expense recognized? Part B .000.In addition to the facts in Part A.payments of $5.000 per month will occur at the beginning of year 8. the lessee must pay 2 percent of any excess of its monthly gross revenue over $1.In addition to the facts in Part A. if known. the leased asset and lease obligation are recorded at the lower fair value. the lesser of the interest rate implicit in the lease. The lessor has indicated that this increase is based on expected inflation during the term of the lease. If the present value of the minimum lease payments is greater than the fair value of the leased property. and the lessee estimates that the difference between its lease payments and the amount for which the property can be subleased is $2. In addition. assume that the lessor agrees to assume the lessee's existing lease with a third party. and the lessee's incremental borrowing rate. The lessee classifies the lease as an operating lease. assume that a scheduled increase in lease payments to $6.In addition to the facts in Part A. that is.000 per month. Part C . assume that the lessor agrees to waive the first two year's rent. The lease payments are reduced by any executory costs paid by the lessor and the lessor's profit thereon.

If the lease is recorded based on a lower fair value. the amortization shall be consistent with the lessee's normal depreciation policy for owned assets. amortization shall be consistent with the lessee's normal depreciation policy except that the depreciable life is reduced to the term of the lease and the residual value is set equal to the expected value of the property to the lessee at the end of the lease term.000. the interest rate is the same as that used to calculate the present value of the lease payments. Normally. The fair value of the land and the building is estimated to be $200. a lessee that guarantees a residual value and has no further interest in the property sets the residual value equal to the amount expected to be realized from its sale. If the lease meets either capitalization criterion (a) or (b). With the exception of land that is not amortized. all of the leased property including the land is amortized over the lesser of the economic life of the building or the term of the lease. Otherwise. Contingent rentals are included in rental expense as they become payable.Minimum lease payments are allocated to interest expense and to a reduction of the obligation using the effective interest method to achieve a constant periodic rate of interest. respectively.000 and $800.000 penalty. the leased property shall be amortized. up to the amount of the guarantee. The lessee's incremental borrowing rate is 11 percent and the lessor's implicit interest . The building's estimated economic life is 35 years. The lease contains a five-year renewal option with a penalty clause. For example. a new implicit interest rate is calculated. Note that when a lease includes both land and buildings and they are not accounted for separately.153 payments at the beginning of each year for a 20-year period. If the lessee fails to renew. The lease requires annual payments of $100. Capital Leases Example 5 Accounting for a Capital Lease A company agrees to a noncancelable lease contract for a plant facility. it must pay a $300.

500. Thus.000 . Normally. the carrying value of the obligation and the leased asset is removed from the balance sheet in conjunction with recording any cash payment required by the guarantee. Why is the lease classified as a capital lease. As a result.000 Accumulated depreciation 94. and how is it reported in the financial statements of the lessee? Accounting for Residual Values and Penalties at the End of a Capital Lease When a lease contains a guaranteed residual value or a penalty for failure to renew that is not sufficient to extend the term of the lease. In the case of the guarantee. For example.000). amortization of the lease obligation results in a residual balance equal to the guarantee or penalty at the end of the lease term.rate for the lease is known to be 10 percent.000 residual guarantee and that the leased asset has a carrying value of $6.000 Leased asset 100. the related amounts are included in the minimum lease payments. the unamortized carrying value of the leased property equals the original estimate of the residual value of the property.500 payment under the residual guarantee and records a profit equal to the excess of the residual value over the carrying value of the leased property: Lease obligation 10. a profit or loss will be recognized.000 at the end of the lease term (original amount of $100. If the residual value is $7. assume that a lease obligation equals the $10. the lessee makes a $2.

000.Cash 2. the revised lease is treated as a new . the breakeven point would be at $10. or  Termination of the lease prior to the expiration of the lease term. the maximum profit cannot exceed $4. Even though the residual value exceeds the $10. so a loss occurs if the residual value is below $6. If the provisions of a lease are changed.500 Profit 1.000 rather than $6.000 at the inception of the lease.  Renewal or extension of the lease beyond the original estimate of the lease term. Changes in Lease Agreements Changes in a capital lease may occur because of  Renegotiation of the lease contract. If the estimated residual value had been $10. other than by renewing or extending the term in a manner that would have changed the original classification if the new terms had been in effect at the inception of the lease.000.500 The breakeven point for the residual value is the original estimate of residual value.000 guarantee.000.

Changes in estimates of economic life. If the minimum lease payments of a capital lease are changed in a way that does not give rise to a new lease agreement (for example. the carrying amounts of the leased property and the obligation must be adjusted. or early termination of a lease: a. The adjustment is the difference between the present value of the minimum lease payments under the revised or new lease and the carrying value of the old lease obligation. and the existing capital lease continues to be accounted for as a capital lease until the end of its original term. If a capital lease is renewed or extended and this does not render a residual guarantee or penalty inoperative. residual value. A profit or loss is recognized for any difference in amounts. The classification criteria described in Modules 1 and 2 are applied to the term of the revised lease. or other amounts related to the lease will affect the classification of the lease. renewal or extension of a lease. Changes in Lease Agreements There are three alternatives for accounting for changes in the provisions of a lease. Likewise. the lease is extended beyond its original term as measured at inception) or if the change gives rise to a new lease agreement that is classified as a capital lease. If the minimum lease payments of a capital lease are changed in a way that gives rise to a new operating lease. The new minimum lease payments are discounted using the rate of interest originally used to record the old lease. the renewal and extension of a capital lease is accounted for as in (a) above. the leased property and the obligation are adjusted to zero. b. The renewal or extension of an operating lease is accounted for as an operating lease.agreement. These changes are reported in the normal manner for changes in accounting estimates. . any extension of the lease other than to avoid payment of a penalty or a guarantee is considered a new lease agreement.

and similar costs are not included. If an operating lease results in a manufacturer's or a dealer's loss but it cannot be classified as a sales-type lease because it does not meet the transfer of ownership criterion (a). The leased property is reported near plant. Initial direct costs are the costs of originating the lease that are directly related to the lease and would not have been incurred in the absence of the specific leasing transaction. and it is depreciated using the lessor's normal depreciation policies. lease solicitation. the leased property and the obligation are adjusted to zero. Even if the rental payments are not equal in amount. Accumulated depreciation is deducted from the investment in the leased property. the loss must be recognized by writing the leased property down to its fair value. Sales-Type Leases . property. Immediate expensing of initial direct costs is permitted in situations in which there is no material difference between immediate expensing and the proportional method. Advertising. If a capital lease is terminated. Leases. revenue must be recognized on a straight-line basis unless another systematic and rational pattern better represents the pattern by which the use benefit of the property is reduced.c. lease servicing. Initial direct costs generally must be deferred and recognized in proportion to the recognition of rental income. Module 3B—Lessor's Accounting for Leases Operating Leases FASB ASC 840. requires that the leased property remain on the balance sheet of the lessor and that rent be recognized as revenue over the term of the lease as it becomes receivable. A profit or loss is recognized for any difference in amounts. and equipment on the balance sheet.

Sales-Type Leases Accounting for a sales-type lease is a three-step process: . Record the sale and capitalize the lease as follows: a. A lease receivable is recorded. Recognize unearned interest income as a contra asset (to the gross investment) equal to the difference between the gross investment and the present value of the gross investment. c. Compute gross investment as the sum of the minimum lease payments and any unguaranteed residual value to the lessor. and the leased property is removed from the balance sheet. Thus. Accounting for a sales-type lease is a three-step process: 1. Record sales revenue equal to the present value of the gross investment in the lease. if any. Remove the carrying value of the leased property from the balance sheet. e. d. b. 2. a profit or loss is recognized at the inception of the lease. and interest revenue will be recognized throughout the term of the lease.Lessors recognize a sales-type lease as though it were a sale and a financing agreement. Cost of sales is recorded equal to the carrying value of the property plus initial direct costs minus the present value of the unguaranteed residual value. Recognize the gross investment as a lease receivable.

a sale has not occurred and no profit or loss is recognized at the inception of the lease even though the leased property is removed from the balance sheet. Unearned interest income and initial direct costs are amortized to income using the interest method. A lease receivable is recorded. The net investment in the lease is the gross investment plus unamortized initial direct costs minus unearned income. Direct Financing Leases Lessors recognize direct financing leases as financing transactions. Record lease payments and amortize unearned income and initial direct costs during the term of the lease as follows: a. Compute gross investment as the sum of the minimum lease payments and any unguaranteed residual value to the lessor. b. Remove the carrying value of the leased property from the balance sheet. . Thus. c. Accounting for a direct financing lease is a three-step process: 1. Recognize the gross investment as a lease receivable. and interest revenue will be recognized throughout the term of the lease.3. b. Capitalize the lease as follows: a. The lease receivable (gross investment in the lease) is reduced by payments received. 2.

Unearned interest income and initial direct costs are amortized to income using the interest method. the related accounting and reporting requirements are not described. The net investment in the lease is the gross investment plus unamortized initial direct costs minus unearned income. They simply apply the normal criteria to determine whether the lease is a capital or an operating lease. lessors must identify those leases meeting the leveraged lease criteria in addition to the criteria for a direct financing lease. but are part of the net investment and are amortized as part of the net investment. b. Lessees do not classify leases as leveraged leases for accounting and reporting.c. . Record lease payments and amortize unearned income and initial direct costs as follows: a. c. Initial direct costs related to direct financing leases are not included in the gross investment. In contrast.) 3. The lease receivable (gross investment in the lease) is reduced by payments received. Because of the specialized nature of leveraged leases. Leveraged Leases Leveraged leases are a specialized form of direct financing lease. Direct Financing Leases Accounting for a direct financing lease is a three-step process: (cont. Recognize unearned interest income as a contra asset (to the gross investment) equal to the difference between the gross investment and the present value of the gross investment.

Otherwise. . governs accounting for sale-leaseback transactions involving only personal property. the transaction is recorded as a purchase of the property and an accompanying direct financing lease. Buyer-lessors simply apply the criteria for classifying a lease as a direct financing lease to sale-leaseback leases. FASB ASC 840. Leases. Sale-leaseback transactions are often facilitated by lease brokers who specialize in structuring the sale-leaseback agreement. The lease-back does not have to include all of the property or extend over the entire economic life of the property. using the straight-line or double-declining-balance methods. for example. it is classified as an operating lease. and the buyer is described as the buyer-lessor. The profit or loss from the sale of the property is deferred rather than recognized in the period of the sale. buyer-lessors record sale-leaseback transactions as a purchase of the property and an accompanying operating lease. it is classified as a capital lease by the seller-lessee. The transaction provides financing to seller-lessee and is an alternative to obtaining a mortgage loan. The original owner is described as the seller-lessee.Module 4—Sale-Leaseback Transactions A sale-leaseback transaction involves the sale of property by its owner who concurrently leases the property from the buyer. Operating Leases If the lease fails to meet one or more of the criteria for capital lease classification. If the lease agreement meets the criteria for a direct financing lease. The profit or loss from the sale of the property is deferred and amortized in proportion to the related gross rental charged to expense over the lease term. The remainder of this module describes the accounting by seller-lessees. Transactions Involving Only Personal Property Capital Leases If the lease meets one of the four criteria for capital lease classification (see Module 2). The deferred profit or loss is amortized in proportion to the amortization of the leased asset.

all of the profit or loss on the sale is recognized at the date of the sale. The remainder is deferred. the following accounting is required: o If the leaseback is classified as an operating lease. o If the leaseback is classified as a capital lease. The remainder is deferred. the seller-lessee is presumed to have retained a minor portion of the use of the asset. o If the fair value of the property is less than its undepreciated cost at the date of the sale.  If the seller-lessee realizes a profit on the sale and retains more than a minor portion of the use of the property but less than substantially all of the use of property. The 90 percent recovery criterion can be used as a guideline for determining whether the leaseback consists of a minor portion. Exceptions Example 6a . a loss should be recognized up to the difference between fair value and undepreciated cost. the sale and leaseback are accounted for as separate transactions. only the amount of profit in excess of the present value of the minimum lease payments over the lease term is recognized at the date of the sale.  If the seller-lessee realizes a loss on the sale. If the present value of a reasonable rental for the leaseback is less than 10 percent of the fair value of the asset sold.Exceptions  If the seller-lessee retains only a minor portion of the use of the property that it sold. only the amount of profit in excess of the recorded amount of the leased asset is recognized at the date of the sale. As a result. all of the loss is recognized.

it is classified as an operating lease. using the straight-line or double-declining-balance methods.000. The profit or loss from the sale of the property is deferred rather than recognized in the period of the sale. the sale and leaseback are accounted for as separate transactions.467 at the beginning of each year for a 10-year period. Operating Leases If the lease fails to meet one or more of the criteria for capital lease classification. How is the sale-leaseback reported in the financial statements of the seller-lessee? Transactions Involving Only Personal Property Capital Leases If the lease meets one of the four criteria for capital lease classification (see Module 2). the equipment is sold to a leasing company for $975.Accounting for a Sale-Leaseback of Personal Property (Operating Lease) A company enters a sale-leaseback arrangement for the new equipment in one of its plants. The company properly classifies the lease as an operating lease. and leased back under a noncancelable lease agreement requiring annual payments of $122. The deferred profit or loss is amortized in proportion to the amortization of the leased asset. The profit or loss from the sale of the property is deferred and amortized in proportion to the related gross rental charged to expense over the lease term. After purchasing the equipment from the manufacturer for $1.000 (its fair value). it is classified as a capital lease by the seller-lessee. Exceptions  If the seller-lessee retains only a minor portion of the use of the property that it sold.000. all of the profit or loss on the sale is recognized at the date of the sale. for example. The 90 percent recovery criterion can be used as a guideline for determining whether the leaseback consists of a . As a result.

only the amount of profit in excess of the present value of the minimum lease payments over the lease term is recognized at the date of the sale. a loss should be recognized up to the difference between fair value and undepreciated cost. the equipment is sold to a leasing company for $975. The remainder is deferred.000. If the present value of a reasonable rental for the leaseback is less than 10 percent of the fair value of the asset sold. . the seller-lessee is presumed to have retained a minor portion of the use of the asset. o If the fair value of the property is less than its undepreciated cost at the date of the sale. The remainder is deferred.  If the seller-lessee realizes a loss on the sale. o If the leaseback is classified as a capital lease. Exceptions Example 6a Accounting for a Sale-Leaseback of Personal Property (Operating Lease) A company enters a sale-leaseback arrangement for the new equipment in one of its plants. and leased back under a noncancelable lease agreement requiring annual payments of $122. the following accounting is required: o If the leaseback is classified as an operating lease.  If the seller-lessee realizes a profit on the sale and retains more than a minor portion of the use of the property but less than substantially all of the use of property.000.minor portion.467 at the beginning of each year for a 10-year period. all of the loss is recognized. After purchasing the equipment from the manufacturer for $1.000 (its fair value). only the amount of profit in excess of the recorded amount of the leased asset is recognized at the date of the sale.

000 loss on the sale is recognized. How is the sale-leaseback reported in the financial statements of the seller-lessee? Accounting for a Sale-leaseback of Personal Property (Operating Lease) Solution Explanation The sales price is less than its book value.000.000 (its fair value). it is sold to a leasing company for $975.467 at the beginning of each year for a 17-year period. Exceptions Example 6b Accounting for a Sale-Leaseback of Personal Property (Capital Lease) A company enters a sale-leaseback arrangement for new equipment. . so immediate loss recognition is necessary.The company properly classifies the lease as an operating lease.000. and leased back under a noncancelable lease agreement requiring annual payments of $122. After purchasing the equipment from the manufacturer for $1. The $25.

The standards also apply to transactions in which the seller-lessee sells property improvements or integral equipment while retaining the underlying land. included in the transaction. irrespective of the relative values of the real estate and the personal property. which is lower than the lessee's incremental borrowing rate.000.The estimated economic life of the equipment is 18 years.000 is sold to a leasing company for its fair value. The company properly classifies the lease as a capital lease because it meets both the economic life and the 90 percent recovery criteria (using a 12 percent discount rate). How is the sale-leaseback reported in the financial statements of the seller-lessee? Exceptions Example 7 Accounting for a Sale-Leaseback of Personal Property (Leaseback of a Part of the Property) A company enters a sale-leaseback arrangement for its existing equipment. $1. Sixty percent of the equipment is leased back. The noncancelable lease agreement requires 60 monthly payments of $13. if any. assuming that the lease is properly classified as an operating lease? Sale-Leaseback Transactions Involving Real Estate The accounting standards for sale-leaseback transactions involving real estate apply to all transactions that include real estate. Owned equipment is depreciated on a straight-line basis. How is the profit for the sale-leaseback reported in the financial statements of the seller-lessee. . Improvements and integral equipment include any physical structure or equipment that is attached to the real estate and cannot be removed and used separately without incurring significant cost. based on relative fair values. Equipment with a net book value of $100. The payments are based on the lessor's implicit interest rate of one percent per month.000.215.

. The buyer's continuing investment is evidenced by a contractual obligation to pay an amount each year that is at least equal to a level 20-year amortization of the total debt for land and the amortization of the debt over the customary amortization term for other real estate.lessee's trade or business in consideration for the payment of rent. the buyer's initial investment must be equal to a major part of the difference between the sales value of the property and the usual loan limits for financing the purchase of the property. In addition. or the buyer-lessor can compel repurchase. that is.  The seller-lessee guarantees the buyer-lessor's return on investment for some period of time.  Payment terms and provisions that transfer all of the other risks and rewards of ownership to the buyer-lessor. the subleasing of the property must be minor. Criteria for Sale-Leaseback Accounting The following circumstances are examples of a seller-lessee's continuing involvement in the leased property:  The seller-lessee has the option to purchase the property.Criteria for Sale-Leaseback Accounting The seller-lessee in a transaction involving real estate is required to use sale-leaseback accounting if the transaction includes all of the following:  A normal leaseback arrangement that includes active use of the property in the seller. This is demonstrated by the seller-lessee's lack of any other continuing involvement. In general. the present value of a reasonable rental on the subleased portion must be less than 10 percent of the fair value of the property sold.  Payment terms and provisions that demonstrate the buyer-lessor's initial and continuing investment in the property. The precise requirements for demonstrating the buyer-lessor's initial and continuing investment are not presented in detail.

it may be necessary to make disclosures related to the contingency if the original lessee has an obligation in case of the default by the new lessee.  The seller-lessee is not relieved of existing financing related to the property. The original lessee may or may not retain a secondary obligation. .  The seller-lessee provides nonrecourse financing to the buyer-lessor for any portion of the sales proceeds or recourse financing where recourse is to the property. and the original agreement is canceled.  The seller-lessee in entitled to share the appreciation of the property with the buyer-lessor. Module 5—Subleases Subleases That Relieve the Original Lessee of Its Obligation The following are examples of transactions that relieve the original lessee of its obligation:  A new lessee is substituted under the original agreement. However. If the original lease was an operating lease. no accounting entries are necessary.  A new lessee is substituted under a new lease agreement.  The seller-lessee sells property improvements or integral equipment but does not lease the underlying land to the buyerlessor. The seller-lessee is required to pay the buyer-lessor for a decline in fair value of the property that is unrelated to excess wear and tear of the property.

A profit or loss is recognized equal to the difference between the carrying values of the asset and obligation. Module 6A—Lessee's Disclosure Requirements General disclosure requirements for all leases include. and sublease rentals (Data related to leases with terms of less than one month that were not renewed may be omitted) The following disclosures are required for noncancelable leases having initial or remaining terms of longer than one year:  Future minimum rental payments for each of the next five years and the total for all future years  The total minimum sublease rentals to be received in all future years under non-cancelable subleases Capital Lease Disclosures . but are not limited to  The basis for determining the amount of contingent rentals. Again. adjusted by any consideration paid or received.  The terms of renewal and purchase options and escalation clauses.If the original lease was a capital lease. contingent rentals. and  Restrictions imposed by lease agreements. for example. limitations of dividend payments or additional debt. the lease asset and obligation are removed from the balance sheet. Operating Lease Disclosures The following disclosures are required for all operating leases:  Total rental expense with separate amounts of minimum rentals. it may be necessary to disclose any contingent obligation.

accumulated amortization. obligations.  Future minimum lease payments for each of the next five years and the total for all future years (Deductions must be made for executory costs and for imputed interest necessary to reduce the minimum lease payments to present value)  The total minimum sublease rentals to be received in all future years under noncancelable subleases. both the obligation for future minimum lease payments and the minimum sublease rentals should be disclosed in the aggregate and for each of the next five years. and lease obligations should be separately identified in the balance sheet or the footnotes (Obligations are classified as current or noncurrent in the normal manner.  Total contingent rentals for each year that an income statement is presented.  If the seller-lessee accounts for the transaction by the deposit method or as a financing.The following disclosures are required for all capital leases:  The gross amount of assets recorded under capital leases (The amount should be classified by major classes of assets and may be combined with comparable information for owned assets). the seller-lessee should describe the terms of the sale-leaseback. including future commitments. or any other circumstances that result in the seller-lessee's continuing involvement in the property. and  Leased assets. . Amortization expense must be disclosed although it can either be reported as part of depreciation or as a separate item in the income statement) Sale-Leaseback Disclosures  In addition to the other lease disclosure requirements.

and $178. 20X3.000.4 million.$8. $20.3 million. computer equipment and trucks.000 for the years ended December 31. Certain leases contain escalation clauses and provide for renewal options. Minimum rental payments under these leases with initial or remaining terms of one year or more at March 31. 20X0.4 million in 20X1. $67.2 million and payments due during the next five years are: 20X4 . 20X0 Note 11 . 20X2. principally for office space.$11.000 and thereafter.7 million. . March 31.000.3 million. $142.$5. $79.Implementation Guidelines Many companies integrate the required lease disclosures with related footnote disclosures. under noncancelable operating leases at December 31. and the disclosures related to the lease obligations can be combined with disclosures related to long-term liabilities.5 million in 20X2 and $12. $13. and 20W8. $0.$6. Even disclosures of rental payments for operating leases can be readily combined with those for long-term liabilities. 20X4.000. $79. respectively. 20X6 . $75.000. 20X5 .6 million. 20X3 Note M .000. 20X8 . the disclosures of leased assets can be combined with disclosures related to owned property subject to depreciation.Commitments and Contingencies The Corporation leases various types of properties. 20W9.$4. 20X5. and thereafter $26. 20X3. 20X7 . Rental expense under operating leases aggregated $13. through noncancelable operating leases. are: 20X1. Corp.9 million.9 million in 20X3. primarily warehouse property. 20X0. For example. Rent expense charged to earnings was $46. Financial Statement Illustrations Disclosures of Operating Leases Ambase Corporation December 31. FoxMyer.Commitments and Contingencies Future minimum rental payments.000. aggregate $63.

and $1. Interest paid was $4.211. and $11.1 million for the years ended August 31.9 million.000.Long-Term Debt Maturities of Debt . $6. insurance.000 in 20X0. $9. 20X5.892. and $5. and normal maintenance costs. respectively. Inc. 20X1. June 29. 20X3 . 20Y1.033.$1.4 million.$34. and 20X6 $79.000. $10.2 million. All of the Company's leases have fixed minimum lease payments except the lease for certain facilities in Milpitas.000.000 in 20W9. Payments under this lease are periodically adjusted based on LIBOR rates.2 million. 20X4 .$37. The Company must also maintain compliance with financial covenants similar to its credit facilities. The facility leases expire at various dates through 20Y1.The aggregate maturities of long-term debt. California. 20X1 Note C . . 20X6 Note 8 . $5. Rent expense was $17.Disclosures of Operating Leases Solectron Corporation August 31. This lease provides the Company with the option at the end of the lease of either acquiring the property at its original cost or arranging for the property to be acquired. Future minimum payments related to lease obligations are $13.$1. for the five fiscal years subsequent to 20X1 are as follows: 20X2 .000.Commitments The Company leases various facilities under operating lease agreements. 20X6. Substantially all leases require the Company to pay property taxes.0 million.231. Disclosures of Capital Leases Action Industries. 20X5 . The Company is contingently liable under a first loss clause for a decline in market value of the leased facilities up to $44.1 million in each of the years in the five-year period ending August 31.950.000 during the year ended June 29.000. $12.8 million. and 20X4.2 million in the event the Company does not purchase the property at the end of the five-year lease term. including capital lease obligations.

Combined Disclosures of Operating and Capital Leases Future minimum obligations on capital leases in effect at February 27.Capital and operating leases: The Company leases certain food distribution warehouse and office facilities.349 20X5 23.Long-Term Debt Leases .025 20X8 19.Combined Disclosures of Operating and Capital Leases Supervalue. Amortization of assets under capital leases was $11. and $6. February 27. include options to purchase. 20X3.233 20X7 21.8. 20X3 Note D .255 . and to a limited extent.4 million in 20X3. $7. 20X2. as well as corporate-owned and operated retail food stores. are as follows (in thousands): Year Lease Obligations 20X4 $25.165 Total future minimum obligations 308. Many of these leases include renewal options. Inc.750 Later 196.733 20X6 22. respectively.8. and 20X1.

125 The present values of future minimum obligations shown are calculated based on interest rates ranging from 7.8. with a weighted average of 10. and 20X1.3 million in 20X3. $. for capital leases was $.554 20X6 45. and $. respectively. 20X2. based primarily on sales performance. Interest expense on the outstanding obligations under capital leases was $14. and computer equipment. and 20X1.1.659 .3. respectively.774 $149. $12. the company is obligated under operating leases. primarily for buildings. Combined Disclosures of Operating and Capital Leases In addition to its capital leases. 20X2. are as follows (in thousands): Year Obligations 20X4 $56. warehouse.356 Present value of net future minimum obligations 158. 20X3. Future minimum obligations on operating leases in effect at February 27.Less interest 149.1. Contingent rent expense.3 million in 20X3. determined to be applicable at the inception of the leases.3% to 13.2%. and $10.8%.899 Less current portion Long-term obligations 9.385 20X5 50.

Rental expense for operating leases was approximately $66.0.$26. the Company leased an airplane and certain furniture and equipment from related parties.$2. and $3. The Company also leases their telephone system and analytical and laboratory equipment under capital leases. $29. Disclosures Related to Sale-Leaseback Transactions Action Industries. 20X0.552 Total future minimum obligations $383.20X7 41. The net minimum payment amounts include $1. June 29.3 million in 20X3. which originally expired in April 20X5. relating to all operating leases with terms greater than one year was $13.8.724.As described in Note 4. and 20W9.300 for fiscal 20X1.914 of interest. and 20X1. 20X3 . 20X1 Note 9 .300. 20X2. net of sublease income.023 Later 154. September 30. Inc.500. was changed to a month-to-month lease in May 20X2.270.374. $2.$2. The future net minimum payments under capital leases are: 20X2 . The office space lease.Commitments Leases . and $35. Combined Disclosures of Operating and Capital Leases Waste Conversion Systems.243 Total rent expense. Inc.070 20X8 35. 20X1 . 20X4 . respectively. The Company leases its office space under an operating lease.

700. The Company does not have continuing involvement under the sale-leaseback transactions.000 in fiscal 20X2). The lease has a term twelve years for the office and eight years for the warehouse and requires minimum annual rental payments of $1.050.5 million of which was received in the form of an interest bearing note receivable due in April 20X5.000 in 20X2. The cash received was utilized to repay existing mortgages on the property ($2.5 million). the Company completed the refinancing of its headquarters facility under a sale/leaseback arrangement.Note D .325. 20X2 Note 1 .655. and $6. $1. Disclosures Related to Sale-Leaseback Transactions Circuit City Stores. The transaction has been accounted for as a financing. and the option to purchase the property at the end of the warehouse lease.000 in 20X3. $1. the Company entered into sale-leaseback transactions with unrelated parties at an aggregate selling price of $69.700.856. Inc. A financing obligation representing the proceeds has been recorded.Lease Commitments In fiscal 20X3. $1.Sale/Leaseback In April 20X1. to be reduced based on payments under the lease.3 million) and expenses of the transaction ($700. wherein the property remains on the books and will continue to be depreciated.000 ($86.000 in 20X6. The Company has the option to renew the lease at the end of the respective lease terms. December 31.195. and the remainder in cash. 20X2 Note 7 . . UAL Corp. $3.000 in 20X5.000 thereafter. $1.Gains on aircraft sale and leaseback transactions are deferred and amortized over the lives of the leases as a reduction of rental expense.655.000 in 20X4. February 28.000) and to repay bank debt ($7. The facility was sold for $14 million.Summary of Significant Accounting Policies Deferred Gains .

February 2.Disclosures Related to Sale-Leaseback Transactions May Department Stores Company February 1. The company and MCAC completed additional sale/leaseback transactions of six department store properties amounting to $57 million in 20X1 and 23 department store properties amounting to $210 million in 20X0. .Long-Term Debt Long-term debt and capital lease obligations were as follows: (dollars in millions) February 1.939 620 570 2.20Z1 MCAC sale/leasebacks On February 1. 20X2 20X1 $3.75% unsecured notes and sinking fund debentures due 20X2 .75% to 12. 20X2 Note . 20X0. the accounting rules specify that the sale/leasebacks be accounted for as loans from MCAC. The leases also provide for renewal options. The base lease terms are 25 years and include fixed annual payments of $58 million and percentage payments based upon sales above defined sales levels. the company sold 37 of its department store properties to MCAC for $367 million and simultaneously leased back the properties.210 $2. As the company is a 50 percent partner in MCA.

or assets. Leases. Operating Lease Disclosures The following disclosures are required for all operating leases:  The cost and carrying amount of property used for leasing and the total accumulated depreciation for such property as of the most recent balance sheet date (The cost and carrying amounts are presented by major category according to nature or function)  Minimum future rentals on noncancelable leases for each of the next five years and in the aggregate as of the most recent balance sheet date  Total contingent rental expense for each period that an income statement is presented Sales-Type and Direct Financing Lease Disclosures The following disclosures are required for all capital leases:  The components of the net investment in leases for each balance sheet presented. All such lessors disclose the following:  A general description of the leasing agreements Other disclosure requirements differ for capital and operating leases. including .Module 6B—Lessor's Disclosure Requirements FASB ASC 840. describes the primary disclosures required of lessors for which leasing is a significant part of their business activities in terms of revenue. net income.

o Initial direct costs of direct financing leases. o Unguaranteed residual values available to the lessor. June 30.  Future minimum lease payments to be received in each of the next five years as of the most recent balance sheet date  Total contingent rentals for each period that an income statement is presented  Sale-Leaseback Disclosures  No additional disclosure requirements are applied for direct financing leases that are part of sale-leaseback transactions.o Future minimum lease payments to be received with separate deductions for executory costs and the accumulated allowance for uncollectible minimum lease payments receivable. and o Unearned interest income. 20X1 Note 9 . equipment and leasehold improvements consist of the following (in thousands of dollars): . Equipment.Property. and Leasehold Improvements Property. Disclosure of Operating Leases Prime Motor Inns Corp.

Minimum future rentals under such leases were $5. $9. and 20W9.582. pursuant to noncancelable operating leases expiring on various dates through 2083. respectively.060.000.867. . including discontinued operations.409. and certain restaurant facilities in Company-owned hotels with an approximate aggregate net carrying value of $8. on property. equipment and leasehold improvements was $7.152.000.222.000 in 20X1.000.505. 20X1. 20X0. 20X6.000.000. and $9.Disclosure of Operating Leases At June 30.852. and 20W9. 20X0. Capitalized interest was $1. and $2. respectively. Depreciation and amortization expense. of which $2.000 is to be received in each of the five years in the period ending June 30.000. the Company was the lessor of land. $5.000 in 20X1.000.

Some leases contain escalation clauses over the lives of the leases. which may be paid on the basis of a percentage of sales in excess of stipulated amounts. which may be received on the basis of a percentage of sales in excess of stipulated amounts. which expire over the next twenty years.670 $5.Leases Description of Leasing Arrangements .653 Net investment in direct financing and sales-type leases 4.956 783 908 Less amount due within one year . buildings. Combined Disclosures of Operating and Direct Financing Leases Direct Financing and Sales-Type Leases .609 Less unearned income 1.The Company's leasing operations consist principally of leasing certain land. The land portions of these leases are classified as operating leases and the buildings portions are classified as capital leases.Components of net investment in direct financing and sales-type leases are as follows at August 31. and equipment (including signs) and subleasing certain buildings to franchise operators.466 1. August 31. These leases. The land portions of these leases are classified as operating leases and expire over the next six years. 20X6 and 20X5: 20X6 Minimum lease payments receivable 20X5 $5.Combined Disclosures of Operating and Direct Financing Leases Sonic Corp. Certain Company-owned restaurants lease land and buildings from third parties. The buildings and equipment portions of these leases are classified principally as direct financing or sales-type leases and expire over the next eight years. These leases include provisions for contingent rentals. 20X6 Note 6 .204 3. include provisions for contingent rentals.

20X6.336 in 20X7. 20X3 (in thousands): Minimum lease payments receivable $93.Summary of Significant Accounting Policies e. Accordingly. the Company is leasing equipment under sales-type lease agreements expiring in various years through 20X9.163.421 $3. Disclosures of Sales-Type Leases Note 2 . and $836 for the years ended August 31. $1. Equipment and sign sales include $1. and 20X4. Disclosures of Sales-Type Leases Sensormatic Electronics Corporation June 30.340. 20X6. 20X5.241 in 20X8.Receivables and net investment in sales-type leases As a result of the ALPS acquisition.120 in 20X9. $681 in 20Y1 and $406 thereafter.158 . Revenue recognition Revenue from sales-type leases (primarily leases with terms of sixty months or greater) is recognized as a "sale" upon shipment in an amount equal to the present value of the minimum rental payments under the fixed noncancelable lease term. $1. respectively.Amount due after one year $3. are $1. $886 in 20Y0. related to sign lease transactions that have been accounted for as sales-type leases. Interest income on receivables under deferred terms and installment contract obligations and net investment in sales-type leases is recognized over the term of the contract using the effective interest method.048 Minimum lease payments receivable for each of the five years after August 31. $1. Initial direct costs incurred in the negotiation and consummation of direct financing and sales-type lease transactions have not been material during fiscal years 20X6 and 20X5. no portion of unearned income has been recognized to offset those costs. 20X3 Note 1 . The net investment in sales-type leases consisted of the following at June 30.

20X7 . 20X3. 20X2. The Company has agreements with third party financing institutions whereby certain receivables under installment contract obligations in the US and net investment in sales-type leases in Europe together with certain related rights are sold to the financing institutions. related to $125. the Company is obligated to repurchase specific receivables and net investment in sales-type leases from the financing institutions. December 31. should certain events (primarily related to customer non-payment) occur. 20X3.$177.076. electric production equipment. and thereafter . 20X0 Note 7 . CLM. manufacturing equipment. The economic lives and lease terms vary with the leases.$2. 20X5 . 20X6 . is a lessor in nine leveraged lease arrangements under which mining equipment.943) (25.$4.Allowance for uncollectible minimum lease payments Unearned interest and maintenance (1.9 million. and May 31.975) $65. of receivables and leases sold to the financing institutions that are subject to full or partial repurchase. of $1. warehouse facilities and office buildings are leased to third parties. respectively. respectively. Inc.$3.Leveraged Lease Financing Receivables The Company. electric transmission lines. Disclosures Related to Direct Financing Leases for Sale-Leaseback Transactions Cilcorp.Leveraged Lease Financing Receivables (cont. satellite transponders.9 million and $51. respectively.644 and $12. are due as follows (in thousands): 20X4 . Under such agreements.240 Net receivables and net investment in sales-type leases at June 30. through its 81 percent-owned leasing subsidiary.4 million. 20X8 . The leasing subsidiary's share of total equipment and facilities cost was approximately $376 million and $377 million at December 31.472 and $12.251.) .835.974.4 million and $0.620.484.$63 and $11.820 and $11. respectively.$647 and $3. 20X0 and 20W9. Disclosures Related to Direct Financing Leases for Sale-Leaseback Transactions Note 7 .692 and $13. The Company accrued loss contingencies at June 30.

545 $48. 1 electric generating station.000.976 Less: Unearned income 144. which are conservative in relationship to appraised residual values.000 of deferred taxes. 20W9.699 122.876. The station is leased to Century Power Corporation (Century).454 Investment in lease financing receivables 125.768 Estimated residual value 122. and $288 million at December 31.846 69.044 155.954. as shown below: (In thousands) Minimum lease payments receivable 20X0 20W9 $146.The cost of the equipment and facilities was partially financed by non-recourse debt provided by lenders. less $22.880 Included in the table above is the Company's approximately seven percent investment in the Springerville Unit No. which sells its output to Tucson Electric Power Company (TEP) under a 28-year power sale agreement. who have been granted as their sole remedy in the event of a lessee default.497. are tested on a periodic basis. an assignment of rentals due under the leases and a security interest in the leased property.Leveraged Lease Financing Receivables (cont. The non-recourse debt balance at that date was $37. respectively.736 $150.391 118. was approximately $43 million and $49 million. 20X0 and 20W9. consisting of lease financing receivables of $20.) . 20X0. Disclosures Related to Direct Financing Leases for Sale-Leaseback Transactions Note 7 . was $1.000. The Company's net investment at December 31.000.290 Less: Deferred taxes arising from leveraged leases 82. Payments made by TEP to Century under the agreement enable Century to meet its lease obligations. Such debt amounted to $277 million at December 31.922. The Company's net investment in leveraged leases at December 31.410 Net investment in leveraged leases $42. Leveraged lease residual value assumptions. 20X0.

renegotiation of the timing or amount of rental payments under the lease could reduce previously reported net income. 20X1. In the event of a TEP bankruptcy and subsequent foreclosure by the nonrecourse lenders. Management cannot predict whether the terms of the lease will be renegotiated. the Company's net income could be reduced by a maximum of $11 million. Separately. TEP has requested that the terms of Century's power sale agreement with TEP be renegotiated. respectively. or predict the amount by which net income may be reduced if this occurs. and has requested that all parties temporarily refrain from legal action to compel performance. TEP has proposed to its lenders a moratorium on principal and interest payments on debt other than first mortgage bonds. TEP and Century breached their obligations to make payments under the power sale agreement and lease. .On February 1. which constitutes an event of default under the lease. Under ASC 840.