How a lessee accounts for a lease has been described in the previous subject. In this subject the focus shifts to dealing with the accounting requirements of lessors.
Under IFRS, leases are classified as finance leases when substantially all the risks and rewards of legal ownership are transferred to the lessee.
Under U.S. GAAP, for a lessor, the lease must be capitalized if it meets any one of the four criteria specified for capitalization by the lessee and both of the following revenue recognition criteria:
Leases not meeting these criteria must be reported as operating leases.
Under U.S. GAAP there are two alternative types of capital leases when dealing with lessors: a sales-type lease and a direct financing lease. IFRS does not distinguish between them. The accounting is the same for IFRS and U.S. GAAP.
1. Sales-Type Lease
Sale-leaseback (S-L) transactions are sales of property by the owner, who then leases the property back from the buyer-lessee. The seller (lessor) leases its own property, rather than selling it outright. Such leases involve two transactions:
At the inception of the lease, a manufacturer treats the transaction as if it sold the asset in exchange for an investment in a capital lease. It recognizes a gross profit from the sale of the asset.
2. Direct Financing Lease
In a direct financing lease, a leasing company purchases a property from a manufacturer and then leases the equipment to the lessee. The distinction between a sales-type lease and a direct financing lease is the presence/absence of a manufacturer's or dealer's profit. In a direct financing lease, the cost of the leased asset equals its market value, so only financing income is involved. In a sales-type lease, the cost of the leased asset is less than its market value (the present market value of lease payments), creating a manufacturer's or dealer's profit in addition to financing income.
As in a direct financing lease, the lessor's original cost or the carrying value (prior to the lease) of the asset approximates the market value of the leased asset (the present value of the MLPs); such leases are pure financing transactions and financial reporting for direct financing leases reflects this fact. No sale is recognized at the inception of the lease and there is no manufacturing or dealer profit. Only financing income is reported.
Effects of Operating and Capital (Finance) Leases on a Lessor's Financial Statements
Cash Flow Statement:
The lessor has an asset on the books with a cost of $1,000. The lessor leases the asset out as a sales-type lease with the present value of the minimum lease payments equal to $1,300. The total minimum lease payments are $2,000 over the lease term.
The lessor recognizes a sale of $1,300 and cost of sales of $1,000, which results in a gross profit of $300 ($1,300 - $1,000).
The corresponding entry is the recognition of a net investment in leases of $1300. The net investment in leases is made up of a gross investment - unearned finance income. Gross investment is equal to the remaining minimum lease payments (not discounted) and the unearned finance income is the interest income that will be earned over the remainder of the lease. In this instance these are as follows:
Gross investment in lease: $2,000
As you can see, the unearned finance income is the difference between the minimum lease payments and the present value of the minimum lease payments. This amount amortizes on the income statement as interest income as the lease is repaid.
|allblack13: why does the expected rate of return increase with more debt? doesn't the wacc equation imply lower wacc with more debt versus equity, as debt normally costs less?|
| djop2002: the more debt, the more financial leverage.The more financial leverage,the more financial risk.The more financial risk, the more return will be expected from shareholders.|
|djop2002: Yes WACC will decrease as you use more debt because the decreasing proportion of equity within WACC will offset the rising cost of equity.|
|Seemorr: They must mean use of more debt increases return on equity.|
| nab3a123: Can someone explain to me a sale-type lease?|
What the notes say is that the owner (lessor) sell the property to the buyer (lessee) and then lease it back.
But how can he be the lessor if he's leasing it back?
Doesn't make sense to me...
| gill15: I was happy until I got to this section|
| gill15: Changed my mind --- its easy --- just do the questions then the notes make sense....|
All the notes should say is that the difference between sales type and direct type is the there is a profit recognized intitially and then everything is the same between two
| jmorris: In case anyone needs... IFRS vs GAAP can be found in this pdf|
|dirdeb: Does it means they are loosing money and then paying for it? so loosing two times!?!|
|ashish100: ^epic username|