FRF for SMEs--Lessee Accounting for Leases
A capital lease should be accounted for by a lessee as the acquisition of an asset and the creation of an obligation. The amount of the asset and obligation to be recorded at the inception of the lease is the present value of the minimum lease payments over the lease term, excluding any known or estimated executory costs (such as insurance, maintenance and taxes) in the lease payments. The calculated value of the asset, of course, cannot be greater than it’s market value.
The lessor’s interest rate implicit in the lease would be used to discount minimum lease payments if it can be obtained and is lower than the lessee’s incremental borrowing rate.
The capitalized value of a leased asset should be amortized over the expected period of use with rates and methods used for other similar assets. If ownership passes to the lessee at the end of the lease, or if there is a bargain purchase option sufficient to induce a lessee to buy, the asset should be amortized over its economic life. Otherwise, it should be amortized over its lease term. Interest expense on the obligation is calculated using the discount rate applied when calculating the present value of the minimum lease payments.
Capitalized lease assets and obligations should be presented separately in the statement of financial position or in the footnotes.
Rental expenses for operating leases (those for which substantially all benefits and risks are not transferred to the lessee) are accounted for on a straight-line basis over the lease term, unless another method is more representative of the lessee’s use of benefits.
Land and Building Leases
When a capital lease allows ownership to be transferred at the end of the lease term or provides a bargain purchase option sufficient to induce the lessee to purchase the asset, land should be capitalized separately from buildings in proportion the their market values at the inception of the lease. When such provisions are not included in the lease, and the market value of the land is minor compared to the total market value of the land and buildings, the assets are considered a single unit. The economic life of the building would ordinarily be the economic life of the single unit. If the market value of the land is significant, the portion of applicable to the land would be accounted for as an operating lease by both the lessee and the lessor.
Disclosures for each major category of capitalized leased assets include:
- Accumulated amortization, including any write-downs of asset values
- The amortization method, including the period and rate used
Capitalized leased obligations disclosures include:
- Interest rate
- Maturity date
- Outstanding balance
- Any collateral under the leases
- Interest expense disclosed separately or as part of interest on long-term debt
- Payments for each of the next five years in accordance with terms of the lease
Operating leases disclosures should include future minimum lease payments in the aggregate and for each of the five succeeding years. Short term leases of one year or less are excluded from this disclosure requirement.
My next blog in this series will address lessor accounting for leases.
by Larry Perry, CPA, CPA Firm Support Services, LLC - Larry has over 40 years experience as a CPA practitioner, author of accounting and auditing manuals, author and presenter of live staff training seminars and author of webcast and self-study CPE programs. He is co-founder of CPA Firm Support Services, LLC (www.cpafirmsupport.com), an organization providing resources, training and consulting to smaller CPA firms. Larry writes a weekly blog on AccountingWEB.com focusing on small audits, reviews and compilations. He is currently developing documentation manuals and handbooks for small audits, reviews and compilations and related electronic practice aids.