Auditing Special Purpose Frameworks: Operating Expenses—Part 1by
This article discusses basic accounting principles for operating expenses under the FRF for SMEs. Part 2 will address basic auditing procedures.
Accounting Principles for the FRF for SMEs
The matching of costs with revenues in the same reporting period is a basic principle for the accrual basis of accounting underlying the presentation of operating expenses. Costs of goods sold and other operating expenses should be recorded in the same period related revenues are recognized.
Generally, operating expenses are recognized on an accrual basis, when an expense is incurred. Fixed assets are depreciated over their useful lives. Intangible assets are amortized over their useful lives (or contractual periods as in the case of asset retirement obligations) or periods specified in the FRF for SMEs. (Goodwill is amortized over the period specified by the Internal Revenue Code or 15 years).
The FRF for SMEs provides guidance for lessees' accounting for capital and operating leases, and for lessors' accounting for sales-type, direct financing and operating leases. The principles are based on the view that property has benefits and risks related to ownership. Further, the FRF for SMEs takes the position that when a lease transfers substantially all the ownership benefits and risks it is essentially an acquisition of an asset and the incurrence of an obligation. Further, it should be accounted for as a capital lease by the lessee and as either a sales-type or direct financing lease by the lessor. This guidance does not apply to copyrights, patents, and other licensing agreements, which are accounted for as intangible assets.
Following is a discussion of basic lease accounting principles under the FRF for SMEs.
One or more criteria in a lease agreement indicating transfers of substantially all the benefits and risks of ownership to lessees, similar to currently applicable U.S. GAAP, include:
- Transfer of ownership at the end of the lease term or a bargain purchase option (that would cause the lessee to purchase).
- A lease term that will enable the lessee to receive substantially all the economic benefit from the asset. This would normally be a term that is 75 percent or more of the remaining useful life of the asset. This criterion normally would not apply to land unless there is reasonable assurance ownership will transfer at the end of the lease term.
- The lessor has some assurance of recovering the cost of the assets and earning a return on that investment. This assurance exists if, at the inception of the lease, the present value of the minimum lease payments excluding executory costs is 90 percent or more of the market value of the asset. The discount rate that should be used to determine present value is the lower of the lessee's incremental borrowing rate or the interest rate implicit in the lease if it can be obtained or estimated. (The implicit rate will be used by a lessor.)
For lessors, the benefits and risks of ownership normally are transferred when:
- Any one of the criteria above is met.
- Credit risk is similar to other receivables.
- Non-reimbursable costs likely to be incurred by the lessor can be estimated to determine if substantial risks are retained, thereby preventing capitalization of the lease.
Again, a lease of an asset that transfers substantially all the benefits and risks of ownership should be accounted for as a capital lease by the lessee and a sales-type or direct financing lease by the lessor.
Auditing procedures for operating expenses will be discussed in my next article. Remember you can download all the articles in this series (45 to date) and my other series from www.accountingweb.com.
Other Resource Materials
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