Presentation 2 Leases

8/18/2019 Presentation 2 Leases

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ACCOUNTING IIIPresentation Question on Leases

Project Team 2 , Seminar Group 7(Seminar 7)

CHUA HAN YANG . MARIANNE LIM LING LI . TAN SIOK MIN RACHEAL . LEE ZHI-AN . YEO WENQING SHERRY


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Part I(1) Objections have been raised against operating leases as it is a form of off-balance sheet financing for

TRUE / FALSE

Under FRS 17.49Lessors shall present assets subject to operating leases in their balance sheets according to the nature o

Under FRS 17.33Lease payments under an operating lease shall be recognised as an expense on a straight-line basis ovterm unless another systematic basis is more representative of the time pattern of the user’s benefit.

Review


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Balance Sheet

Asset: 300 Liabilities: 200

Equity: 100

300 300

Balance Sheet


- 100 (Asset) + 100(Net Lease Receivable) Equity: 100

300

Conclusion: If a lessor enters into an operating lease → Indifferent between Operating & Finance Le

Illustration for Lessor

Operating Lease

D/E Ratio = 200/100 = 2

Only Incurring Rental Income

Finance Lease

D/E Ratio = 200/100 = 2

Incurring Unearned Interest, Principal Payments & Recogn

*Credit: A/P Low Kin Yew

Lease Receivable – Unearned Intere

Reference: David.M Katz. (March 1, 2014.). The path of Lease Resistance. Retrieved August 29, 2015, from htt

p://ww2.cfo.com/accounting-tax/2014/03/path-le

Dr Lease Receivable 120Cr Unearned Interest Income 20Cr PPE 100


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Illustration for Lessee

Operating LeaseBalance Sheet


Equity: 100

300 300

Balance Sheet

Asset: 300 Liabilities: 200 +100

+100 (Asset) Equity: 100

400 400

D/E Ratio = 200/100 = 2

Conclusion: If a lessee enters into an operating lease → No liabilities incurred!!!!!! → Off-B/S Finan

Only Incurring Rental Expense

Finance Lease

D/E Ratio = 300/100 = 3 (Lesser having a higher ratio!!!!!)

Incurring Interest, Principal Payments & Recognizing Asse

*Credit: A/P Low Kin YewReference: David.M Katz. (March 1, 2014.). The path of Lease Resistance. Retrieved August 29, 2015, from htt

p://ww2.cfo.com/accounting-tax/2014/03/path-le

Dr Leased PPE 100Cr Lease Payable 80Cr Cash/Payable* 20*Lessee’s initial direct costs


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Problems in FRS 17

1. Undue Complexity in Classification → Hard to determine Operating/Finance lease

2. Does not faithfully represent lease transactionsi. Lack of comparability between Finance & Operatingii. Rights & Obligations of Operating leases omitted →Off B/S Financingiii. Lessor’s residual interest in leased asset not separately measured or disclosed

3. Fails to meet user’s needs (User try to capitalize operating leases to enhance comparability)

SolutionsNew lease standards to be issued in 2nd half of 2015


Reference: FASB. (May 19, 2015.). Leases – Joint Project . Retrieved August 29, 2015, from http://www.fasb.org/jsp/FASB/FASBContent_C/ProjectUpdateP


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Part I(2) In lease accounting, the lessor never has to compute PV(MLP), it only applies to the lessee.

Reason 1

MLP = + /∗

*GRV/BPO may be different between Lessee & Lessor → May have different PV(MLP), both needs to co

TRUE / FALSE

Reason 2Under FRS 17.20 At the commencement of the lease term, lessees shall recognise finance leases as assets and liabilities inbalance sheets at amounts equal to the fair value of the leased property or, if lower, the present value of tlease payments, each determined at the inception of the lease. The discount rate to be used in calculatingvalue of the minimum lease payments is the interest rate implicit in the lease, if this is practicable to deterthe lessee’s incremental borrowing rate shall be used. Any initial direct costs of the lessee are added to threcognised as an asset.

Interest rate may be different → Depending on whether lessee knows about the implicit interest rate


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Part I(2) In lease accounting, the lessor never has to compute PV(MLP), it only applies to the lessee.

Reason 3Guidelines – It determines the lease classification for lessor

TRUE / FALSE

Tests

Is there a transfer of Ownership?

Is there a Bargain Purchase Option?

Is lease term > 75% of useful life?

Is PV of MLP at least substantially all of asset’s FV? MLP may be substantial for Lessee but may not befor Lessor, thus accounting for it differently

Is leased asset of specialized nature?


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Part I(3) In computing its MLP, the lessee has to include contingent rent that is payable during the lease term.

TRUE / FALSE

Under FRS 17.25Subsequent Measurement

Minimum lease payments shall be apportioned between the finance charge and the reduction of the outstThe finance charge shall be allocated to each period during the lease term so as to produce a constant peinterest on the remaining balance of the liability. Contingent rents shall be charged as expenses in the perthey are incurred.

Under FRS 17.4Contingent rent is that portion of the lease payments that is not fixed in amount but is based on the futurethat changes other than with the passage of time (e.g. percentage of future sales, amount of future use, fufuture market rates of interest).


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Part IIDarrent Inc sells its equipment to Darryl Inc at a price of $20 million and immediately leases it back on alease (with future rentals that are anticipated to be lower than market rentals). The carrying amount in Darrent Inc’s books at the time of the sale was $18 million while the fair value of the equipment was det

professional valuer to be $23 million. At the point of the sale and leaseback, Darrent Inc should recognize

From the Question, we know...• Sale and Leaseback Transactions• Operating Lease• FV(23) > SP(20) > CA(18)• Future rentals anticipated to be lower than market rentals

Book GL = SP – CA = 2mArr GL = SP – FV = (3m)Mkt GL = FV – CA = 5m

(E) A gain of $2 million



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Part III Alpha Precision Pte Ltd (Alpha) leases a piece of standard equipment from King Leasing Pte Ltd (King) o2015. The fair value of the equipment is $229,343 and it is leased for its entire useful life of 5 years. Thpayment computed by King is $55,000 and the first payment is payable on the signing of the lease o

2015. Subsequent payments are due on each anniversary of the signing of the agreement. Alpha’s increborrowing rate is 12% and it is aware of the implicit interest rate of the lease. Alpha uses the straight-lincompute depreciation and its financial year-end is 31 December .

a. Determine the implicit interest rate of the lease.

ALP computed by – Lessor (King)

Use Lessor’s IRR Annu

55,000 55,000 55,000 55,000 55,000

PV=229,343

i%

0


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Part III Alpha Precision Pte Ltd (Alpha) leases a piece of standard equipment from King Leasing Pte Ltd (King) o2015. The fair value of the equipment is $229,343 and it is leased for its entire useful life of 5 years. Thpayment computed by King is $55,000 and the first payment is payable on the signing of the lease o


a. Determine the implicit interest rate of the lease.

ALP = (Fair Value at start – PV of est. Residual Value)/PV of annuity factor

55,000 =229,343 − 0

11 + % 0

+ … + 1

1 + % 4

By Calculator:PV = 229,343PMT = 55,000Mode: BeginningN=5i % = 9.9999% ≈ 10% (Ans)

ALP computed by – Lessor (King)

Use Lessor’s IRR Annu


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b. In compliance with FRS17 Leases, prepare the journal entries to record the lease arrangement iAlpha (Lessee) for the financial years ended 31 December 2015 and 2016.

Tests Alpha

Is there a transfer of Ownership? No Information

Is there a Bargain Purchase Option? No information

Is lease term > 75% of useful life? Yes, 100% “leased for its entire useful life of 5years”

Is PV of MLP at least substantially all of asset’s FV? Yes, 100%, FV=229,343

Is leased asset of specialized nature? No

Conclusion: Finance Lease!!!!

What kind of lease? Operating? Finance?


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Since Lessee is aware of the implicit interest rate,

Interest Rate = 10%PV(MLP) = 229,343 ( Since there is no residual value) = FV of Equipment ALP = 55,000 (Given)Lease Term = 5 Years

Amount of Interest Expense to be amortized over lease term= (ALP * No. of years) – PV(MLP) = (55,000*5) – 229,343= 45,657

Annual Depreciation = Lower of FV or PV(MLP)/No. of years= 229,343/5= 45,869


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Year ALP Interest (10%) Principal Liability Balan

01/01/15 - - - 229,343

01/01/15 55,000 - 55,000 174,343

01/01/16 55,000 174,343*10%= 17,434 55,000-17,434= 37,566 174,343 – 37,56136,777

01/01/17 55,000 13,678 41,322 95,455

01/01/18 55,000 9,545 45,455 50,000

01/01/19 55,000 5,000 50,000 0

Amortization schedule


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Date Accounts Dr Cr

01/01/15 Dr Lease Equipment 229,343

Cr Lease Payable 174,343

Cr Cash 55,000

31/12/15 Dr Interest Expense 17,434

Cr Accrued Interest Payable 17,434

Dr Depreciation Expense 45,869

Cr Accumulated Depreciation 45,869

AcLeat

Int@

en

DeLeFin


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Date Accounts Dr Cr

01/01/16 Dr Accrued Interest Payable 17,434

Dr Lease Payable 37,566

Cr Cash 55,000

31/12/16 Dr Interest Expense 13,678

Cr Accrued Interest Payable 13,678

Dr Depreciation Expense 45,869

Cr Accumulated Depreciation 45,869

PayInteBal

Int@

en

DeLeFin


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Part IV Alpha Precision Pte Ltd (Alpha) leases a piece of standard equipment from King Leasing Pte Ltd (King) o2015. The fair value of the equipment is $229,343 and it is leased for its entire useful life of 5 years. Thpayment computed by King is $55,000 and the first payment is payable on the signing of the lease o


Use the same information as in Part III, except now assume that King (Lessor) is a retailer of the standarand has sold and provided financing to Alpha. The cost of the standard equipment is $150,000. The marate is 12%. A 1% variance in interest rate is considered significant. King’s financial year -end is 31 Decem

IRR used by Lessor = 10%FRS 17.45 “ requires sales to be recorded at MLP discounted at fair rate”Mkt Interest Rate = 12% (Use this)N = 5 YearsMode: BeginningFV = 229,343ALP = 55,000Cost = 150,000


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a. Compute the gross profit of King arising from the sales transaction.Gross Investment (GI) = MLP + URV

= (55,000 * 5) + 0 = 275,000

Per FRS 17.45, using Market fair rate (12%)

Net Investment (NI) = Fair Value = PV(GI)

=55,000+,

. + ⋯ +

,

.^

= 222,054Gross Profit (GP) = NI – Cost

= 222,054 – 150,000 = 72,054Interest Income = GI – NI

= 275,000 – 222,054 = 52,946

Arrangement w/o FRS 17.45

Discount Rate% 10%

Sales Price 229,343

Gross Profit Reported 79,343

Interest Income Deferred 45,657

Part IV Alpha Precision Pte Ltd (Alpha) leases a piece of standard equipment from King Leasing Pte Ltd (King) o2015. The fair value of the equipment is $229,343 and it is leased for its entire useful life of 5 years. Thpayment computed by King is $55,000 and the first payment is payable on the signing of the lease o


LR


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b. Prepare the journal entries to account for the sale-type lease in the books of King for the financ31 December 2015.

Year ALP Interest (12%) Principal Liability Balan

01/01/15 - - - 222,054

01/01/15 55,000 - 55,000 167,054

01/01/16 55,000 20,046 34,954 132,100

01/01/17 55,000 15,852 39,148 92,952

01/01/18 55,000 11,153 43,847 49,107

01/01/19 55,000 5,893 49,107 0

Amortization schedule


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b. Prepare the journal entries to account for the sale-type lease in the books of King for the financ31 December 2015.

Date Accounts Dr Cr

01/01/15 Dr Lease Receivable 275,000

Cr Sales 222,054

Cr Unearned Interest 52,946

Dr COGS 150,000

Cr Inventory 150,000

Dr Cash 55,000

Cr Lease Receivable 55,000

31/12/15 Dr Unearned Interest 20,046

Cr Interest Income 20,046

Rectyp

Sa

1st Be

IntFin31


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Instructions

Correct answer → Bid multiplied by 2Wrong Answer → Bid Forfeited

Why Wait? Place your Bid!!!


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Question 1 out of 3

Under an annuity due, payments must be made at the end of each period.

1) True

2) False

Pop Quiz!!!!!

An annuity due requires lease payments be made at the beginning of each period. An ordinary annuityrequires payments be made at the end of each period.


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If the lease meets the requirements for a sales-type lease, then the initial entry would be recordea normal sales transaction with a credit to sales revenue and a debit to cost of goods sold.Dr Lease Receivable 275,000Cr Sales 222,054

Cr Unearned Interest 52,946Dr COGS 150,000

Cr Inventory 150,000

Question 2 out of 3

The lessor records sales revenue and the cost of goods sold in the initial jourentries for a sales-type lease assuming lease meets the requirements for a stype lease.

1) False2) True

Pop Quiz!!!!!

(E.g Part lV b)


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Cost of goods sold and sales revenue are recorded at the inception of a direcfinancing lease.

1) True

2) False (E.g Part lll b)

A direct financing lease is a method of financing and not sales. At the inception of this transactioasset is removed from the books of the lessor at cost, but no sales revenue is recorded. Reon this type of lease is in the form of interest revenue over the term of the lease.Dr Lease Equipment 229,343

Cr Lease Payable 174,343Cr Cash 55,000

Question 3 out of 3

Pop Quiz!!!!!


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Have you had enough????


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If a leased asset is not recorded as an asset and liability by the lessee,

1) the current ratio and rate of return are generally lowered2) Comparability between companies is improved3) The borrowing power of the lessee may be increased4) Financial ratios are generally unaffected as compared to recording the as

and liabilities.

Bonus Qn

Pop Quiz!!!!!

1) Incorrect because the current ratio and rate of return are usually lowered if the item appears on th

2) Incorrect because comparability between companies is impacted if two or more companies recordtransactions differently

3) Correct because the lessee have lower liabilities, lower D/E Ratio and thus lower risk in borrowing4) Incorrect because when you change the composition of assets and liabilities, financial ratios will b


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References

1. David.M Katz. (March 1, 2014.). The path of Lease Resistance. Retrieved August 29, 2015, from

http://ww2.cfo.com/accounting-tax/2014/03/path-lease-resistance/

2. FASB. (May 19, 2015.). Leases – Joint Project . Retrieved August 29, 2015, fromhttp://www.fasb.org/jsp/FASB/FASBContent_C/ProjectUpdatePage&cid=900000011123

3. ACCA. (August 10, 2015). Lease Operating or Finance?. Retrieved August 29, 2015, fromhttp://www.accaglobal.com/sg/en/student/exam-support-resources/fundamentals-exams-study-resources/f7/technical-articles/lease.html

4. Cengage. (n.d.). Chapter 21, Accounting for Leases. Retrieved August 29, 2015, fromhttp://www.cengage.com/resource_uploads/downloads/053846805X_228065.pdf

5. A/P Low Kin Yew Seminar 4,5,6 Slides
http://ww2.cfo.com/accounting-tax/2014/03/path-lease-resistance/http://www.fasb.org/jsp/FASB/FASBContent_C/ProjectUpdatePage&cid=900000011123http://www.accaglobal.com/sg/en/student/exam-support-resources/fundamentals-exams-study-http://www.accaglobal.com/sg/en/student/exam-support-resources/fundamentals-exams-study-http://www.cengage.com/resource_uploads/downloads/053846805X_228065.pdfhttp://www.cengage.com/resource_uploads/downloads/053846805X_228065.pdfhttp://www.accaglobal.com/sg/en/student/exam-support-resources/fundamentals-exams-study-http://www.fasb.org/jsp/FASB/FASBContent_C/ProjectUpdatePage&cid=900000011123http://ww2.cfo.com/accounting-tax/2014/03/path-lease-resistance/

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Presentation 2 Leases

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