Accounting for Sale and Lease

IntroductionThis course emphasizes accounting by lessees: however, there are many parallels between lessee and lessor accounting. Where appropriate, the modules are organized into A and B parts that describe the lessee's accounting and the lessor's accounting, respectively. In all of the two-part modules, the description of the lessor's accounting in part B is abbreviated and relies on the more complete description of the lessee's accounting presented in part A.A lease contract gives the lessee (leaseholder) certain rights related to the leased property and imposes an obligation to pay for these rights. The rights of the lessee are less than those obtained from the purchase of the property. Generally accepted accounting principles establish criteria for determining whether a lease agreement transfers sufficient rights to give the transaction the substance of an outright purchase. If the accounting criteria are met, the lease is described as a capital lease, and the leased asset and the lease obligation are reported in the lessee's balance sheet. In effect, the lease is reported in the same manner as an installment purchase of the leased asset. If the accounting criteria are not met, the lease is described as an operating lease and is reported as an executory contract (that is, a simple rental arrangement) in the periods that performance occurs.IntroductionThe flexibility that lease agreements provide with respect to property rights and financial obligations results in continued growth in the volume of lease transactions. Consider the following: Leases may provide financing of 100 percent of the asset's cost. Leases may limit the lessee's exposure to losses due to obsolescence. A company that is not able to benefit from the tax depreciation of a new asset because of net operating loss carryforwards can indirectly obtain this benefit via reduced lease payments to a lessor that can benefit from the depreciation of the asset. Sale-leaseback transactions are a source of financing that can provide off-balance-sheet leverage as well as significant tax advantages. Leases can provide a means of reducing the alternative minimum tax (AMT). There is almost infinite flexibility in the assignment of the risks and rewards of ownership and in structuring the financing obligation.Many lessee companies prefer the off-balance-sheet financing aspect of operating leases. To the extent that a company's balance sheet appears to have too much debt or it is close to defaulting on existing debt covenants, operating leases may provide a financing mechanism that does not cause further deterioration in critical debt-equity ratios. Although one may question the real benefits of off-balance-sheet financing, many lessees carefully structure lease agreements to avoid meeting the accounting requirements for capital lease treatment. IntroductionAccounting for lease agreements is often complicated by differences between their legal form and their economic substance. If sufficient property rights are transferred, the economic substance of a lease is the same as a legal purchase. But how is the determination made that a lease agreement transfers sufficient property rights to the lessee to justify reporting the lease as if a purchase has occurred? US generally accepted accounting principles (GAAP) provides specific criteria (often referred to as "bright-line" tests) to identify the critical point at which a lease must be reported as a capital lease. Nonetheless, US GAAP does not ensure that companies with substantially identical lease agreements will report these lease agreements identically. In fact, the criteria are such that companies wishing to avoid capital lease accounting while obtaining most of the benefits of ownership generally are able to do so.FASB Accounting Standards Codification (ASC) 840, Leases, provides the authoritative guidance for all lease transactions. As previously noted, the FASB and the IASB are continuing work on a joint project on leases. The objective of the accounting for leases project is to comprehensively reconsider the guidance in FASB ASC 840 and IAS 17, Leases, along with subsequent amendments and interpretations, to ensure that financial statements provide useful, transparent, and complete information about leasing transactions to investors and other users of financial statements. The Boards began deliberations of lease accounting issues in 2007. They published a discussion paper for public comment in March, 2009 that explores these issues and describes both Board's preliminary views.An exposure draft (ED) on a proposed new, converged leasing standard has been issued but was met with significant resistance. Almost all companies will be significantly impacted because of the widespread use of leases. Most notably, the new leasing model proposes to bring virtually all leases onto the balance sheet. For both lessees and lessors, this is a major change, as operating leases would be rendered obsolete. As of March 2013, the FASB and IASB are in the process of re-deliberating the proposed guidance with an aim to re-expose a new ED in the second quarter of 2013. One "Big Four" public accounting firm has gone on record that they do not believe any new guidance will be effective before 2016.IntroductionThe new standard will likely require a right-of-use approach, which requires the reporting of the rights and obligations conveyed by all leases, including short-term leases, on the balance sheet. In addition, it is likely that there will be no grandfathering of existing leases, which means companies will need to reassess all existing leases, with the exception of certain capital leases, if the new guidance is adopted. For lessors, the likely outcome is a performance obligation approach, which will keep the leased asset on the lessor's balance sheet. The lessor would also recognize a receivable for the rental payments that will be received over the lease term and a corresponding liability for the obligation to provide use of the leased asset to the lessee. The practical effect of this approach is a gross up of the balance sheet. The FASB and IASB are still evaluating this proposed presentation and may consider whether the performance obligation should be netted against the leased asset or the receivable. In addition, they are also considering how upfront recognition of manufacturer or dealer profit might fit into the performance obligation approach. For lessees, the days of debating whether a lease is a capital or operating lease appear to be nearing an end, as lessees would be required to recognize an asset and a corresponding liability for all leases. Companies that are lessees should be mindful of how this change may impact financial ratios, debt covenants, and perhaps their overall business model.

Applicability of the FASB PronouncementsFASB ASC 840 applies to financial reporting of leases by both lessors and lessees.A lease is an agreement that conveys the right to use property, plant, or equipment usually for a stated period of time. Significantly, this definition does not include agreements that convey the right to use only intangible assets or services. However, agreements that include substantial services or intangibles in addition to plant, property, or equipment are considered leases for the purposes of financial reporting.The standards do not apply to Lease agreements that convey rights to explore for or to extract natural resources, including oil, gas, minerals, and timber; or Licensing agreements for motion pictures, plays, manuscripts, patents, copyrights, and other intangibles.Module 1ALessee's Classification of Leases Lessees must classify leases as either operating or capital. Operating leases are accounted for as rental agreements in a manner similar to that of other executory contracts. Capital leases are accounted essentially as if an installment purchase of the leased asset has occurred.FASB ASC 840, Leases, identifies four criteria for classifying leases. If one or more of these criteria are satisfied by a lease agreement at its inception, it is classified as a capital lease. All other leases are classified as operating leases. Once classified, there are no further changes in classification unless the terms of the lease are modified. A lease of personal property meeting any of the following criteria at its inception is a capital lease:a. Ownership is transferred to the lessee by the end of the lease term. b. A bargain purchase option for the leased property is available to the lessee. A bargain purchase option is as an option to purchase the property at a price low enough relative to its fair value to provide reasonable assurance that the lessee will exercise the option. c. The term of the lease equals or exceeds 75 percent of the remaining estimated economic life of the leased property, except that this criterion is not applicable if the beginning of the lease term falls within the last 25 percent of the total estimated economic life. d. The present value of the minimum lease payments, excluding any portion representing executory costs, equals or exceeds 90 percent of the fair value of the leased property to the lessor. Like the second criterion, this criterion is not applicable if the beginning of the lease term falls within the last 25 percent of the total estimated economic life.The (a) and (b) criteria are straightforward and do not cause significant problems in practice, even though judgment is required to determine whether a purchase option qualifies as a bargain. The (c) and (d) criteria are difficult to apply, and they will be discussed in detail.Criterion (c): Comparing the Lease Term to the Economic Life of the PropertyTwo measurements are required to determine whether the lease term exceeds 75 percent of the economic life of the leased property:1. The economic life of the leased asset 2. The term of the lease Once the measurements are made, a simple comparison is required to determine whether the term of the lease exceeds 75 percent of the remaining estimated economic life of the asset. Note again that this criterion is not applied if the leased property is in the last 25 percent of its total economic life at the inception of the lease.The economic life of a leased asset is defined as the remaining period during which the asset will be economically useful for the purpose for which was intended at the inception of the lease. The economic life is not limited by the lease term, and it includes use by parties other than the lessee. The estimate of economic life assumes that normal repairs and maintenance will be performed.Criterion (c): Comparing the Lease Term to the Economic Life of the PropertyThe term of the lease includes: The fixed non-cancelable term of the lease; Periods for which bargain renewal options apply. A bargain renewal option allows the lessee to extend the lease at a rental amount sufficiently less than a fair rental amount to provide reasonable assurance of renewal; Periods for which failure to renew results in a penalty high enough that renewal is reasonably assured; Periods for which ordinary renewal options apply and for which it is expected that either (1) a guarantee by the lessee of the lessor's debt related to the property will be in effect, or (2) a loan by the lessee to the lessor related to the property will exist; Periods for which ordinary renewal options apply preceding the exercise date of a bargain purchase option; and Periods for which the lessor may force renewal or extension of the lease term, but not beyond the date that a bargain purchase option is exercisable. The implicit assumption is that a lessee will agree to let the lessor force extension of the lease term only if it wants to lease the property for the longer period.Criterion (c): Comparing the Lease Term to the Economic Life of the PropertyA noncancelable lease is one that is not cancelable by the lessee. In addition, a lease is considered noncancelable even when the following conditions are present: The lease is cancelable upon the occurrence of some remote contingency. The lease is cancelable with the permission of the lessor. The lease is cancelable if the lessee enters into a new lease with the lessor. The lease is cancelable but the lessee is subject to such a large penalty that continuation of the lease is reasonably assured.The FASB has foreclosed most opportunities to structure leases so that the lease term, as measured in the context of the capital lease criterion, is less than the actual term. Nonetheless, companies wanting to avoid the 75 percent of economic life threshold for capital lease classification are often able to do so because of the subjectivity inherent in the estimation of the property's economic life.Criterion (c): Comparing the Lease Term to the Economic Life of the PropertyExample 1Applying the 75 Percent of Estimated Economic Life CriterionA company agrees to a noncancelable lease contract for a new machine. The lease requires monthly payments for a three-year term. At its option the lessee may renew the lease for an additional year after which it has the option to purchase the machine for $500. The machine is expected to have a fair value of $15,000 in four years when the option is exercisable. The economic life of the machine is estimated to be five years. Does the lease agreement meet the (c) criterion for classification as a capital lease?

Applying the 75 Percent of Estimated Economic LifeCriterionNoncancelable lease term3 years

Ordinary renewal period prior to bargain purchase option+ 1 year

Lease term4 years

The lease term is 80 percent (4 years/5 years) of the estimated economic life. This exceeds the 75 percent threshold, and the lease must be classified as a capital lease. There is no need to examine the other three criteria because capital lease classification is required if any of the four are met.

Solution ExplanationA bargain purchase option exists because the option price, $500, is substantially below the estimated fair market value of the machine, $15,000. In this situation, the ordinary renewal term preceding the option date must be added to the noncancelable term. Specifically it will renew the lease to take advantage of the bargain purchase option. The same logic underlies the inclusion of periods subject to bargain renewal options or high penalties for failure to renew.Criterion (d): Comparing the Present Value of the Minimum Lease Payments to the Fair Value of the Leased PropertyA lease is classified as a capital lease if the present value of the minimum lease payments, excluding any portion related to executory costs, equals or exceeds 90 percent of the fair value of the leased property to the lessor. Like criterion (c), criterion (d) is not applied if the property is in the last 25 percent of its total economic life at the inception of the lease.Of the 4 criteria, the 90 percent recovery criterion most often causes a lease to be classified as a capital lease.Criterion (d) is by far the most complex to apply. Three measurements are required:1. Amounts and timing of the minimum lease payments less executory costs 2. Discount rate for calculating the present value of the minimum lease payments 3. Fair value of the leased property to the lessor at the inception of the lease4. Criterion (d): Comparing the Present Value of the Minimum Lease Payments to the Fair Value of the Leased Property5. Before considering the intricacies of these measurements, examine the following example of the application of the present value criterion.Example 2Applying the 90 Percent Recovery CriterionA company agrees to a noncancelable lease contract for a new machine. The lease requires $1,000 payments at the beginning of each month for a three-year term. The lessee has the option to renew the lease for $500 per month for an additional three years. The fair rental value of the machine during the renewal period would be $800 per month. The normal selling price of the new machine is $40,000. The lease agreement indicates that $50 of each lease payment is payment for maintenance and repairs during the term of the lease and that the lessor's implicit interest rate used to determine the amount of the lease payments is 12 percent. Does the lease agreement meet the criterion (d) for classification as a capital lease?

Applying the 90 Percent Recovery CriterionPresent value of minimum lease payments(12 percent discount rate):36 payments @ $950$28,888

36 payments @ $4509,565

Net present value$38,453

90% of fair value of property: $40,000 90% = $36,000The net present value of the lease minimum lease paymentsexceeds 90 percent of the fair value of the property (96 percent) at the inception of the lease, so the lease must be classified as a capital lease.

Solution ExplanationThe minimum lease paymentsinclude both the noncancelable rental payments and the bargain renewal payments. There is a presumption that renewal is reasonably assured because of the bargain offered by the renewal option. The normal sales price is a measure of the fair value of the leased property. If the present value of the lease payments is less than 90 percent of the fair value, the lease may still qualify as a capital lease because it meets one of the other criteria.The measurement of the minimum lease payments, discount rate, and fair market value of the leased propertywill be discussed in detail. Because of the variety of lease agreements, the FASB provides detailed guidance with respect to each of the measurements.Minimum Lease PaymentsThe minimum lease payments are those payments the lessee is obligated to make, plus any payments it can be required to make in connection to the leased property. Guarantees of the lessor's debt and obligations to pay executory costs are excluded from the minimum lease payments. Executory costs are costs such as insurance, maintenance, and taxes related to the leased property, whether paid by the lessor or the lessee. Executory costs paid by the lessor and included in the lease payments include the lessor's profit on those costs. Contingent rentals generally are excluded from the minimum lease payments.If a lease contains a bargain purchase option, the minimum rental payments and the amount of the bargain purchase option comprise the minimum lease payments, and all other amounts are excluded. Minimum rental payments do not include payments contingent on increases in the cost or value of the property during construction or contingent on the volume of future use of the property. However, contingent rentals based on an existing index or rate such as the consumer price index or the prime interest rate are included based on the level of the index or rate at the inception of the lease.If a lease does not contain a bargain purchase option, the minimum lease payments include The minimum rental payments during the term of the lease; Any residual value of the property guaranteed by the lessee or a related party. If the lessee has guaranteed the difference between a stated amount and the amount realized by the lessor, the guaranteed amount is set equal to the stated amount, that is, the maximum guarantee. When the lessor can require the lessee to purchase the property, the purchase amount is considered to be a guaranteed residual value; and A penalty payment that the lessee must make or can be required to make upon failure to renew or extend the lease. A penalty is not included in the minimum lease payments if the lease term has been extended because the presence of the penalty provides reasonable assurance that the lease will be extended.Discount RateThe discount rate for calculating the present value of the minimum lease payments is the lesser of the interest rate implicit in the lease (as computed by the lessor) or the lessee's incremental borrowing rate. If it is not practical to determine the lessor's implicit interest rate, the lessee's incremental borrowing rate must be used as the discount rate.The implicit interest rate is the rate that causes the present value of the minimum lease payments and any unguaranteed residual value to equal the fair value of the property. Conceptually, this is the calculation that the lessor made to determine the amount of the lease payments.The lessee's incremental borrowing rate is the rate at which the lessee could borrow funds to purchase the leased property. A secured borrowing rate may be used if the lessor would have used a secured loan to acquire the leased property.FASB ASC 840, Leases, does not explicitly require the lessee to estimate the lessor's implicit interest rate. A narrow interpretation of the standard is common in practice, and lessees routinely maintain that it is not practical to determine the lessor's implicit rate unless it is disclosed by the lessor. For a lessee that is attempting to avoid classifying a lease as a capital lease, a high interest rate is preferable because it results in a lower present value for the minimum lease payments. As result, the lessee may prefer to not know the lessor's implicit rate because it might be lower than the lessee's incremental borrowing rate. Lessors are aware of this situation, and may willingly refuse to disclose their implicit rate, which allows the lessee to use its own incremental borrowing rate to discount the minimum lease payments.Fair Value of Leased PropertyThe fair value of the leased property at the inception of the lease is the amount for which the property could be sold in an arm's-length transaction. When the lessor is the manufacturer or dealer, the fair value ordinarily is the normal selling price reflecting any discounts and all market conditions at the inception of the lease. For other lessors, the fair value is ordinarily the cost of the leased asset. When there is a significant period of time between acquisition of the asset and the inception of the lease, the fair value of the property should be modified to reflect any changes in market conditions.Module 1BLessor's Classification of Leases Lessors must classify leases into one of four categories:1. Sales-type leases - These leases normally arise when a manufacturer or dealer uses lease agreements as a mechanism for selling products. 2. Direct financing leases - These leases normally arise when a financial institution uses lease agreements as an alternative to making a direct loan that would be used by a borrower to purchase rather than lease the property. 3. Leveraged leases - Leveraged leases are similar to direct financing leases except that they involve a third party that shares the risk with the financial institution. 4. Operating leases - Operating leases are ordinary rental agreements. All leases that are not properly classified as one of the other three categories are classified as operating leases.The first three categories are differing forms of capital leases that are accounted for as if either an installment sale of the leased property or a financing transaction has occurred. Operating leases are accounted for as rental agreements in a manner similar to that of other executory contracts. Once classified, there are no further changes in classification unless the terms of the lease are modified.Module 1BLessor's Classification of Leases To be classified as a sales-type lease, direct financing lease, or a leveraged lease, a lease agreement for personal property must meet at least one of four criteria:a. Ownership is transferred. b. A bargain purchase option is included. c. The term of the lease equals or exceeds 75 percent of the remaining estimated economic life of the leased property. d. The present value of the minimum lease payments, excluding any portion representing executory costs, equals or exceeds 90 percent of the fair value of the leased property to the lessor.These are the same criteria used by lessees. Module 1A describes the detailed procedures for applying the four criteria.In addition to these four criteria, lessors apply two additional criteria to determine whether a lease is a capital lease (sales-type, direct financing, or leveraged):e. Collectability of the minimum lease payments is reasonably predictable. f. No important uncertainties exist with respect of unreimbursable costs, for example, warranty costs, which may be incurred by the lessor. A lessor classifies a lease as a capital lease only when both of these criteria are met. Routine estimation of uncollectible accounts, future warranty costs, or executory costs is not considered to be evidence that a lease agreement fails to meet these two criteria.Sales-Type LeasesA sales-type lease meets at least one of the (a) through (d) criteria, and both (e) and (f). In addition, the fair value of the leased property at the inception of the lease must be different from its cost (or carrying amount, if different). That is, the property is being sold for a profit or a loss. Normally this type of lease is recorded by manufacturers or dealers in the property who use lease transactions as an alternative to outright sales.If a manufacturer sells its leases to a financing subsidiary that, in turn, accounts for the leases as direct financing leases, the consolidated financial statements must report the leases as sales-type leases.Direct Financing LeasesA direct financing lease meets at least one of the (a) through (d) criteria, and both (e) and (f). In addition, the fair value of the leased property at the inception of the lease must be equal to its cost (or carrying amount, if different), and the lease must not qualify as a leveraged lease. Thus, there is no profit or loss at the inception of the lease; rather, it is solely a financing transaction. Normally this type of lease is undertaken by financial institutions as an alternative to a loan collateralized by the property.The renewal of either a sales-type or a direct financing lease during the lease term is classified as a direct financing lease, except when a sales-type lease is renewed within the final few months of its term. In this case, the renewal continues to be classified as sales-type lease.Leveraged LeasesA leveraged lease is a form of direct financing lease, and it must satisfy the same criteria described previously, including the equality of the fair value of the leased property at the inception of the lease and the property's cost. Leases that meet the criteria for a sales-type lease are classified as sales-type leases and never as leveraged leases. In addition to meeting the criteria for a direct financing lease, leveraged leases must meet three additional criteria:g. The agreement involves at least three parties: a lessee, a long-term creditor, and a lessor (the equity participant). h. The financing provided by the long-term creditor is nonrecourse with respect to the general credit of the lessor. The financing provides substantial leverage to the lessor, and the long-term creditor may have recourse to the leased property and unremitted rental payments. i. The lessor's net investment declines during the early years of the lease and then rises in later years. More than one cycle of this type may occur. The net investment is defined as the lessor's investment in the lease less deferred taxes arising from temporary differences between tax and financial income related to the lease. Module 2ALessee's Classification of Real Estate LeasesBecause of the relatively long economic lives of real estate, FASB ASC 840, Leases, modifies the application of the four capital lease criteria for leases of real estate. Real estate leases are divided into four categories:1. Leases of land 2. Leases of land and buildings 3. Leases of real estate and personal property 4. Leases of a part of a buildingLeases of LandFor leases that involve only land, the economic life and 90 percent recovery criteria [(c) and (d)] are not applicable. Implicitly, the risks and benefits of ownership are not transferred to the lessee unless title to the land will eventually be obtained. Thus, the lessee classifies a lease of land as capital only if either (a) or (b) criterion is met at the inception of the lease. These two criteria are identical with those for classification of leases of personal property:a. Ownership is transferred to the lessee by the end of the lease term. b. A bargain purchase option for the leased property is available to the lessee. A bargain purchase option is defined as an option to purchase at a price low enough relative to the fair value of the property to provide reasonable assurance that the lessee will exercise its option.Leases of Land and BuildingsClassification of a lease of both land and buildings is a multi-step process. The steps are as follows:1. Apply the transfer of ownership and the bargain purchase option criteria [(a) and (b)]. If either of the criteria is met, the lease is classified as a capital lease. However, the land and buildings will be capitalized separately. 2. When neither the (a) nor the (b) criteria is met, the lessee compares the fair value of the land to the fair value of all of the leased property. If the fair value of the land is less than 25 percent of the total fair value of the leased property, the property is evaluated as a single unit (assumed to be a building) for the purpose of applying the economic life and fair value of the property criteria. Thus, the lease is classified as a capital lease if either the (c) or (d) criterion is met:c. The term of the lease equals or exceeds 75 percent of the remaining estimated economic life of the leased building, except that this criterion is not applicable if the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the building. d. The present value of the minimum lease payments, excluding any portion representing executory costs, equals or exceeds 90 percent of the fair value of the leased property to the lessor. This criterion is not applicable if the beginning of the lease term falls within the last 25 percent of the total estimated economic life.Leases of Land and BuildingsClassification of a lease of both land and buildings is a multi-step process. The steps are as follows: (cont.)2. When neither the (a) nor the (b) criteria is met, the lessee compares the fair value of the land to the fair value of all of the leased property. (cont.) If the fair value of the land is 25 percent or more of the total fair value of the leased property, the minimum lease payments are separated into the part related to the land and the part related to the building. This is done by determining the fair value of the land and applying the lessee's incremental borrowing rate to determine the amount of the minimum lease payments applicable to the land. The remaining of the minimum lease payments are attributed to the building.If the building element of the lease meets either criterion (c) or (d), the building element is classified as a capital lease, and the land element is classified as an operating lease. If the building element of the lease meets neither the (c) nor (d) criterion, the entire lease (building and land elements) is treated as a single operating lease.Leases of Land and BuildingsExample 3Classification of a Lease Including Land and BuildingsA company agrees to a noncancelable lease contract for a plant facility. The lease requires annual payments of $100,153 at the beginning of each year for a 20-year period. The lease contains a 5-year renewal option with a penalty clause. If the lessee fails to renew, it must pay a $300,000 penalty. The fair value of the land and the building is estimated to be $300,000 and $750,000, respectively. The building's estimated economic life is 35 years. The lessee's incremental borrowing rate is 10 percent and the lessor's implicit interest rate for the lease is not known by the lessee. Is the lease classified as an operating or a capital lease?

Leases of Real Estate and Personal PropertyA lease that includes both real estate and personal property is accounted for as though it were two separate leases. The lessee estimates the portions of the lease payments applicable to the real estate and personal property elements. The two elements are classified by applying the appropriate criteria for personal property and real estate as described previously.Leases of a Part of a BuildingLeases may involve leased property that is part of a larger unit of real estate, for example, a lease of a floor of an office building or a store unit in a retail mall. This poses a problem in applying the 90 percent recovery criterion. Note that the criteria related to the transfer of ownership and for a bargain purchase option will almost never be met because the lease does not involve the whole property unit. For a lease of part of a larger unit of real estate, FASB ASC 840, Leases requires the following classification steps:1. If the fair value of the leased property is objectively determinable, the lease is classified by applying the criteria for real estate leases as described above. 2. If the fair value of the leased property is not objectively determinable, the lease is classified by applying only criterion (c). The estimated economic life of the building is used as the economic life of the property unit being leased.Module 2BLessor's Classification of Real Estate LeasesFor the purpose of classifying real estate leases, lessors separately analyze four types of leases:1. Leases of land 2. Leases of land and buildings 3. Leases of real estate and personal property 4. Leases of a part of a buildingThese four types of leases have differing criteria for classifying a lease as a sales-type, direct financing, leveraged, or operating lease. The classification of real estate leases generally parallels that for personal property (see Module 1B).Leases of LandSales-type leases are leases that transfer ownership of the land [criterion (a)] and give rise to a manufacturer's or dealer's profit (or loss). Note that criteria (e) and (f) do not apply.Direct financing leases are leases other than leveraged leases that meet either criteria (a) or (b) (ownership is transferred, or a bargain purchase option exists) and both criteria (e) and (f) (that is, collectibility of the minimum lease payments is reasonable, predictable, and no important uncertainties exist with respect of unreimbursable costs to be incurred by the lessor) and do not give rise to a manufacturer's or a dealer's profit (or loss).Leveraged leases meet the criteria described above for direct financing leases plus criteria (g), (h), and (i) as described in Module 1B.Operating leases include all other leases; even those that give rise to a manufacturer's or dealer's profit (or loss) but do not meet criterion (a).Leases of Land and BuildingsClassification of a lease of both land and buildings is a multi-step process. All leases that do not meet the criteria for a capital lease described below are classified as operating leases.The first step is to apply the transfer of ownership and bargain purchase option criteria [(a) and (b)] as follows: Sales-type leases include leases that meet criterion (a) and give rise to a manufacturer's or dealer's profit (or loss). This type of lease is accounted for as a single unit. Direct financing leases include leases other than leveraged leases that meet either criteria (a) or (b) and both criteria (e) and (f) and do not give rise to a manufacturer's or a dealer's profit (or loss). Leveraged leases meet the criteria described above for direct financing leases plus criteria (g), (h), and (i) as described in Module 1B.Leases of Land and BuildingsWhen neither the (a) nor (b) criterion is met, the lessor follows essentially the same procedure as was described for the lessee in Module 2A. If the fair value of the land is less than 25 percent of the total fair value of all leased property, the property is evaluated as a single unit for applying criteria (c) and (d). If no manufacturer's or dealer's profit (or loss) exists, and either criteria (c) or (d) are met, and both criteria (e) and (f) are met, the lease is a direct financing lease unless (g), (h), and (i) also are met in which case the lease is a leveraged lease.If the fair value of the land is greater than 25 percent of the total fair value of all leased property, the land and the building must be considered separately for classifying the lease. This is done by determining the fair value of the land and applying the lessee's incremental borrowing rate to determine the amount of the minimum lease payments applicable to the land. The remainder of the minimum lease payments are attributed to the building. If the building element meets either criteria (c) or (d) and both (e) and (f) and no manufacturer's or dealer's profit (or loss) exists, the lease is a direct financing lease unless (g), (h), and (i) also are met in which case the lease is a leveraged lease. The land is accounted for separately as an operating lease. If the building cannot be classified as either a direct financing lease or a leveraged lease, the building and the land are treated as a single operating lease.Leases of Both Real Estate and EquipmentThe portions of the minimum lease payments related to the personal property and the real estate must be estimated so that the equipment lease and the real estate portions of the lease can be classified as though they were separate lease agreements.Leases of Part of a BuildingIf the cost and the fair value of the portion of the building that has been leased can be objectively determined, the lease is classified in the normal manner for a real estate lease. If either the cost or the fair value cannot be objectively determined, the lessor classifies the lease as an operating lease.Module 3ALessee's Accounting for LeasesOperating LeasesFASB ASC 840, Leases, requires that rental expense for operating leases be recognized over the lease term as it becomes payable. Expected changes in rental payments that are dependent on future events are considered contingent rentals and are recognized as they become probable and estimable. When the minimum lease payments are not level, rental expense shall be recognized on a straight-line basis unless some other rational and systematic basis better represents the time pattern of benefit derived from the use of the leased asset. Contingent lease payments that are not included in the minimum lease payments are expensed when they become payable.In the case of unequal lease payments, a distinction is made between (1) scheduled rent increases that are not dependent on future events, and (2) increases or decreases that are dependent on future events such as interest rates or sale volume. Scheduled increases are part of minimum lease payments and must be recognized on a straight-line basis unless there is evidence that the increased payments reflect changes in physical control or access to the property. The use of factors such as the time value of money, anticipated inflation, or expected future revenues to allocate expected increases in the minimum lease payments are not permitted because they do not relate to the time pattern of the physical access of the property.FASB ASC 840 guidance indicates that the physical use of the property is the basis for expense recognition on other than a straight-line basis. The interpretation of use is that access to or control of the leased property is the relevant variable, not actual usage. Thus, a scheduled rent increase occurring because the lessee will gain access to and control over additional leased property is expensed over the period that the lessee has control of the additional leased property. Otherwise, scheduled increases shall be recognized on a straight-line basis over the lease term. For example, a lessee that has control of all of the leased property at the inception of the lease but agrees to rent increases that reflect expected increases in the physical use of the leased property must recognize the additional rent expense on a straight-line basis over the lease term.Operating LeasesExample 4Recognition of Operating Lease ExpensePart A - A company agrees to a noncancelable lease contract for one floor of a building. The lease requires lease payments of $5,000 at the beginning of each month for a 15-year period. In addition, the lessee must pay 2 percent of any excess of its monthly gross revenue over $1,000,000. The lessee classifies the lease as an operating lease. How is lease expense recognized?Part B - In addition to the facts in Part A, assume that a scheduled increase in lease payments to $6,000 per month will occur at the beginning of year 8. The lessor has indicated that this increase is based on expected inflation during the term of the lease.Part C - In addition to the facts in Part A, assume that the lessor agrees to waive the first two year's rent. The first lease payment is due two years from the inception of the lease.Part D - In addition to the facts in Part A, assume that the lessor agrees to assume the lessee's existing lease with a third party. The old lease has three years remaining, and the lessee estimates that the difference between its lease payments and the amount for which the property can be subleased is $2,000 per month.

Capital LeasesFASB ASC 840 requires that the lessee record a capital lease as an asset and an obligation equal to the present value of the minimum lease payments during the lease term. The lease payments are reduced by any executory costs paid by the lessor and the lessor's profit thereon. The discount rate used to calculate the present value is the same rate used to apply the 90 percent recovery criterion for lease capitalization, that is, the lesser of the interest rate implicit in the lease, if known, and the lessee's incremental borrowing rate.If the present value of the minimum lease payments is greater than the fair value of the leased property, the leased asset and lease obligation are recorded at the lower fair value.Minimum lease payments are allocated to interest expense and to a reduction of the obligation using the effective interest method to achieve a constant periodic rate of interest. Normally, the interest rate is the same as that used to calculate the present value of the lease payments. If the lease is recorded based on a lower fair value, a new implicit interest rate is calculated. Contingent rentals are included in rental expense as they become payable.With the exception of land that is not amortized, the leased property shall be amortized. If the lease meets either capitalization criterion (a) or (b), the amortization shall be consistent with the lessee's normal depreciation policy for owned assets. Otherwise, amortization shall be consistent with the lessee's normal depreciation policy except that the depreciable life is reduced to the term of the lease and the residual value is set equal to the expected value of the property to the lessee at the end of the lease term. For example, a lessee that guarantees a residual value and has no further interest in the property sets the residual value equal to the amount expected to be realized from its sale, up to the amount of the guarantee. Note that when a lease includes both land and buildings and they are not accounted for separately, all of the leased property including the land is amortized over the lesser of the economic life of the building or the term of the lease.Capital LeasesExample 5Accounting for a Capital LeaseA company agrees to a noncancelable lease contract for a plant facility. The lease requires annual payments of $100,153 payments at the beginning of each year for a 20-year period. The lease contains a five-year renewal option with a penalty clause. If the lessee fails to renew, it must pay a $300,000 penalty. The fair value of the land and the building is estimated to be $200,000 and $800,000, respectively. The building's estimated economic life is 35 years. The lessee's incremental borrowing rate is 11 percent and the lessor's implicit interest rate for the lease is known to be 10 percent. Why is the lease classified as a capital lease, and how is it reported in the financial statements of the lessee?

Accounting for Residual Values and Penalties at the End of a Capital LeaseWhen a lease contains a guaranteed residual value or a penalty for failure to renew that is not sufficient to extend the term of the lease, the related amounts are included in the minimum lease payments. As a result, amortization of the lease obligation results in a residual balance equal to the guarantee or penalty at the end of the lease term. In the case of the guarantee, the unamortized carrying value of the leased property equals the original estimate of the residual value of the property. Thus, the carrying value of the obligation and the leased asset is removed from the balance sheet in conjunction with recording any cash payment required by the guarantee. Normally, a profit or loss will be recognized.For example, assume that a lease obligation equals the $10,000 residual guarantee and that the leased asset has a carrying value of $6,000 at the end of the lease term (original amount of $100,000). If the residual value is $7,500, the lessee makes a $2,500 payment under the residual guarantee and records a profit equal to the excess of the residual value over the carrying value of the leased property:Lease obligation10,000

Accumulated depreciation94,000

Leased asset100,000

Cash2,500

Profit1,500

The breakeven point for the residual value is the original estimate of residual value, so a loss occurs if the residual value is below $6,000. Even though the residual value exceeds the $10,000 guarantee, the maximum profit cannot exceed $4,000. If the estimated residual value had been $10,000 at the inception of the lease, the breakeven point would be at $10,000 rather than $6,000.Changes in Lease AgreementsChanges in a capital lease may occur because of Renegotiation of the lease contract, Renewal or extension of the lease beyond the original estimate of the lease term, or Termination of the lease prior to the expiration of the lease term.If the provisions of a lease are changed, other than by renewing or extending the term in a manner that would have changed the original classification if the new terms had been in effect at the inception of the lease, the revised lease is treated as a new agreement. The classification criteria described in Modules 1 and 2 are applied to the term of the revised lease. Likewise, any extension of the lease other than to avoid payment of a penalty or a guarantee is considered a new lease agreement.Changes in estimates of economic life, residual value, or other amounts related to the lease will affect the classification of the lease. These changes are reported in the normal manner for changes in accounting estimates.Changes in Lease AgreementsThere are three alternatives for accounting for changes in the provisions of a lease, renewal or extension of a lease, or early termination of a lease:a. If the minimum lease payments of a capital lease are changed in a way that does not give rise to a new lease agreement (for example, the lease is extended beyond its original term as measured at inception) or if the change gives rise to a new lease agreement that is classified as a capital lease, the carrying amounts of the leased property and the obligation must be adjusted. The adjustment is the difference between the present value of the minimum lease payments under the revised or new lease and the carrying value of the old lease obligation. The new minimum lease payments are discounted using the rate of interest originally used to record the old lease. If the minimum lease payments of a capital lease are changed in a way that gives rise to a new operating lease, the leased property and the obligation are adjusted to zero. A profit or loss is recognized for any difference in amounts. b. If a capital lease is renewed or extended and this does not render a residual guarantee or penalty inoperative, the renewal and extension of a capital lease is accounted for as in (a) above. The renewal or extension of an operating lease is accounted for as an operating lease, and the existing capital lease continues to be accounted for as a capital lease until the end of its original term. c. If a capital lease is terminated, the leased property and the obligation are adjusted to zero. A profit or loss is recognized for any difference in amounts.Module 3BLessor's Accounting for LeasesOperating LeasesFASB ASC 840, Leases, requires that the leased property remain on the balance sheet of the lessor and that rent be recognized as revenue over the term of the lease as it becomes receivable.The leased property is reported near plant, property, and equipment on the balance sheet, and it is depreciated using the lessor's normal depreciation policies. Accumulated depreciation is deducted from the investment in the leased property.Even if the rental payments are not equal in amount, revenue must be recognized on a straight-line basis unless another systematic and rational pattern better represents the pattern by which the use benefit of the property is reduced.Initial direct costs generally must be deferred and recognized in proportion to the recognition of rental income. Immediate expensing of initial direct costs is permitted in situations in which there is no material difference between immediate expensing and the proportional method. Initial direct costs are the costs of originating the lease that are directly related to the lease and would not have been incurred in the absence of the specific leasing transaction. Advertising, lease solicitation, lease servicing, and similar costs are not included.If an operating lease results in a manufacturer's or a dealer's loss but it cannot be classified as a sales-type lease because it does not meet the transfer of ownership criterion (a), the loss must be recognized by writing the leased property down to its fair value.Sales-Type LeasesLessors recognize a sales-type lease as though it were a sale and a financing agreement. Thus, a profit or loss is recognized at the inception of the lease, and the leased property is removed from the balance sheet. A lease receivable is recorded, and interest revenue will be recognized throughout the term of the lease.Accounting for a sales-type lease is a three-step process:1. Compute gross investment as the sum of the minimum lease payments and any unguaranteed residual value to the lessor. 2. Record the sale and capitalize the lease as follows: a. Recognize the gross investment as a lease receivable. b. Remove the carrying value of the leased property from the balance sheet. c. Recognize unearned interest income as a contra asset (to the gross investment) equal to the difference between the gross investment and the present value of the gross investment. d. Record sales revenue equal to the present value of the gross investment in the lease. e. Cost of sales is recorded equal to the carrying value of the property plus initial direct costs minus the present value of the unguaranteed residual value, if any. Sales-Type LeasesAccounting for a sales-type lease is a three-step process:3. Record lease payments and amortize unearned income and initial direct costs during the term of the lease as follows: a. The lease receivable (gross investment in the lease) is reduced by payments received. b. Unearned interest income and initial direct costs are amortized to income using the interest method. c. The net investment in the lease is the gross investment plus unamortized initial direct costs minus unearned income.Direct Financing LeasesLessors recognize direct financing leases as financing transactions. Thus, a sale has not occurred and no profit or loss is recognized at the inception of the lease even though the leased property is removed from the balance sheet. A lease receivable is recorded, and interest revenue will be recognized throughout the term of the lease.Accounting for a direct financing lease is a three-step process:1. Compute gross investment as the sum of the minimum lease payments and any unguaranteed residual value to the lessor. 2. Capitalize the lease as follows: a. Recognize the gross investment as a lease receivable. b. Remove the carrying value of the leased property from the balance sheet. c. Recognize unearned interest income as a contra asset (to the gross investment) equal to the difference between the gross investment and the present value of the gross investment.Direct Financing LeasesAccounting for a direct financing lease is a three-step process: (cont.)3. Record lease payments and amortize unearned income and initial direct costs as follows: a. The lease receivable (gross investment in the lease) is reduced by payments received. b. Unearned interest income and initial direct costs are amortized to income using the interest method. c. The net investment in the lease is the gross investment plus unamortized initial direct costs minus unearned income.Initial direct costs related to direct financing leases are not included in the gross investment, but are part of the net investment and are amortized as part of the net investment.Leveraged LeasesLeveraged leases are a specialized form of direct financing lease. Lessees do not classify leases as leveraged leases for accounting and reporting. They simply apply the normal criteria to determine whether the lease is a capital or an operating lease. In contrast, lessors must identify those leases meeting the leveraged lease criteria in addition to the criteria for a direct financing lease. Because of the specialized nature of leveraged leases, the related accounting and reporting requirements are not described.Module 4Sale-Leaseback TransactionsA sale-leaseback transaction involves the sale of property by its owner who concurrently leases the property from the buyer. The lease-back does not have to include all of the property or extend over the entire economic life of the property. The original owner is described as the seller-lessee, and the buyer is described as the buyer-lessor. The transaction provides financing to seller-lessee and is an alternative to obtaining a mortgage loan. Sale-leaseback transactions are often facilitated by lease brokers who specialize in structuring the sale-leaseback agreement.FASB ASC 840, Leases, governs accounting for sale-leaseback transactions involving only personal property. Buyer-lessors simply apply the criteria for classifying a lease as a direct financing lease to sale-leaseback leases. If the lease agreement meets the criteria for a direct financing lease, the transaction is recorded as a purchase of the property and an accompanying direct financing lease. Otherwise, buyer-lessors record sale-leaseback transactions as a purchase of the property and an accompanying operating lease.The remainder of this module describes the accounting by seller-lessees.Transactions Involving Only Personal PropertyCapital LeasesIf the lease meets one of the four criteria for capital lease classification (see Module 2), it is classified as a capital lease by the seller-lessee. The profit or loss from the sale of the property is deferred rather than recognized in the period of the sale. The deferred profit or loss is amortized in proportion to the amortization of the leased asset, for example, using the straight-line or double-declining-balance methods.Operating LeasesIf the lease fails to meet one or more of the criteria for capital lease classification, it is classified as an operating lease. The profit or loss from the sale of the property is deferred and amortized in proportion to the related gross rental charged to expense over the lease term.Exceptions If the seller-lessee retains only a minor portion of the use of the property that it sold, the sale and leaseback are accounted for as separate transactions. As a result, all of the profit or loss on the sale is recognized at the date of the sale. The 90 percent recovery criterion can be used as a guideline for determining whether the leaseback consists of a minor portion. If the present value of a reasonable rental for the leaseback is less than 10 percent of the fair value of the asset sold, the seller-lessee is presumed to have retained a minor portion of the use of the asset. If the seller-lessee realizes a profit on the sale and retains more than a minor portion of the use of the property but less than substantially all of the use of property, the following accounting is required: If the leaseback is classified as an operating lease, only the amount of profit in excess of the present value of the minimum lease payments over the lease term is recognized at the date of the sale. The remainder is deferred. If the leaseback is classified as a capital lease, only the amount of profit in excess of the recorded amount of the leased asset is recognized at the date of the sale. The remainder is deferred. If the seller-lessee realizes a loss on the sale, all of the loss is recognized. If the fair value of the property is less than its undepreciated cost at the date of the sale, a loss should be recognized up to the difference between fair value and undepreciated cost.ExceptionsExample 6aAccounting for a Sale-Leaseback of Personal Property (Operating Lease)A company enters a sale-leaseback arrangement for the new equipment in one of its plants. After purchasing the equipment from the manufacturer for $1,000,000 (its fair value), the equipment is sold to a leasing company for $975,000, and leased back under a noncancelable lease agreement requiring annual payments of $122,467 at the beginning of each year for a 10-year period. The company properly classifies the lease as an operating lease. How is the sale-leaseback reported in the financial statements of the seller-lessee?

Transactions Involving Only Personal PropertyCapital LeasesIf the lease meets one of the four criteria for capital lease classification (see Module 2), it is classified as a capital lease by the seller-lessee. The profit or loss from the sale of the property is deferred rather than recognized in the period of the sale. The deferred profit or loss is amortized in proportion to the amortization of the leased asset, for example, using the straight-line or double-declining-balance methods.Operating LeasesIf the lease fails to meet one or more of the criteria for capital lease classification, it is classified as an operating lease. The profit or loss from the sale of the property is deferred and amortized in proportion to the related gross rental charged to expense over the lease term.Exceptions If the seller-lessee retains only a minor portion of the use of the property that it sold, the sale and leaseback are accounted for as separate transactions. As a result, all of the profit or loss on the sale is recognized at the date of the sale. The 90 percent recovery criterion can be used as a guideline for determining whether the leaseback consists of a minor portion. If the present value of a reasonable rental for the leaseback is less than 10 percent of the fair value of the asset sold, the seller-lessee is presumed to have retained a minor portion of the use of the asset. If the seller-lessee realizes a profit on the sale and retains more than a minor portion of the use of the property but less than substantially all of the use of property, the following accounting is required: If the leaseback is classified as an operating lease, only the amount of profit in excess of the present value of the minimum lease payments over the lease term is recognized at the date of the sale. The remainder is deferred. If the leaseback is classified as a capital lease, only the amount of profit in excess of the recorded amount of the leased asset is recognized at the date of the sale. The remainder is deferred. If the seller-lessee realizes a loss on the sale, all of the loss is recognized. If the fair value of the property is less than its undepreciated cost at the date of the sale, a loss should be recognized up to the difference between fair value and undepreciated cost.ExceptionsExample 6aAccounting for a Sale-Leaseback of Personal Property (Operating Lease)A company enters a sale-leaseback arrangement for the new equipment in one of its plants. After purchasing the equipment from the manufacturer for $1,000,000 (its fair value), the equipment is sold to a leasing company for $975,000, and leased back under a noncancelable lease agreement requiring annual payments of $122,467 at the beginning of each year for a 10-year period. The company properly classifies the lease as an operating lease. How is the sale-leaseback reported in the financial statements of the seller-lessee?

Accounting for a Sale-leaseback of Personal Property (Operating Lease)

Solution ExplanationThe sales price is less than its book value, so immediate loss recognition is necessary. The $25,000 loss on the sale is recognized. ExceptionsExample 6bAccounting for a Sale-Leaseback of Personal Property (Capital Lease)A company enters a sale-leaseback arrangement for new equipment. After purchasing the equipment from the manufacturer for $1,000,000 (its fair value), it is sold to a leasing company for $975,000, and leased back under a noncancelable lease agreement requiring annual payments of $122,467 at the beginning of each year for a 17-year period. The estimated economic life of the equipment is 18 years. The company properly classifies the lease as a capital lease because it meets both the economic life and the 90 percent recovery criteria (using a 12 percent discount rate). Owned equipment is depreciated on a straight-line basis. How is the sale-leaseback reported in the financial statements of the seller-lessee?

ExceptionsExample 7Accounting for a Sale-Leaseback of Personal Property(Leaseback of a Part of the Property)A company enters a sale-leaseback arrangement for its existing equipment. Equipment with a net book value of $100,000 is sold to a leasing company for its fair value, $1,000,000. Sixty percent of the equipment is leased back, based on relative fair values. The noncancelable lease agreement requires 60 monthly payments of $13,215. The payments are based on the lessor's implicit interest rate of one percent per month, which is lower than the lessee's incremental borrowing rate. How is the profit for the sale-leaseback reported in the financial statements of the seller-lessee, assuming that the lease is properly classified as an operating lease?

Sale-Leaseback Transactions Involving Real EstateThe accounting standards for sale-leaseback transactions involving real estate apply to all transactions that include real estate, irrespective of the relative values of the real estate and the personal property, if any, included in the transaction. The standards also apply to transactions in which the seller-lessee sells property improvements or integral equipment while retaining the underlying land. Improvements and integral equipment include any physical structure or equipment that is attached to the real estate and cannot be removed and used separately without incurring significant cost.Criteria for Sale-Leaseback AccountingThe seller-lessee in a transaction involving real estate is required to use sale-leaseback accounting if the transaction includes all of the following: A normal leaseback arrangement that includes active use of the property in the seller- lessee's trade or business in consideration for the payment of rent. In addition, the subleasing of the property must be minor, that is, the present value of a reasonable rental on the subleased portion must be less than 10 percent of the fair value of the property sold. Payment terms and provisions that demonstrate the buyer-lessor's initial and continuing investment in the property. The precise requirements for demonstrating the buyer-lessor's initial and continuing investment are not presented in detail. In general, the buyer's initial investment must be equal to a major part of the difference between the sales value of the property and the usual loan limits for financing the purchase of the property. The buyer's continuing investment is evidenced by a contractual obligation to pay an amount each year that is at least equal to a level 20-year amortization of the total debt for land and the amortization of the debt over the customary amortization term for other real estate. Payment terms and provisions that transfer all of the other risks and rewards of ownership to the buyer-lessor. This is demonstrated by the seller-lessee's lack of any other continuing involvement. Criteria for Sale-Leaseback AccountingThe following circumstances are examples of a seller-lessee's continuing involvement in the leased property: The seller-lessee has the option to purchase the property, or the buyer-lessor can compel repurchase. The seller-lessee guarantees the buyer-lessor's return on investment for some period of time. The seller-lessee is required to pay the buyer-lessor for a decline in fair value of the property that is unrelated to excess wear and tear of the property. The seller-lessee provides nonrecourse financing to the buyer-lessor for any portion of the sales proceeds or recourse financing where recourse is to the property. The seller-lessee is not relieved of existing financing related to the property. The seller-lessee sells property improvements or integral equipment but does not lease the underlying land to the buyer-lessor. The seller-lessee in entitled to share the appreciation of the property with the buyer-lessor.Module 5SubleasesSubleases That Relieve the Original Lessee of Its ObligationThe following are examples of transactions that relieve the original lessee of its obligation: A new lessee is substituted under the original agreement. The original lessee may or may not retain a secondary obligation. A new lessee is substituted under a new lease agreement, and the original agreement is canceled.If the original lease was an operating lease, no accounting entries are necessary. However, it may be necessary to make disclosures related to the contingency if the original lessee has an obligation in case of the default by the new lessee.If the original lease was a capital lease, the lease asset and obligation are removed from the balance sheet. A profit or loss is recognized equal to the difference between the carrying values of the asset and obligation, adjusted by any consideration paid or received. Again, it may be necessary to disclose any contingent obligation.Module 6ALessee's Disclosure RequirementsGeneral disclosure requirements for all leases include, but are not limited to The basis for determining the amount of contingent rentals; The terms of renewal and purchase options and escalation clauses; and Restrictions imposed by lease agreements, for example, limitations of dividend payments or additional debt.Operating Lease DisclosuresThe following disclosures are required for all operating leases: Total rental expense with separate amounts of minimum rentals, contingent rentals, and sublease rentals (Data related to leases with terms of less than one month that were not renewed may be omitted)The following disclosures are required for noncancelable leases having initial or remaining terms of longer than one year: Future minimum rental payments for each of the next five years and the total for all future years The total minimum sublease rentals to be received in all future years under non-cancelable subleasesCapital Lease DisclosuresThe following disclosures are required for all capital leases: The gross amount of assets recorded under capital leases (The amount should be classified by major classes of assets and may be combined with comparable information for owned assets); Future minimum lease payments for each of the next five years and the total for all future years (Deductions must be made for executory costs and for imputed interest necessary to reduce the minimum lease payments to present value) The total minimum sublease rentals to be received in all future years under noncancelable subleases; Total contingent rentals for each year that an income statement is presented; and Leased assets, accumulated amortization, and lease obligations should be separately identified in the balance sheet or the footnotes (Obligations are classified as current or noncurrent in the normal manner. Amortization expense must be disclosed although it can either be reported as part of depreciation or as a separate item in the income statement)Sale-Leaseback Disclosures In addition to the other lease disclosure requirements, the seller-lessee should describe the terms of the sale-leaseback, including future commitments, obligations, or any other circumstances that result in the seller-lessee's continuing involvement in the property. If the seller-lessee accounts for the transaction by the deposit method or as a financing, both the obligation for future minimum lease payments and the minimum sublease rentals should be disclosed in the aggregate and for each of the next five years.Implementation GuidelinesMany companies integrate the required lease disclosures with related footnote disclosures. For example, the disclosures of leased assets can be combined with disclosures related to owned property subject to depreciation, and the disclosures related to the lease obligations can be combined with disclosures related to long-term liabilities. Even disclosures of rental payments for operating leases can be readily combined with those for long-term liabilities.Financial Statement IllustrationsDisclosures of Operating LeasesAmbase Corporation December 31, 20X0Note 11 - Commitments and ContingenciesFuture minimum rental payments, principally for office space, under noncancelable operating leases at December 31, 20X0, are: 20X1, $67,000; 20X2, $75,000; 20X3, $79,000; 20X4, $79,000; 20X5, $20,000 and thereafter, $0. Rent expense charged to earnings was $46,000, $142,000, and $178,000 for the years ended December 31, 20X0, 20W9, and 20W8, respectively.FoxMyer, Corp. March 31, 20X3Note M - Commitments and ContingenciesThe Corporation leases various types of properties, primarily warehouse property, computer equipment and trucks, through noncancelable operating leases. Certain leases contain escalation clauses and provide for renewal options. Rental expense under operating leases aggregated $13.9 million in 20X3, $13.5 million in 20X2 and $12.4 million in 20X1. Minimum rental payments under these leases with initial or remaining terms of one year or more at March 31, 20X3, aggregate $63.2 million and payments due during the next five years are: 20X4 - $11.4 million; 20X5 - $8.3 million; 20X6 - $6.3 million; 20X7 - $5.7 million; 20X8 - $4.6 million; and thereafter $26.9 million. Disclosures of Operating LeasesSolectron Corporation August 31, 20X6Note 8 - CommitmentsThe Company leases various facilities under operating lease agreements. The facility leases expire at various dates through 20Y1. Substantially all leases require the Company to pay property taxes, insurance, and normal maintenance costs. All of the Company's leases have fixed minimum lease payments except the lease for certain facilities in Milpitas, California. Payments under this lease are periodically adjusted based on LIBOR rates. This lease provides the Company with the option at the end of the lease of either acquiring the property at its original cost or arranging for the property to be acquired. The Company is contingently liable under a first loss clause for a decline in market value of the leased facilities up to $44.2 million in the event the Company does not purchase the property at the end of the five-year lease term. The Company must also maintain compliance with financial covenants similar to its credit facilities.Future minimum payments related to lease obligations are $13.9 million, $12.4 million, $9.2 million, $6.2 million, and $1.1 million in each of the years in the five-year period ending August 31, 20Y1. Rent expense was $17.0 million, $10.8 million, and $11.1 million for the years ended August 31, 20X6, 20X5, and 20X4, respectively.Disclosures of Capital LeasesAction Industries, Inc.June 29, 20X1Note C - Long-Term DebtMaturities of Debt - The aggregate maturities of long-term debt, including capital lease obligations, for the five fiscal years subsequent to 20X1 are as follows: 20X2 - $1,950,000, 20X3 - $1,231,000, 20X4 - $34,000, 20X5 - $37,000, and 20X6 - $79,000.Interest paid was $4,033,000 during the year ended June 29, 20X1; $5,892,000 in 20X0; and $5,211,000 in 20W9.Combined Disclosures of Operating and Capital LeasesSupervalue, Inc.February 27, 20X3Note D - Long-Term DebtLeases - Capital and operating leases: The Company leases certain food distribution warehouse and office facilities, as well as corporate-owned and operated retail food stores. Many of these leases include renewal options, and to a limited extent, include options to purchase. Amortization of assets under capital leases was $11.8, $7.8, and $6.4 million in 20X3, 20X2, and 20X1, respectively. Combined Disclosures of Operating and Capital LeasesFuture minimum obligations on capital leases in effect at February 27, 20X3, are as follows (in thousands):YearLease Obligations

20X4$25,349

20X523,733

20X622,233

20X721,025

20X819,750

Later196,165

Total future minimum obligations308,255

Less interest149,356

Present value of net future minimum obligations158,899

Less current portion9,774

Long-term obligations$149,125

The present values of future minimum obligations shown are calculated based on interest rates ranging from 7.3% to 13.8%, with a weighted average of 10.2%, determined to be applicable at the inception of the leases.Interest expense on the outstanding obligations under capital leases was $14.8, $12.1, and $10.3 million in 20X3, 20X2, and 20X1, respectively.Contingent rent expense, based primarily on sales performance, for capital leases was $.3, $.1, and $.3 million in 20X3, 20X2, and 20X1, respectively.Combined Disclosures of Operating and Capital LeasesIn addition to its capital leases, the company is obligated under operating leases, primarily for buildings, warehouse, and computer equipment.Future minimum obligations on operating leases in effect at February 27, 20X3, are as follows (in thousands): Year Obligations

20X4$56,385

20X550,554

20X645,659

20X741,070

20X835,023

Later154,552

Total future minimum obligations$383,243

Total rent expense, net of sublease income, relating to all operating leases with terms greater than one year was $13.0, $2.8, and $3.3 million in 20X3, 20X2, and 20X1, respectively.Combined Disclosures of Operating and Capital LeasesWaste Conversion Systems, Inc.September 30, 20X1Note 9 - CommitmentsLeases - As described in Note 4, the Company leased an airplane and certain furniture and equipment from related parties.The Company leases its office space under an operating lease. The office space lease, which originally expired in April 20X5, was changed to a month-to-month lease in May 20X2. The Company also leases their telephone system and analytical and laboratory equipment under capital leases.The future net minimum payments under capital leases are: 20X2 - $26,374; 20X3 - $2,724; 20X4 - $2,270. The net minimum payment amounts include $1,914 of interest.Rental expense for operating leases was approximately $66,500; $29,300; and $35,300 for fiscal 20X1, 20X0, and 20W9.Disclosures Related to Sale-Leaseback TransactionsAction Industries, Inc.June 29, 20X1Note D - Sale/LeasebackIn April 20X1, the Company completed the refinancing of its headquarters facility under a sale/leaseback arrangement. The facility was sold for $14 million, $3.5 million of which was received in the form of an interest bearing note receivable due in April 20X5, and the remainder in cash. The cash received was utilized to repay existing mortgages on the property ($2.3 million) and expenses of the transaction ($700,000) and to repay bank debt ($7.5 million). The transaction has been accounted for as a financing, wherein the property remains on the books and will continue to be depreciated. A financing obligation representing the proceeds has been recorded, to be reduced based on payments under the lease. The lease has a term twelve years for the office and eight years for the warehouse and requires minimum annual rental payments of $1,655,000 in 20X2; $1,655,000 in 20X3; $1,700,000 in 20X4; $1,700,000 in 20X5; $1,856,000 in 20X6; and $6,325,000 thereafter. The Company has the option to renew the lease at the end of the respective lease terms, and the option to purchase the property at the end of the warehouse lease.Disclosures Related to Sale-Leaseback TransactionsCircuit City Stores, Inc.February 28, 20X2Note 7 - Lease CommitmentsIn fiscal 20X3, the Company entered into sale-leaseback transactions with unrelated parties at an aggregate selling price of $69,195,000 ($86,050,000 in fiscal 20X2). The Company does not have continuing involvement under the sale-leaseback transactions.UAL Corp.December 31, 20X2Note 1 - Summary of Significant Accounting PoliciesDeferred Gains - Gains on aircraft sale and leaseback transactions are deferred and amortized over the lives of the leases as a reduction of rental expense. Disclosures Related to Sale-Leaseback TransactionsMay Department Stores CompanyFebruary 1, 20X2Note - Long-Term DebtLong-term debt and capital lease obligations were as follows: February 1,February 2,

(dollars in millions)20X220X1

2.75% to 12.75% unsecured notes

and sinking fund debentures due

20X2 - 20Z1$3,210$2,939

MCAC sale/leasebacks620 570

On February 1, 20X0, the company sold 37 of its department store properties to MCAC for $367 million and simultaneously leased back the properties. The company and MCAC completed additional sale/leaseback transactions of six department store properties amounting to $57 million in 20X1 and 23 department store properties amounting to $210 million in 20X0. As the company is a 50 percent partner in MCA, the accounting rules specify that the sale/leasebacks be accounted for as loans from MCAC. The base lease terms are 25 years and include fixed annual payments of $58 million and percentage payments based upon sales above defined sales levels. The leases also provide for renewal options. Module 6BLessor's Disclosure RequirementsFASB ASC 840, Leases, describes the primary disclosures required of lessors for which leasing is a significant part of their business activities in terms of revenue, net income, or assets. All such lessors disclose the following: A general description of the leasing agreementsOther disclosure requirements differ for capital and operating leases.Operating Lease DisclosuresThe following disclosures are required for all operating leases: The cost and carrying amount of property used for leasing and the total accumulated depreciation for such property as of the most recent balance sheet date (The cost and carrying amounts are presented by major category according to nature or function) Minimum future rentals on noncancelable leases for each of the next five years and in the aggregate as of the most recent balance sheet date Total contingent rental expense for each period that an income statement is presentedSales-Type and Direct Financing Lease DisclosuresThe following disclosures are required for all capital leases: The components of the net investment in leases for each balance sheet presented, including Future minimum lease payments to be received with separate deductions for executory costs and the accumulated allowance for uncollectible minimum lease payments receivable; Unguaranteed residual values available to the lessor; Initial direct costs of direct financing leases; and Unearned interest income. Future minimum lease payments to be received in each of the next five years as of the most recent balance sheet date Total contingent rentals for each period that an income statement is presented Sale-Leaseback Disclosures No additional disclosure requirements are applied for direct financing leases that are part of sale-leaseback transactions.Disclosure of Operating LeasesPrime Motor Inns Corp.June 30, 20X1Note 9 - Property, Equipment, and Leasehold ImprovementsProperty, equipment and leasehold improvements consist of the following (in thousands of dollars):

Disclosure of Operating LeasesAt June 30, 20X1, the Company was the lessor of land, and certain restaurant facilities in Company-owned hotels with an approximate aggregate net carrying value of $8,060,000, pursuant to noncancelable operating leases expiring on various dates through 2083. Minimum future rentals under such leases were $5,852,000, of which $2,222,000 is to be received in each of the five years in the period ending June 30, 20X6.Depreciation and amortization expense, including discontinued operations, on property, equipment and leasehold improvements was $7,867,000; $9,409,000; and $9,582,000 in 20X1, 20X0, and 20W9, respectively.Capitalized interest was $1,000,000; $5,505,000; and $2,152,000 in 20X1, 20X0, and 20W9, respectively.Combined Disclosures of Operating and Direct Financing LeasesSonic Corp.August 31, 20X6Note 6 - LeasesDescription of Leasing Arrangements - The Company's leasing operations consist principally of leasing certain land, buildings, and equipment (including signs) and subleasing certain buildings to franchise operators. The land portions of these leases are classified as operating leases and expire over the next six years. The buildings and equipment portions of these leases are classified principally as direct financing or sales-type leases and expire over the next eight years. These leases include provisions for contingent rentals, which may be received on the basis of a percentage of sales in excess of stipulated amounts. Some leases contain escalation clauses over the lives of the leases.Certain Company-owned restaurants lease land and buildings from third parties. These leases, which expire over the next twenty years, include provisions for contingent rentals, which may be paid on the basis of a percentage of sales in excess of stipulated amounts. The land portions of these leases are classified as operating leases and the buildings portions are classified as capital leases. Combined Disclosures of Operating and Direct Financing LeasesDirect Financing and Sales-Type Leases - Components of net investment in direct financing and sales-type leases are as follows at August 31, 20X6 and 20X5:20X620X5

Minimum lease payments receivable$5,670$5,609

Less unearned income1,4661,653

Net investment in direct financing and sales-type leases4,2043,956

Less amount due within one year783908

Amount due after one year$3,421$3,048

Minimum lease payments receivable for each of the five years after August 31, 20X6, are $1,336 in 20X7; $1,241 in 20X8; $1,120 in 20X9; $886 in 20Y0; $681 in 20Y1 and $406 thereafter. Initial direct costs incurred in the negotiation and consummation of direct financing and sales-type lease transactions have not been material during fiscal years 20X6 and 20X5. Accordingly, no portion of unearned income has been recognized to offset those costs.Equipment and sign sales include $1,340; $1,163; and $836 for the years ended August 31, 20X6, 20X5, and 20X4, respectively, related to sign lease transactions that have been accounted for as sales-type leases.Disclosures of Sales-Type LeasesSensormatic Electronics CorporationJune 30, 20X3Note 1 - Summary of Significant Accounting Policiese. Revenue recognitionRevenue from sales-type leases (primarily leases with terms of sixty months or greater) is recognized as a "sale" upon shipment in an amount equal to the present value of the minimum rental payments under the fixed noncancelable lease term. Interest income on receivables under deferred terms and installment contract obligations and net investment in sales-type leases is recognized over the term of the contract using the effective interest method. Disclosures of Sales-Type LeasesNote 2 - Receivables and net investment in sales-type leasesAs a result of the ALPS acquisition, the Company is leasing equipment under sales-type lease agreements expiring in various years through 20X9. The net investment in sales-type leases consisted of the following at June 30, 20X3 (in thousands): Minimum lease payments receivable$93,158

Allowance for uncollectible minimum lease payments(1,943)

Unearned interest and maintenance(25,975)

$65,240

Net receivables and net investment in sales-type leases at June 30, 20X3, are due as follows (in thousands): 20X4 - $177,820 and $11,076; 20X5 - $4,644 and $12,835; 20X6 - $3,692 and $13,251; 20X7 - $2,472 and $12,974; 20X8 - $63 and $11,484; and thereafter - $647 and $3,620, respectively.The Company has agreements with third party financing institutions whereby certain receivables under installment contract obligations in the US and net investment in sales-type leases in Europe together with certain related rights are sold to the financing institutions. Under such agreements, should certain events (primarily related to customer non-payment) occur, the Company is obligated to repurchase specific receivables and net investment in sales-type leases from the financing institutions. The Company accrued loss contingencies at June 30, 20X3, and May 31, 20X2, of $1.4 million and $0.4 million, respectively, related to $125.9 million and $51.9 million, respectively, of receivables and leases sold to the financing institutions that are subject to full or partial repurchase. Disclosures Related to Direct Financing Leases for Sale-Leaseback TransactionsCilcorp, Inc.December 31, 20X0Note 7 - Leveraged Lease Financing ReceivablesThe Company, through its 81 percent-owned leasing subsidiary, CLM, is a lessor in nine leveraged lease arrangements under which mining equipment, electric production equipment, manufacturing equipment, electric transmission lines, satellite transponders, warehouse facilities and office buildings are leased to third parties. The economic lives and lease terms vary with the leases. The leasing subsidiary's share of total equipment and facilities cost was approximately $376 million and $377 million at December 31, 20X0 and 20W9, respectively.Disclosures Related to Direct Financing Leases for Sale-Leaseback TransactionsNote 7 - Leveraged Lease Financing Receivables (cont.)The cost of the equipment and facilities was partially financed by non-recourse debt provided by lenders, who have been granted as their sole remedy in the event of a lessee default, an assignment of rentals due under the leases and a security interest in the leased property. Such debt amounted to $277 million at December 31, 20X0, and $288 million at December 31, 20W9. Leveraged lease residual value assumptions, which are conservative in relationship to appraised residual values, are tested on a periodic basis. The Company's net investment in leveraged leases at December 31, 20X0 and 20W9, was approximately $43 million and $49 million, respectively, as shown below:(In thousands)20X020W9

Minimum lease payments receivable$146,736$150,768

Estimated residual value122,699122,976

Less: Unearned income144,044155,454

Investment in lease financing receivables125,391118,290

Less: Deferred taxes arising from leveraged leases82,846 69,410

Net investment in leveraged leases$42,545$48,880

Included in the table above is the Company's approximately seven percent investment in the Springerville Unit No. 1 electric generating station. The station is leased to Century Power Corporation (Century), which sells its output to Tucson Electric Power Company (TEP) under a 28-year power sale agreement. Payments made by TEP to Century under the agreement enable Century to meet its lease obligations. The Company's net investment at December 31, 20X0, was $1,954,000, consisting of lease financing receivables of $20,922,000, less $22,876,000 of deferred taxes. The non-recourse debt balance at that date was $37,497,000.Disclosures Related to Direct Financing Leases for Sale-Leaseback TransactionsNote 7 - Leveraged Lease Financing Receivables (cont.)On February 1, 20X1, TEP and Century breached their obligations to make payments under the power sale agreement and lease, respectively, which constitutes an event of default under the lease. TEP has requested that the terms of Century's power sale agreement with TEP be renegotiated, and has requested that all parties temporarily refrain from legal action to compel performance. Separately, TEP has proposed to its lenders a moratorium on principal and interest payments on debt other than first mortgage bonds.Under ASC 840, renegotiation of the timing or amount of rental payments under the lease could reduce previously reported net income. Management cannot predict whether the terms of the lease will be renegotiated, or predict the amount by which net income may be reduced if this occurs. In the event of a TEP bankruptcy and subsequent foreclosure by the nonrecourse lenders, the Company's net income could be reduced by a maximum of $11 million.