Calculate and Interpret Leverage and C ...
In a finance lease, the lessor transfers substantially all the risks and rewards incidental to legal ownership of a leased asset. A finance lease is also economically similar to borrowing money and buying an asset.
Under IFRS, if a lessor enters into a finance lease:
A direct financing lease is distinguished from a sales-type lease based on the carrying value of the leased asset relative to the present value of lease payments. A direct financing lease is reported when the present value of lease payments is equal to the value of the leased asset to the lessor. The lease is a sales-type lease whenever the present value of lease payments exceeds the value of the leased asset. The income statement effect will therefore differ based on the type of lease.
In a direct financing lease, the lessor exchanges a lease receivable for the leased asset, and no longer reports the leased asset on its books. Additionally, the lessor’s revenue is derived from interest on the lease receivable.
In a sales-type lease, the lessor “sells” an asset to the lessee while providing financing on the sale. The lessor will therefore report revenue from the sale, cost of goods sold, profit on the sale, as well as interest revenue earned from financing the sale. The lessor will also show a profit on the transaction in the year of inception and interest revenue over the lease’s life.
From the perspective of the lessee:
A company enters into a lease agreement to acquire the use of some equipment for three years beginning on January 1, 2014. The lease requires 3 annual payments of $13,472, commencing on January 1, 2014. The useful life of the equipment is 3 years, its salvage value is $0, and its fair value is $75,000. The company accounts for the lease as a finance lease, and uses straight-line depreciation.
The amount reported on the balance sheet as a leased asset on January 1, 2014, and December 31, 2014 are closest to:
A. January 1, 2014: $75,000; December 31, 2014: $50,000
B. January 1, 2014: $0; December 31, 2014: $13,472
C. January 1, 2014: $50,000; December 31, 2014: $25,000
The correct answer is A.
The amount initially reported as a leased asset on January 1, 2014 is $75,000. Depreciation expense each year is [($75,000-$0)/3 years] = $25,000. Therefore, on December 31, 2014, the carrying amount of the leased asset = initial recognition amount – accumulated depreciation = $75,000 – $25,000 = $50,000.
XYZ company leased a machine with a value of $100,000 at the beginning of the year. The machine has an expected lifetime of 5 years with no residual value. If the company leased that machine under an operating lease contract, it should report at the end of that year:
A. A depreciation expense of $20,000.
B. A rent expense equal to the annual rent payment for the machine.
C. None of the above.
The correct answer is B.
Under an operating lease contract, the company using the asset should report only the rent expense paid to the lessor. Under finance lease contracts, the company reports the asset’s value on its balance sheet and reports depreciation expense of the asset.
Reading 30 LOS 30h:
Determine the initial recognition, initial measurement, and subsequent measurement of finance leases
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