Leases: Lessee Perspective (Portfolio 5117)

BNA Tax and Accounting Portfolio 5117, Leases: Lessee Perspective (Accounting Policy and Practice Series), explains and analyzes financial accounting for leases from the perspective of the lessee and explores the dynamics of the relationship between lessees and lessors with respect to the motivations behind leasing and the economic and financial reporting perspectives of leasing. 

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BNA Tax and Accounting Portfolio 5117, Leases: Lessee Perspective (Accounting Policy and Practice Series), explains and analyzes financial accounting for leases from the perspective of the lessee and explores the dynamics of the relationship between lessees and lessors with respect to the motivations behind leasing and the economic and financial reporting perspectives of leasing. The Portfolio explains in detail why lessees enter into leasing transactions. It also comprehensively discusses pricing considerations for lessees.
Definitions of leasing terms play an important part in classifying leases. From the lessee's point of view, the portfolio analyzes pertinent definitions from accounting, structuring, economic, and practical perspectives. Because, however, leases often involve complex customized contractual agreements among several parties, the lessee must analyze the specific facts and circumstances of the agreements before classifying the lease as a capital lease or as an operating lease. The Portfolio discusses in detail the lease classification tests and the rules for recording both operating and capital leases.
This Portfolio enhances the user's understanding of GAAP by explaining and interpreting specific circumstances embodied in the general definition and terminology used when classifying a lease. It considers the rationales underlying the positions of the Financial Accounting Standards Board (FASB).
Worksheet 1 provides a glossary defining significant terms and acronyms used in this Portfolio. The Worksheets also include examples of quantitative analyses that enter into leasing decisions and examples of how selected public companies have disclosed leasing transactions.
The second in a sub-series of portfolios on accounting for leases, this work augments APP 5114, Accounting for Leases: Fundamental Principles. Additional titles focus on sale-leaseback transactions, other special topics, and leasing from the lessor's perspective. The FASB and the International Accounting Standards Board (IASB) are collaborating to revise and converge their standards on Accounting for Leases. This Portfolio will be updated as necessary to reflect any new rules or principles. For a summary of the most recently proposed rules and their potential impact on lessee accounting, see APP 5114, Accounting for Leases: Fundamental Principles at Section I.D.
This Portfolio may be cited as BNA Tax and Accounting Portfolio 5117, Sebik & Starczewski, Leases: Lessee Perspective (Accounting Policy and Practice Series).


Joseph P. Sebik, B.A., Accounting, Queens College of the City University of New York (1977); graduate credits towards MBA; Controllership, St. Johns University; Certified Public Accountant, New York State (1980); member of the Accounting Committee of the Equipment Leasing Association (ELA) since 2000; recurring speaker at ELA Accounting Conferences; author of numerous articles on leasing; member of the AICPA; over 20 years of lease accounting and financial reporting experience with Price Waterhouse, IBM Credit Corporation, Citicorp Global Equipment Finance, JPMorgan Capital, Citi Bankers Leasing (a division of Citigroup Inc.), and ICON Capital Corp.

Lisa Marie Starczewski, J.D. (summa cum laude), Villanova University School of Law; B.A. (magna cum laude), Smith College. Ms. Starczewski served as Editor-in-Chief of the Villanova Law Review (1987–88) and has taught at the Villanova University School of Law. She practiced law with Morgan, Lewis & Bockius and Schnader, Harrison, Segal & Lewis. Ms. Starczewski has co-authored two other Accounting Policy and Practice Portfolios: 5101, Revenue Recognition: Fundamental Principles; and 5114, Accounting for Leases: Fundamental Principles. She has also authored numerous Tax Management Portfolios (also published by BNA), including 714 T.M., Partnerships—Allocation of Liabilities; Basis Rules; 565 T.M., Installment Sales; 752 T.M., Corporate Alternative Minimum Tax; 587 T.M., Noncorporate Alternative Minimum Tax; 503 T.M., Deductions: Overview and Conceptual Aspects; and 504 T.M., Deduction Limitations: General. She has received the Tax Management Distinguished Author Award and is a member of the Tax Management U.S. Income Advisory Board.


Detailed Analysis

I. Introduction, Scope, and Purposes of Portfolio


II. Reasons for Leasing From the Lessee's Perspective

A. Introduction

B. Statistics and Perspectives

C. Tax Management and Planning

1. Nature of Analysis

2. Tax Planning for Lessees

a. Effect of Net Operating Losses (NOLs) on Leasing Decision

b. Effect of Lessee's Alternative Minimum Tax Position on Decision to Lease

c. Effect of Tax Rate on Decision to Lease

d. Effect of Interest Deduction Limitations on Decision to Lease

D. Avoiding Risk of Asset Obsolescence

1. Technological Assets

2. Automobiles

3. Aircraft

E. Asset Management

F. Preservation of and Access to Capital

1. 100% Financing

2. Alternative Sources of Capital

a. Banks Outside of Lessee's Bank Group

b. Specialized Lenders

c. Insurance Company Long-Term Investors

d. Captive Leasing Companies

e. Independent Non-Bank Financing Companies

G. Lower Cost of Capital

1. Lessor's Tax Benefits

2. Percentage of Asset Value Financed

H. Financial Reporting

1. Operating Lease Benefit-Improved Financial Ratio

a. Internal Benefits

b. External Benefits

2. Smoothing of Asset-Related Expenses

3. Operating Versus Capital Budgets

4. Capital Lease Benefit

5. Manufacturing Companies

I. Type of Assets

1. Information Technology

2. Trucks and Tractor-Trailers

3. Aircraft

4. Construction Equipment

5. Railroad Cars and Locomotives

III. Pricing Considerations for Lessees

A. The Process

B. Items to Consider When Requesting and Analyzing Lease Proposals

1. In General

2. Measurement Rates and Methodologies

a. Lease Rate Factor

b. Running Rate

c. Lessee All-In Financing Rate or Internal Rate of Return

d. Pre-Tax Present Value of Payments

e. All-In Pre-Tax Present Value

f. After-Tax Net Present Value

3. Financial Reporting Treatment

4. Tax Treatment

5. Rent Structure

C. Buyout Options

1. In General

2. Single Investor Tax Leases

3. Tax Leveraged Leases

D. Detailed Asset Description

E. Tax In-Service Date

F. Residual Value Considerations

1. In General

a. Tax Nature of the Lease

b. Nature of the Market

2. Use of an Appraisal

a. In General

b. Valuation Approaches

i. Retail Value

ii. Wholesale Value

iii. Orderly Liquidation Value

iv. Distress Value

v. Go-Dark Value

vi. Inflated and Uninflated Values

c. Appraisal Methodologies

i. Cost Approach

ii. Income Approach

iii. Market Value Approach

G. Synthetic/Non-Tax Lease Pricing

1. Unique Considerations

2. Pricing Generally

3. Single Investor Synthetic Lease

4. Leveraged Synthetic Lease

H. Tax Lease Pricing

1. In General

a. Pricing Steps

b. Working Guidelines

2. Inputs for Tax Lease Pricing

3. Single Investor Tax Lease Pricing

4. Tax Leveraged Leases

a. Pricing Methodology

b. Parties Typically Involved in a Tax Leveraged Lease

c. Steps to Executing a Lease

5. TRAC Leases

a. In General

b. Scope

c. Mechanics of a TRAC Lease

d. Economics of a TRAC Lease

e. Types of TRACs

i. Full TRAC

ii. Modified or Split TRAC

f. Setting the TRAC Amount

g. Benefits of TRAC Leasing

I. Credit Tenant Leases

1. Background

2. Pricing Approach

3. Choosing Between a Credit Tenant Lease and a Tax Lease

J. Worksheet Examples

IV. Financial Accounting and Reporting: Lessee Perspective

A. Methodology, Scope, and Organization

B. Issues That Arise Prior to Classification of a Lease

1. In General

2. Nature of Assetâ€"Can the Asset Be Leased Under FAS 13?

a. In General

b. Software

c. Integral Equipment

d. Construction-in-Process

e. Pool of Similar Assets

f. Rotables or Lease Replacement Parts

g. Precious Metals

h. Limited Use Assets

3. Is the Transaction a "Lease" Subject to FAS 13?

a. In General

b. Determining Whether an Arrangement Contains a Lease-In General

c. Service Contracts That Involve Leasing

d. Software Arrangements That Include Leases

e. Multiple Element Arrangements

f. Leases to Exploit Natural Resources

g. Licensing Agreements

4. Nature of Lessor

C. Definitions

1. Inception of a Lease

a. In General

b. The Definition

c. Determining the Inception Date of the Lease

i. Basic Leasing Transactions

ii. Master Lease Agreements

iii. Build-to-Suit Transactions

d. Inception Date-Effect on Determining Lessee's Incremental Borrowing Rate

2. Fair Value of the Leased Property

a. In General

b. Timing of the Fair Value Determination

c. Use of Appraisals in Determining Fair Values

3. Related Parties in a Lease

a. In General

b. Effect of FIN 46R

c. Intercompany Leasing

4. Bargain Purchase Option

5. Bargain Renewal Option

6. Lease Term

7. Estimated Economic Life of Leased Property

8. Estimated Residual Value of Leased Property

9. Unguaranteed Residual Value

a. Definition

b. Summary Chart

10. Minimum Lease Payments

a. Variables

b. Summary Chart

c. Specific Items

11. Interest Rate Implicit in the Lease

12. Lessee's Incremental Borrowing Rate

13. Initial Direct Costs

14. Contingent Rentals

15. Penalty

a. Definition

b. Summary Chart

16. Other Definitions (Not in Accounting Literature)

a. Interim Rent or Stub Rent

b. Guaranteed Residual Value

c. Economic Compulsion

d. Base Lease Commencement Date

e. Rent Holiday

D. Classification of Leases

1. In General

2. Similarity to Tax Guidelines

3. Application of Classification Tests to Leases That Combine Multiple Assets

a. In General

b. Types of Assets Often Leased as a Group

i. Computer Installations

ii. Groups of Rail Freight Cars

iii. Groups of Trucks, Tractors, or Trailers

iv. Production Facility Equipment

v. Example of a Facility Lease With Varying Start Dates

E. Distinguishing Capital Leases From Operating Leases

1. Automatic Title Transfer Test

2. Bargain Purchase Option Test

a. In General

b. Non-Tax Leases

c. Tax Oriented Leases

d. Single Investor Leases

e. Tax Leveraged Leases

f. Use of Appraisers and Tax Professionals

3. Lease Term Test

4. 90% Present Value Test

a. In General

b. Calculation of "Minimum Lease Payments"

i. In General

ii. Effect of Non-Performance Related Default Covenants

iii. Investment Tax Credits

iv. When Is the 90% Test Performed?

c. Interest Rate Implications in the 90% Test

i. Determining Lessor's Implicit Interest Rate

ii. Effect of Lessee's Incremental Borrowing

iii. Determining the Incremental Borrowing Rate to Use

d. Determining the Fair Value

i. In General

ii. Sale-Leasebacks

iii. Constructed Assets

iv. Purchase Agreements for Assets With Fluctuating Value

F. Leases Involving Real Estate

V. Recording the Lease

A. Scope of Discussion

B. Capital Leases

1. General Accounting Treatment

2. Amortizing Recorded Amounts

3. Examples

C. Operating Leases

1. Nature of Recorded Amounts

2. Examples

D. Disclosure Requirements

1. FAS 13 Requirements

2. FIN 45 Disclosures

a. Fundamental Principle

b. Scope of Requirements

c. Methodology for Quantifying Exposure

d. Illustrations

3. SEC Disclosure Requirements

Working Papers



Worksheet 1 Glossary of Terms

Worksheet 2 Lease Versus Own Analysis

Worksheet 3 Pricing Models

Worksheet 4 Synthetic Leveraged Leases

Worksheet 5 Master Lease Agreement

Worksheet 6 Sample Term Sheet

Worksheet 7 Appraiser's Bargain Purchase Option Analysis

Worksheet 8 Appraiser's Sample Valuation Letter

Worksheet 9 Sample Residual Value Curves

Worksheet 10 IBM Global Financing Options Definitions

Worksheet 11 SEC Reporting Requirements

Worksheet 12 Lease Balance to Residual Curve Analysis

Worksheet 13 Accounting for Leases: General Disclosures

Worksheet 14 Sample Restatement Disclosures

Worksheet 15 Sample Public Company Disclosures




Internal Revenue Service

Securities and Exchange Commission

SEC Reports

Financial Accounting Standards Board

FASB Statements

FASB Interpretations

FASB Technical Bulletins

Emerging Issues Task Force

EITF Issues

American Institute of Certified Public Accountants

AICPA Statements of Position

AICPA Professional Standards

International Accounting Standards Board



Books, Articles, Speeches, and Letters

BNA Portfolios

Web Sites