Lease Paper 6

(b) Sale-leaseback transactions are treated as though two transactions were a single financing transaction, if the lease qualifies as a capital lease. Any gain on the sale is deferred and amortized over the lease term (if possession reverts to the lessor) or the economic life (if ownership transfers to the lessee); both are ten years in this case. Since this is a capital lease, the entire gain ($150,000 – $100,000 = $50,000) is deferred at 1/1/Y1. At 12/31/Y1, an adjusting entry must be prepared to amortize 1/10 of the unearned gain (1/10 × $50,000 = $5,000), because the lease covers ten years. Therefore, the unearned gain at 12/31/Y1 is $45,000 ($50,000 – $5,000).

(b) Any profit related to a sale-leaseback transaction in which the seller-lessee retains the property leased (i.e., the sellerlessee retains substantially all of the benefits and risks of the ownership of the property sold), shall be deferred and amortized in proportion to the amortization of the leased asset, if a capital lease. If it is an operating lease, the profit will be deferred in proportion to the related gross rental charged to expense over the lease term. It is important to note that losses, however, are recognized immediately for either a capital or operating lease. Since the gain on the sale should be deferred in either case, no gain is recognized at the time of the sale. NOTE: An example of an operating lease in which substantially all of the remaining use of the leased asset is retained by the lessee occurs when the lease term begins within the last 25% of the asset’s original useful life.

(d) In a sale-leaseback transaction, if the leaseback is recorded as a capital lease and the lessee has retained substantially all of the rights to use the property, then any gain on the sale must be deferred and amortized over the life of the property in proportion to the amortization of the leased asset. This deferred gain acts as an asset valuation allowance resulting in the net amount shown for the leased asset being equal to the same carrying value as if the sale and leaseback transaction had not occurred.

(a) A termination of an operating lease requires that the fair value of the termination costs be recognized as an expense or loss in calculating income from continuing operations in the year the lease was terminated.

(b) A modification to a capital lease that changes the classification of the lease to an operating lease requires the transaction be accounted for as a sales-leaseback transaction. Since Hopper retains substantially all rights to use the property (and the property is not within the last 25% of its useful life), the gain will be deferred and recognized over the remaining lease term. 56. (c) A loss on a capital lease termination is recognized immediately as a loss from continuing operations.

(c) A loss on a capital lease termination is recognized immediately as a loss from continuing operations.

(c) The requirement is to identify how the lease should be classified. Answer (c) is correct because IFRS requires a lease to be classified as a finance lease if substantially all the risks or benefits of ownership have been transferred to the lessee. Because the lease contains a bargain purchase option, it meets the criteria for a finance lease. Answer (a) is incorrect because the lease does not qualify as an operating lease since the risks and benefits of ownership have been transferred. Answer (b) is incorrect because US GAAP uses the term “capital lease,” whereas IFRS uses the term “finance lease.” Answer (d) is incorrect because IFRS does not use the term “sales-type lease.”

(c) The requirement is to identify how Santiago should account for the lease. Answer (c) is correct because IFRS provides that because land has an indefinite life, if title is not expected to pass by the end of the lease term, then the substantial risks and rewards of ownership do not transfer. Thus, the lease should be separated into two components. The land should be recorded as an operating lease and the building should be recorded as a finance lease.

(d) The requirement is to identify the incorrect statement regarding lease accounting under IFRS. Answer (d) is correct because IFRS does not use the same thresholds as US GAAP. IFRS standards require more judgment

(d) The requirement is to identify the rate used to capitalize a finance lease when the implicit rate cannot be determined. Answer (d) is correct because the lessee’s incremental borrowing rate is used.