9/22 - CHAPTER 15

Contractual arrangement
- Lessor (owner) - right to control asset
- Lessee (user) - makes period cash payments to lessor

Why lease?
- Reduces upfront cash needed to use an asset
- Payments often lower than installment payments
- Offers flexibility and lower cost when disposing the asset
- Might offer protection against the risk of declining asset values
- Might offer tax incentives

Lease classifications
- Finance lease (called sales-type lease for lessor) - you can sell with or without profit
- Operating lease (also called operating lease for lessor)

A lease is considered a finance/sales-type lease if it meets one or more of the 5 criteria

1. The title passes to the lessee in the end of the lease
2. At the end of the lease, you have an option to purchase the title at a bargained price
3. The lease term is for the major part of the remaining economic life of the underlying asset (ex: 7 yrs in a 10 year
life)
4. The present value of the lease payments equals or exceeds substantially all of the FV of the underlying asset
5. The asset is specialized to your business and nobody else can use it at the end of the term

Lessee records a payable and an asset

Lessor records a receivable, and credits the asset (removing the asset)
(beginning of the year)

(recorded at the end of the year)

The lessee has to depreciate the asset as it uses it (AMORTIZATION)

Sales-type leases with selling profit

- Occurs when the FV of the asset exceeds the cost or carrying value
- Lessor recognizes a selling profit at the BEGINNING of the lease term
- Selling profit is the difference between sales revenue and the CoGS
- Lessor also recognizes interest revenue over the lease term

Lessor
- When there is a selling profit, all lessor entries, other than the entry at the beginning of the lease to include the
selling profit, are the SAME as the entries for a sales-type lease without a selling profit

Lessee
- The lessee’s accounting is not impacted by whether or not the lessor recognizes a profit
Operating Leases
- Doesn’t meet any of the criteria for a finance lease
- Fundamental rights and responsibilities of ownership are retained by the lessor (assets are not removed from
lessor’s books)
- Lessee merely uses the asset temporarily
- A sale is NOT recorded by the lessor, the lessor records lease revenue on a straight line basis
- Lessee records the right-of-use asset and lease payable at commencement based on present value of lease
payments (lessee does NOT record depreciation, it is recorded by the lessor)
- Lease payable is considered a non-debt liability (when calculated in ratios, it will not be considered a debt-liability)
Because the lessor didn’t EARN the revenue (the machine wasn’t used yet at first payment), it is recorded as DEFERRED
LEASE REVENUE
Lessee must record amortization expense in the SAME AMOUNT as lease payable in order to reduce the right-of-use
asset

Lessor will now recognize the deferred revenue from the first payment, as well as collect cash from the second payment
(and defer the second payment as deferred revenue to be recognized at the end of next year). Lessor also records
depreciation of the asset in their books

**When interest + amortization is FIXED, it is operating lease. If it is different every year, it is FINANCING LEASE

Finance lease
- Amortization reflects the right to use asset and the financing of that right
Operating lease
- Lease expense is recorded in a manner designed to mirror