CHAPTER 15 Leases 857 1. The agreement specifies that ownership of the asset transfers to the lessee. 2. The agreement contains a bargain purchase option. 3. The noncancelable lease term is equal to 75% or more of the expected economic life of the asset. 4. The present value of the “minimum lease payments” 5 is equal to or greater than 90% of the fair value of the asset. Additional Consideration Periods covered by bargain renewal options are not included in the lease term if a bargain purchase option is present. This is because the lease term should not extend beyond the date a bargain purchase option becomes exercisable. For example, assume a BPO allows a lessee to buy a leased delivery truck at the end of the noncancelable five-year lease term. Even if an option to renew the lease beyond that date is considered to be a bargain renewal option, that extra period would not be included as part of the lease term. Remember, we presume the BPO will be exercised after the initial five-year term, making the renewal option irrelevant. 5 Minimum lease payments are defined on the next page. Illustration 15–3 Criteria for Classification as a Capital Lease Let’s look closer at these criteria. S i nce our objective is to determine when the risks and rewards of ownership have been transferred to the lessee, the first criterion is self-evident. If legal title passes to the lessee during, or at the end of, the lease term, obviously ownership attributes are transferred. A bargain purchase option (BPO) is a provision in the lease contract that gives the lessee the option of purchasing the leased property at a bargain price. This is defined as a price sufficiently lower than the expected fair value of the property (when the option becomes exercisable) that the exercise of the option appears reasonably assured at the inception of the lease. Because exercise of the option appears reasonably assured, transfer of ownership is expected. So the logic of the second criterion is similar to that of the first. Applying criterion 2 in practice, though, often is more difficult because it is necessary to make a judgment now about whether a future option price will be a bargain. If an asset is leased for most of its useful life, then most of the benefits and responsibilities of ownership are transferred to the lessee. GAAP specifies, quite arbitrarily, that 75% or more of the expected economic life of the asset is an appropriate threshold point for this purpose. Although the intent of this criterion is fairly straightforward, implementation sometimes is troublesome. First, the lease term may be uncertain. It may be renewable beyond its initial term. Or the lease may be cancelable after a designated noncancelable period. When either is an issue, we ordinarily consider the lease term to be the noncancelable 6 term of the lease plus any periods covered by bargain renewal options . 7 A bargain renewal option gives the lessee the option to renew the lease at a bargain rate. That is, the rental payment is sufficiently lower than the expected fair rental of the property at the date the option becomes exercisable that exercise of the option appears reasonably assured. Criterion 1: Transfer of ownership. Criterion 2: Bargain purchase option. Criterion 3: Lease term is 75% of economic life. 6 Noncancelable in this context is a lease that is cancelable only by (a) the occurrence of some remote contingency, (b) permission of the lessor, (c) a new lease with the same lessor, or (d) payment by the lessee of a penalty in an amount such that continuation of the lease appears, at inception, reasonably assured. FASB ASC Master Glossary–Noncancelable Lease Term (previously “Accounting for Leases: Sale and Leaseback Transactions Involving Real Estate, Sales-Type Leases of Real Estate, Definition of the Lease Term, Initial Direct Costs of Direct Financing Leases,” Statement of Financial Accounting Standards No. 98 (Stamford, Conn.: FASB, 1988), par. 22). 7 If applicable, the lease term also should include (a) periods for which failure to renew the lease imposes a penalty on the lessee in an amount such that renewal appears reasonably assured, (b) periods covered by ordinary renewal options during which a guarantee by the lessee of the lessor’s debt directly or indirectly related to the leased property is expected to be in effect or a loan from the lessee to the lessor directly or indirectly related to the leased property is expected to be outstanding, (c) periods covered by ordinary renewal options preceding the date that a bargain purchase option is exercisable, or (d) periods representing renewals or extensions of the lease at the lessor’s option. FASB ASC Master Glossary–Lease Term (previously “Accounting for Leases: Sale and Leaseback Transactions Involving Real Estate, Sales-Type Leases of Real Estate, Definition of the Lease Term, Initial Direct Costs of Direct Financing Leases,” Statement of Financial Accounting Standards No. 98 (Stamford, Conn.: FASB, 1988), par. 22).
Spiceland_Inter_Accounting8e_Ch15
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