Capital leases and operating leases are the two classifications of leases described in FASB pronouncements from the standpoint of the lessee.
Do not discuss the criteria for distinguishing between capital leases and operating leases.
Answer the following questions in the Discussion Board:
- Describe how a capital lease would be accounted for by the lessee both at the inception of the lease and during the first year of the lease, assuming the lease transfers ownership of the property to the lessee by the end of the lease.
- Describe how an operating lease would be accounted for by the lessee both at the inception of the lease and during the first year of the lease, assuming equal monthly payments are made by the lessee at the beginning of each month of the lease. Describe the change in accounting, if any, when rental payments are not made on a straight-line basis.
- Compare and contrast a sales-type lease with a direct-financing lease as follows.
- Lease receivable.
- Recognition of interest revenue.
- Manufacturer’s or dealer’s profit.
Just do response each # 1 to 3 posted down below only!!
Professor and Class,
A. In a capital lease, the lessee would account for the inception of the lease by debiting the leased equipment and crediting the leased liability. During the first year, they would debit the lease liability and credit cash.
B. In an operating lease, the lessee would account for the inception of the lease y debiting the leased equipment and crediting lease liability. To account for the first payment debit the rent expense and credit the cash.
C. A sales type lease records the lease receivable and the cost of goods sold, whereas the direct financing lease the lessor records a lease receivable instead of a lease asset. In regards to interest revenue, it would be recorded the same way under both lease types. A sales type lease involves manufacturer’s or dealer’s profit and a direct financing lease does not include that.
At the inception of the capital lease, the lessee would account the lease as an asset and obligation. The lease payments that would be made throughout the year would decrease the liability and interest expense that is being paid. The lessee normal depreciation method would be used when the asset is amortized. An asset or a liability would not be recorded at the time of the inception. The rent payments of the lease would be expensed and would be a payable for the company.
When it comes to sales-types, and direct-financing of a lease, the lease receivable would not change one from another. The lease would represent the present value of the payments. The recognition of interest revenue is recognized over the term of the lease with both sales-type lease and direct-financing. This would create a rate of return for the lease. Lastly, manufacturer’s or dealer’s profit would change depending on the sales-type or direct-financing lease. When it comes to sales-types, the excess of sales price over the carrying amount would be profit, and needs to be included in the income in the period when the equipment is leased. However, with the direct-financing only the interest would be part of the income of the lease.
a/ The ownership of the noncancellation capital lease would be transferred from the lessor to the lessee by the end of the lease term. During the lease period, the lessee would record the payment by computing the present value of minimum payments and include the expense costs like interest expense and the executory costs such as property taxes and interests. Besides, at the inception and during the first year of the lease, the lessee would account the capital lease as an asset and an obligation in its books (Robbins & Judge, 2016, p. 1205). Also, the capital lease can be depreciated at the end of each year under the straight-line method.
b/ Different from the capital lease, in an operating lease, the lessor has the ownership of the asset while the lessee receives the use of the asset and pays the monthly fees for using it in a period of time and that could be more than one year. Therefore, this amount is not recorded as the asset or obligation during the lease term in the lessee’s books. Instead, the payments would be recorded as expenses for the entire rental term and it would become payable. The rent expenses are recorded during the lease each time making a payment. If rent payments are not made on a straight-line basis, the rent expense would not be recognized on a straight-line basis.
c/ Both sales-type lease and direct-financing lease are considered as capital leases.
Lease receivable – the same for both sales-type and direct-financing lease. It is the present value of the minimum payments from the lessee. Keep in mind that the minimum payments would be excluded taxes, maintenance, and insurance, etc. because the lessor shall pay for it. It is recorded at the time when the lease inception.
Recognition of interest revenue – the same for both sales-type and direct- financing lease. Interest is recognized during the lease term using the effective interest method to come up with the periodic returned interest rate.
Manufacturer’s or dealer’s profit – different from sales-type and direct-financing lease. In a sales-type lease, if the sales price is more than the carrying value, the excess amount is considered as manufacturer’s or dealer’s profit and the lessor records as a gain or loss. Also, it would be added to the income when the lease is recorded. On the other hand, a direct-financing lease does not have the manufacturer’s or dealer’s profit because it only earns a profit on interest.