ACCT3321 Study Guide - Final Guide: Interest Expense, Finance Lease, Effective Interest Rate

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3 Jul 2018

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LEASES

- The lessor = person who owns the asset/supplier and is receiving payments at

established dates

- Lessee = person who uses the asset [having all risk and ownership]/customer… in

exchange for consideration (lease payments) throughout a period of time (lease

term)

- Is a contract, or part of a contract, that conveys the right to use an asset (the

underlying asset) for a period of time in exchange for consideration.

- A firm may recognise assets it does not own as long as it is able to control the use

- A lease exists when the customer controls the use of the underlying asset

throughout the period of use, meaning that the customer:

oObtains substantially all of the economic benefits from the use of the

identified asset throughout the period of use; and

oDirect the use of the asset throughout the period of use, which means the

customer has the ability to change how, and for what purpose, the asset is

used during the contractual term

-Lease payments: fixed payments (excluding service cost component) + (if included in

the lease contract) residual value guarantee and/or price of a purchase option.

-Lease term: the period for which a lessee has the right to use the underlying asset,

from the commercial date of the contract.

Can the right of use of the asset acquired under the lease contract be considered an asset?

Can the obligation to make lease payments in the future be considered a liability?

New lease standard – AASB 16

- Operative on 1 Jan 2019

- It requires the lessee to recognise assets and liabilities for the right and obligations

created by leases

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- All leases are represented in the statement of financial position of the lessee, with

only two exemptions, and there is a reduction of complexity of application

-Exceptions:

oLeases with a duration of less than or equal to 12 months

oLeases of low value assets (tablets, phones, laptops…) [with a value of less

than $5,000].

- The application of the new accounting standard:

oSome organisations (e.g. large retailers) they need to recognise more leased

assets and lease liabilities

oThis will increase their reported debt and assets and this will increase their

reported leverage

oThe increased leverage could have implications for various accounting0based

debt covenants

oThe new lease standard = that the expenses tend to be ‘front loaded’ – higher

in the earlier years, as the interest expense is higher in earlier years, having

implications for reported profits and for contractual arrangements that use

reported profits

Old lease standard – AASB 117

- Many leases were not represented on the entity’s balance sheet

- The accounting model failed to meet the needs of users of financial statements

- The requirement for recognition of leases were too complicated

ACCOUNTING FOR LEASES BY THE LESSEE

- Lessee = the person/firm who uses the asset and makes payments to the lessor for

enabling its use.

INITIAL RECOGNITION

-Accounting for leases

oRequires assets and liabilities to be recognised by the lessee for all leases of

more than 12 months, with

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Document Summary

The lessor = person who owns the asset/supplier and is receiving payments at established dates. Lessee = person who uses the asset [having all risk and ownership]/customer in exchange for consideration (lease payments) throughout a period of time (lease term) Is a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration. A firm may recognise assets it does not own as long as it is able to control the use. Lease payments: fixed payments (excluding service cost component) + (if included in the lease contract) residual value guarantee and/or price of a purchase option. Lease term: the period for which a lessee has the right to use the underlying asset, from the commercial date of the contract. It requires the lessee to recognise assets and liabilities for the right and obligations created by leases.

Related Questions

Choose the correct answer

32. An essential element of a lease isthat the

a. lessor conveys less than his or her totalinterest in the property.

b. lessee provides a sinking fund equal to oneyearâs lease payments.

c. property that is the subject of the leaseagreement must be held for sale by the lessor prior to the draftingof the lease agreement.

d. term of the lease is substantially equal to theeconomic life of the leased property.

33. What impact does a bargainpurchase option have on the present value of the minimum leasepayments computed by the lessee?

a. There is no impact as the option does not enterinto the transaction until the end of the lease term.

b. The lessee must increase the present value of theminimum lease payments by the present value of the optionprice.

c. The lessee must decrease the present value of theminimum lease payments by the present value of the optionprice.

d. The minimum lease payments would be increased bythe present value of the option price if, at the time of the leaseagreement, it appeared certain that the lessee would exercise theoption at the end of the lease and purchase the asset at the optionprice.

34. The methods of accounting for alease by the lessee are

a. operating and capital lease methods.

b. operating, sales, and capital lease methods.

c. operating and leveraged lease methods.

d. None of these answers are correct.

35. Which of the following is a correct statement of one of thecapitalization criteria?

a. The lease transfers ownership of the property tothe lessor.

b. The lease contains a purchase option.

c. The lease term is equal to or more than 75% ofthe estimated economic life of the leased property.

d. The minimum lease payments (excluding executorycosts) equal or exceed 90% of the fair value of the leasedproperty.

whitewolf712

Kola Corporation (âKolaâ) leases quality weapons to customers. She gains a loyal following of customers because quality is of limited supply but high demand due to its usefulness for the upcoming winter. Further, Kola tends to offer more favorable financing terms than competitors offering substitutive products (e.g., Walnut, LLC).

Kola was recently approached by the Noodle, Inc. (Noodle) which is interested in leasing a substantial stock of weapons over a potentially lengthy period of time. Noodle has indicated a willingness to pay any rate that Kola Corporation demands for its quality products, but generally receives an interest rate of 12% on all other borrowing transactions. Noodleâs management are a very noble group, so payments are reasonably assured. Further, there are no material cost uncertainties.

Kola has gathered its council to discuss entering into such a contract with Noodle and has invited you to provide financial council. Kolaâs board has proposed several alternative sets of lease terms (below) and would like you determine what Noodleâs annual payments will be under each scenario, if payments are made at the beginning of the period.

	A	B	C	D
Fair value of weapons to be leased	$365,760	$365,760	$365,760	$365,760
Book value of weapons to be leased	$365,760	$290,760	$365,760	$365,760
Desired Profit on Lease Initiation	$0	$75,000	$0	$0
Lease Term	11 years	11 years	6 years	6 years
Useful Life of leased assets	13 years	13 years	6 years	6 years
Desired rate of return	10%	10%	10%	13.225%
Residual Value (guaranteed)	$24,350	$24,350	$25,000	$75,000

REQUIRED:

Prepare a schedule for Kola which uses Excel to compute Noodleâs necessary annual payment under each of the scenarios listed in the chart above. The schedule should list for each scenario above the desired present value of lease payments, future value of the leased asset, the lease term, and the interest rate and utilize an Excel formula to compute a payment. Kola is a high paying client of your firm, so the schedule should be extremely organized and professional looking (e,g., include a title, date, description in the top left-hand corner and utilize borders, font effects, etc. in cells to make the worksheet look visually appealing).

(Note: You must use only Excel to prepare and present all parts of this table. Do not use a hand-held calculator, and do not use the compound interest tables to solve any part of this problem. Points will be deducted if Excel formulas are not used for each necessary computation.)

Prepare a worksheet that determines the type of lease for each party to the transaction. The purpose of this worksheet is to automate the determination of lease type. This worksheet should show:

The particulars for each lease scenario.

List each capital lease requirement and indicate whether or not it is met

Use Excel formulas where meeting a particular criteria requires a calculation or is contingent on one of the lease criteria (e.g., âifâ statements). The only items that should be hard-keyed in here are the particulars for the lease scenario and the answers to the first two capital lease criteria (ownership transfer, and bargain purchase option) for the lessee/lessor and the answers to the two lessor-only capital lease criteria.

For the requirements below, assume Kola Corporation chooses lease option A and enters into an agreement with Noodle on 1/1/18. Noodle should return the weapons on 12/31/2028.

Prepare a lease amortization schedule describing the pattern of payments and interest over the lease term for both Kola and Noodle.

(Note: You must use only Excel to prepare and present all parts of this table. Do not use a hand-held calculator, and do not use the compound interest tables to solve any part of this problem.)

Prepare the appropriate entries for both Kola and Noodle on 1/1/18. Numbers in journal entries should be linked to the table prepared in number 3 above or computed using Excel formulas.

Prepare the appropriate entries for both Kola and Noodle through 1/1/21. Numbers in journal entries should be linked to the table prepared in number 3 above or computed using Excel formulas.

Prepare the appropriate entries for both Kola and Noodle on 12/31/2028. Assume the weapons returned to Kola have a residual value of $500.

periwinkleotter127

You Tell Me, Am I a Lease? (USING GAAP NOT IFRS)

Auto Inc. (Auto) is a company based in New York that manufactures automobiles and exports the finished vehicles to Europe. Auto manufactures two models; the most popular model is a four-door sedan (Sedan), and the other is a less common, highly customizable luxury sports car (Luxury Car). Auto contracts Trans-Atlantic Inc. (Atlantic) to ship its products to Europe. Atlantic has a fleet of 10 multi-use shipping vessels, each with capacity for 2,000 vehicles. The terms of the shipping contracts are as follows: â¢ Sedan contract terms: o The term is five years. o MV Manhattan, a ship in Atlanticâs fleet, is dedicated to shipping Autoâs Sedans for the term of the contract. o Auto determines (1) which European ports receive shipments and (2) the order in which deliveries are made to the ports; Auto instructs Atlantic accordingly. o Auto has the option to send the ship below capacity. If the ship is below capacity, Atlantic cannot use the excess capacity to ship products of its other customers. â¢ Luxury Car contract terms: o The term is five years. o Atlantic is required to deliver shipments of Luxury Cars within five weeks of notification from Auto that an order of Luxury Cars is ready for shipping. o Atlantic may choose any ship from its fleet to complete the request. o Auto may provide 250 to 2,000 Luxury Cars in a single request; however, shipping requests of Luxury Car generally do not exceed 500 vehicles in a single request because of the lower production volume and longer manufacturing time of Luxury Car. o Atlantic has the option to use excess capacity to ship products of its other customers. o After notification from Auto that Luxury Cars are ready to ship, Atlantic determines when within the five-week period to ship the cars, as well as the shipping route. Autoâs CFO understands that the new leasing standard has certain provisions that may affect how the company treats contracts of this nature.

Required: Analyze the above and prepare a memorandum addressing the impact (if any) of the new leasing standard on Autoâs shipping arrangements for the following considerations:

1. Determine whether each of Autoâs contracts with Atlantic for Sedan and Luxury Car contains an identified asset.

2. Determine whether each contract conveys the right to control the use of the identified asset to the lessee.

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ACCT3321 Study Guide - Final Guide: Interest Expense, Finance Lease, Effective Interest Rate

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