8. Accounting and Reporting by the Lessee
h. determine the initial recognition, initial measurement, and subsequent measurement of finance leases;
i. compare the disclosures relating to finance and operating leases;
For an operating lease, for a lessee, what is the appropriate accounting reporting?
- No entry is made at the inception of the lease.
- Over the life of the lease, only the annual rental expense (an operating expense) of $10,000 will be charged to income and CFO.
For an operating lease, for the lessor, what is the appropriate accounting reporting?
- The leased asset is reported on the lessor's balance sheet, because the lessor still retains ownership of the asset. Accordingly, the lessor will depreciate the asset during the term of lease.
- Over the life of the lease, periodic lease payments from the lessee are reported as rental revenue on the income statement. They are recorded as operating cash flows.
For a capital lease, for a lessee, what is the appropriate accounting reporting?
- At lease inception and asset and liability equal to the current present value of the lease payments is recognized
- Over the life of the lease,
- the annual rental expense is allocated between interest and principal payments according to the amortization schedule
- the cost of the asset is charged to operating expense using the straight line method over the term of the lease
What is an "implicit interest rate of the lease"?
The discount rate that sets the aggregate present value of lease payments to be equal to the fair market value of the leased asset.
What are the effects on the balance sheet of a capital lease for the lessor?
Gross and Net amounts are reported at each BS date
What is the most important impact of a capital lease on the balance sheet?
The most important impact of a CL is the impact on leverage ratios, which results in an increase in debt to equity and other leverage ratios. As lease obligations aren't recognized for OL, leverage ratios are understated.
What are the differences between an operating lease and a capital lease on the income statement?
An OL charges constant rental payments to expense as accrued, whereas a CL recognizes and apportions depreciation and interest expense over the term of the lease.
All other factors remaining equal, firms reporting operating leases will report better performance because?
- Their balance sheet will report less debt.
- They will report higher profits, which appear to be generated by a relatively smaller investment in assets.