ORIE 3150

October 4, 2018

Leases
Homework #5 Comments

 85% of the class submitted Homework #5.

 Please work the problems yourself if you did
not submit it.
 I assure you that looking at the posted
answers is not the best way to learn the
material.
20 % to 50%

 Equity Method: Use the T account!

Don’t be led astray…
Include the
change in the Oh! Oh,
stock price! OK.
No. There is no “change in stock price”

 Equity Method: Use the T account!

Leases

 Lease accounting has changed!

 We will call the new lease methods Topic 842
Accounting (which is the FASB document
describing the changes).
 The new method must be used for the 2019
fiscal year and later
Only New Leases

 We will only cover the new way to do lease

accounting in this class.
Leases

 A lease is a contractual agreement between

a lessor (owner) and a lessee (renter) that
grants the right to use specific property for a
period of time in return for cash payments.
 Leases are always contracts (legally
enforceable items), but they can be one of
two types.
Operating Leases

 In an operating lease the intent is

temporary use of the property by the
lessee with continued ownership of
the property by the lessor.
Finance Lease

 A finance lease transfers

substantially all the benefits and risks
of ownership from the lessor to the
lessee.
Leases

 Both the Finance Lease and the Operating

Lease show up on the balance sheet as
liabilities.
Leases

 For finance leases, the interest and

amortization of the lease are presented
separately on the income statement.
 However, for operating leases, the two are
combined into a single line-item.
Finance Lease

1. Recognize a right-of-use asset and a lease

liability, initially measured at the present
value of the lease payments, on the balance
sheet

2. Recognize interest on the lease liability

separately from amortization of the right-of-
use asset on the income statement
Finance Lease

 The amortization of the leased asset will be

done over the lease term if the lessee intends
to return the asset to the lessor at lease end.
 The amortization of the leased asset will be
done over the useful life of the asset if the
lessee intends to keep the asset at lease
end.
 Amortize over the
lease term if you
intend to return the
asset
 Amortize over the
useful life of the asset
if you intend to keep
the asset
Operating Lease

1. Recognize a right-of-use asset and a lease

liability, initially measured at the present
value of the lease payments, on the balance
sheet
2. Recognize a single lease cost, calculated so
that the cost of the lease is allocated over
the lease term on a generally straight-line
basis
The New Lease Checklist

 a. The lease transfers ownership of the underlying asset

to the lessee by the end of the lease term.
 b. The lease grants the lessee an option to purchase the
underlying asset that the lessee is reasonably certain to
exercise.
 c. The lease term is for the major part of the remaining
economic life of the underlying asset.
 d. The present value of the sum of the lease payments
equals or exceeds substantially all of the fair value of the
underlying asset.
If one or more is true, it is a capital lease!
New Lease Checklist

 The checklist does not have clear break

points or “bright lines.”
 E.g., “The lease term is for the major part
of the remaining economic life of the
underlying asset.”
 What’s “the major part?” 51%? 90%?
 This was done on purpose. It is
ambiguous!
I don’t like
ambiguous
things!
 Best Song of 2014!

“Mr. Ambiguous” by Mamamoo (2014)

1. Ownership Transfer

 There is no need to return the asset to the

lessor.
 Just keep it.
 Obviously this is just a way to finance the
acquisition of an asset.
2. Bargain Purchase Option
3. Lease Term

 If we lease the asset for a long time, then it is

a capital lease.
 Most vehicle leases are for only 3 or 4 years
and do not qualify as “long” leases.
4. Amount of Lease Payments

 If the present value of all lease payments

equals or exceeds the fair market value at the
inception of the lease, then it is a capital
lease.
 The fair market value can be the cash price
or an appraised value.
Finance Lease

1. Record the asset and liability at the

beginning of the lease.
2. Find the interest expense
Interest expense = Lease Liability x i
3. Amortize over the appropriate period
4. Continue each period until the end of the
lease.
Operating Lease

1. Record the asset and the liability at the

beginning of the lease.
2. Record the Lease Expense as equal to the
cash payment. The lease liability is drawn
down the same amount as in the financing
lease.
Examples