Lease Accounting: Residual Value, Guarantees, Bargain Purchase Options, and Related Concepts

A set of Q&A flashcards covering residual value, guarantees (guaranteed vs unguaranteed), how they affect lessor and lessee calculations, lease classification criteria, bargain purchase options, termination penalties, leasehold improvements, and related journal entries.

What is residual value (salvage value) in a lease context?

The amount the lessor expects to recover from the asset at the end of the lease term; the asset’s end-of-life value.

Can residual value be guaranteed or unguaranteed by the lessee, and what does that mean?

Yes. A guaranteed residual means the lessee guarantees the asset will be worth at least that amount; an unguaranteed residual means no such guarantee.

From the lessor's perspective, how does a guaranteed residual value affect the 'amount to be recovered' and the lease payments?

A guaranteed residual reduces the 'amount to be recovered' by the present value of the residual, leading to lower lease payments.

What is the 'amount to be recovered' in the lessor's lease payment calculation?

The total amount the lessor expects to recover over the lease term before considering the residual value; reduced by the present value of the expected residual value.

Do guaranteed or unguaranteed residual values affect the lessee's initial PV of lease payments?

Generally no; the PV of lease payments is based on the cash payments. An exception occurs if there is an expected cash payment (e.g., guaranteed residual cash) at end or upon termination.

What is the 75% rule for lease classification?

If the lease term is at least 75% of the asset's useful life, classify as a finance lease (lessee) / sales-type lease (lessor); otherwise it is usually an operating lease.

What is a bargain purchase option and its effect on classification?

An option to buy at a price significantly below expected fair value makes the lease a finance lease for the lessee and a sales-type lease for the lessor; affects lease payments via the present value of the exercise price.

How is a bargain purchase option treated in the lessor's lease payment calculation?

Subtract the present value of the exercise price from the amount to be recovered when determining lease payments.

How is a bargain purchase option treated in the lessee's lease payment calculation?

Add the present value of the exercise price to the ROU asset and to lease payable.

What is the effect of a guaranteed purchase option or termination penalties on payments?

These are additional cash payments to be considered similarly to the exercise price; they can increase the 'amount to be recovered' if expected.

What are leasehold improvements?

Improvements paid by the lessee to the leased asset; recorded as an asset (leasehold improvements) on the lessee's balance sheet and depreciated over the lease term or asset’s useful life; returned to the lessor at end of lease.

How are indirect costs and prepaid items treated in leases for accounting?

If part of lease payments, indirect costs are included in the lease payments; lessee adds to ROU asset; lessor records deferred rent revenue and allocates over the term.

What is the lessee's initial journal entry for a lease (ROU)?

Record a right-of-use (ROU) asset and a lease liability equal to the present value of lease payments.

What is the lessor's initial entry for a finance/sales-type lease?

Derecognize the leased asset and recognize a lease receivable; may record a residual asset separately depending on specifics.

What happens to the PV of the residual value in the lessor's calculation?

PV of the residual value reduces the amount to be recovered and may appear as a residual asset; in practice often integrated into the lease receivable.

From the lessee's perspective, when would the PV of guaranteed residual or cash be added to the ROU asset?

Only if a cash payment is expected at end or due to guarantee; otherwise it does not affect initial measurement.

How does a lease term end when a bargain purchase option exists?

The lease term ends on the day the option is expected to be exercised; the ROU asset is amortized over the expected useful life or term, with the exercise price treated as an additional cash payment.

What is the general treatment of termination penalties in lease calculations?

If termination is reasonably certain, penalties are treated as an additional cash payment and included in the 'amount to be recovered' similarly to a bargain purchase option.

What are indirect costs and prepaid items in the context of lease payments for accounting?

If included in lease payments, indirect costs go to the lessee's ROU asset and to the lessor's deferred rent revenue; prepaid items are handled similarly depending on whether the lease is operating, finance, or sales type.

Why are leasehold improvements relevant in lease accounting?

They are improvements made by the lessee to the leased asset, recorded as an asset and depreciated; returned to the lessor at the end of the lease.