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Welcome back. We're not going to switch gears and start talking
about lessor accounting in this lesson.
So, lessor accounting had a different set of issues.
With ASC accounting, issue was that the obligation was off balance sheet.
There was fewer issues especially in the user community with lessor accounting.
They were pretty comfortable with the way that we currently
accounted for both sales type leases and operating leases.
So ASC 842 didn't make major changes to lessor accounting overall,
but there are some in there are also
some interesting interactions with revenue recognition as we previously noted.
So, in the FASB world,
there are still three types of leases.
And this is from the lessor perspective.
There's a sales type lease,
a direct financing lease,
and an operating lease.
Operating leases, of course,
are any lease other than a sales type or direct financing lease.
So in the section, we'll be primarily be talking about the other two.
Now this is a little different from IFRS.
IFRS is generally the same but there's one difference,
the direct financing leases.
That classification does not exist in IFRS.
So what is a direct financing lease?
Well, from the perspective of the lessor,
it's a lease that doesn't qualify as a sales type lease.
It doesn't meet any of those criteria in paragraph 842-10-25-2,
that is the transfer of title, the bargain purchase.
It doesn't meet those criteria.
It doesn't qualify as a finance lease unless
you include a third party residual value guarantee.
Now remember, if the guarantee is coming from the lessee,
you included it in the lease obligation because the lessee is
obligated to make the payment if
the residual value of the leased asset is not at
least equal to a minimum guaranteed value at the end of the lease.
Well, you can also go out and get those guarantees from a third party.
It's actually kind of common today.
But if you have a third party usage who will guarantee,
it's not considered a sales type lease because it's not
considered that control has passed to the lessee.
So if I have the lessee,
gives us the residual value guarantee,
then the lessee now has control of the leased asset and it would be a sales type lease.
If the guarantee is from a third party,
and that's what makes you cross
the 90 percent threshold to be considered a finance lease,
it's not considered a sale because control has not
passed and that's the criteria in ASC 606 to recognize revenue.
This therefore, is a new category of direct financing lease.
Now, that term was used previously in ASC 840,
the old leasing standard,
but it has a new meaning in ASC 842.
It's not going to be real common because people may not
be inclined to get these third party residual value guarantees,
at least not as incentivized as they were previously.
Before, it allowed you to have
a certain situation where the lessor could recognize the sale,
but the lessee would only recognize an operating lease.
Well, that's not going to be the case any more.
The lessee is going to have to recognize that operating lease on the balance sheet,
and the lessor is not going to be able to get a sale if it's a third party guarantee.
So this is something that we don't expect to see a lot of in the future,
so we're not really going to provide any examples of it here but it
is a possibility it could exist.
What you're going to see more often is actually a sales type lease.
And that's a lease that meets the criteria as
a finance type lease and it will be classified as a sale.
And this will be the new default.
So a finance lease will only be direct financing
in that special circumstances of a third party guarantee.
Otherwise, it's going to be a sales type lease.
So you're going to record that by debiting an asset for the net investment in the lease.
And here is the formula for how you would calculate that.
And you're going to credit revenue for the same amount.
So I'm going to take the present value of the lease receivable,
plus the residual value guarantee and unguaranteed at the implicit rate in the lease,
remember in lessor has to use their implicit rate in the lease,
and we're going to credit revenue from the same amount.
And then I'm going to debit the carrying value the asset as cost of
sales and I'm going to derecognize the carrying value the asset.
I will not capitalize initial cost if the fair value is not equal to the carrying value.
So there's my profit or loss formula.
You don't really have to memorize this,
it's going to pop out when you do the journal entries.
But this is a formula that you would have that's in the standard. The discount rate.
Again, the number that causes the following equation to be true,
the present value and lease payments plus the present value the residual asset,
will be equal to the fair value of the underlying asset minus
any retained investment tax credits plus any deferred initial direct costs of the lessee.
We'll calculate a discount rate that will make that equation
equal and we will use that to calculate
the lease receivable and the investment in the lease.
So the lease receivable will be recognized in
the sales type lease and it will be testable for impairment.
Now, it's not going to be tested with a separate method in the leasing standard.
Instead, you're going to go and look at the financial instruments impairment literature.
There won't be a separate test here.
So this is going to be subject to what's called CECL,
the current expected credit loss model, starting in 2020.
Well, after the commencement date,
you're not going to remeasure that residual value that you've estimated upfront,
unless the lease is modified and that
modification is not accounted for as a separate contract.
Recall from the modifications,
that would be if there's not a new right of use asset provided with a commensurate rent.
What about impairment of the residual asset?
Well, the residual asset is accounted for as collateral during the lease term.
And you would look at it for sale or release after the lease term.
So the cash flows after the lease term are not considered when you do the impairment.
So that's the basics of lessor accounting when
the lease is accounted for as a sales type lease.
We'll do an example next.
John HeppClinical Assistant Professor of Accountancy
