Accounting for Leases: Fundamental Principles (Portfolio 5114)

BNA Tax and Accounting Portfolio 5114-2nd, Accounting for Leases: Fundamental Principles (Accounting Policy and Practice Series), is the first in a three-part series on Accounting for Leases.

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BNA Tax and Accounting Portfolio 5114-2nd, Accounting for Leases: Fundamental Principles (Accounting Policy and Practice Series), is the first in a three-part series on Accounting for Leases. This Portfolio surveys the complex lease accounting rules which affect both lessees and lessors. The Portfolio discusses the background of lease accounting and financial reporting rules, short and long-term lease accounting trends, and the current state of the lease accounting rules.
Generally Accepted Accounting Principles (GAAP) classify leases and prescribe accounting and disclosure requirements depending on a lease's classification. Leases must be classified from both the lessors and lessees perspective under overlapping but not completely symmetrical definitions. Definitions and terminology also may differ depending on how a lease is structured. This portfolio surveys the distinctly different accounting treatments followed by lessees and lessors, and how the accounting treatment provides substantially different reporting results, often as a result of minor structural changes in a lease.
Headline investigations of accounting improprieties at Enron Corporation and other companies revealed that some companies had exploited GAAP for leasing to achieve suspect “off-balance sheet” results. Policymakers reacted to these incidents by attempting to fix perceived problems in the rules. This Portfolio explains the nature of the changes that have occurred and how they have affected the structuring of complex leasing transactions. The Portfolio also addresses the nature of the changes to the guidelines that affect the structuring of more complex leasing transactions as a result of policymakers post-Enron attempt to fix the perceived problems associated with any off-balance sheet activity.
The Portfolio provides an overview of the disclosure requirements applicable to both lessees and lessors and includes sample disclosures. It may be cited as BNA Tax and Accounting Portfolio 5114-2nd, Sebik and Starczewski, Accounting for Leases: Fundamental Principles (Accounting Policy and Practice Series).


Joseph P. Sebik, C.P.A.

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, and Citi Bankers Leasing (a division of Citigroup Inc.).

Lisa Marie Starczewski, Esq.

Lisa Marie Starczewski, B.A., Smith College (magna cum laude, 1985); Villanova University School of Law, J.D. (summa cum laude, 1988); former associate, Morgan, Lewis & Bockius; Schnader, Harrison, Segal & Lewis; Editor-in-Chief, Villanova Law Review (1987-88); member of adjunct faculty, Villanova University School of Law; Author, 714 T.M., Partnerships - Allocation of Liabilities; Basis Rules; 550 T.M., At-Risk Rules; 565 T.M., Installment Sales; 752 T.M., Corporate Alternative Minimum Tax; 587 T.M., Noncorporate Alternative Minimum Tax; 621 T.M., IRS National Office Procedures - Rulings, Closing Agreements; Co-Author, 517 T.M., Scholarships and Educational Expenses; 503 T.M., Deductions: Overview and Conceptual Aspects; and 504 T.M., Deduction Limitations: General; author of several chapters in the Tax Practice Series and contributor to various tax publications; recipient of Distinguished Author award; Member, Tax Management U.S. Income Advisory Board.

Table of Contents

Detailed Analysis

I. Introduction and Perspectives

A. Nature and Significance of Leasing

B. Continuing Evolution of Lease Accounting Rules

C. Focus of Portfolio

D. Recent Developments and the Future

E. Scope of Portfolio

II. Current State of Lease Accounting

Introductory Material

A. Basic Economics of Leasing

B. The Development of Lease Accounting Rules

C. Market Responses to Foundational Accounting and Tax Rules

D. The "Spark of Change"

E. The Effect of Accounting Scandals and Sarbanes-Oxley on Lease Structures

1. In General

2. Sarbanes-Oxley

a. Mandatory Certification of Financial Statements

b. Creation of the Public Company Accounting Oversight Board

c. Mandatory Disclosure of Off-Balance Sheet Transactions

d. Summary

3. 2005 SEC Reports Mandated by Sarbanes-Oxley

F. Transparency and Consistency

1. In General

2. The "Off-Balance Sheet" Issue

a. Background

b. Common Misconceptions

c. Bright Line Rules

G. Lease Accounting Trends

1. Short-Term Trends

a. Diminished Demand for Large, Structured Synthetic Leases

b. Elimination of LILOs and SILOs

c. Cooperation and Conservatism Among "Big 4" Accounting Firms

d. Economic Justification, Appropriateness, and Disclosures

e. Structural Changes

f. Reevaluation of Selected Practices

(1) Real Estate Rent Holidays During Construction Periods

(2) Build-to-Suit (Lessor)

(3) Residual Value Insurance on Multiple Assets

2. Long-Term Trends

a. Synchronizing U.S. GAAP and International Accounting Standards

b. The "New Approach" to Lease Accounting

III. Definition and Classification of Leases

Introductory Material

A. Summary and Overview

B. Characterization of Leases - Commercial Law

C. Characterization of Leases - Tax Law

1. In General

2. Leveraged Leases

3. TRAC Leases

4. Conditional Sale

5. First Amendment Lease

D. Classification of Leases - Accounting

1. In General

2. Accounting Classifications Summarized

3. "Leases" Subject to FAS 13

a. Definition of "Lease" in FAS 13

b. Determining When an Arrangement Contains a Lease Subject to FAS 13

c. Software Arrangements That Include Leases

E. Definition of Terms

1. Related Parties

2. Inception of a Lease

3. Fair Value of the Leased Property

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

10. Minimum Lease Payments

11. Interest Rate Implicit in the Lease

12. Lessee's Incremental Borrowing Rate

13. Initial Direct Costs

14. Contingent Rentals

15. Penalty

F. FAS 13 Classification Tests

1. Classification by the Lessee

2. Classification by the Lessor

a. In General

b. Sales-Type Leases

c. Direct Financing Leases

d. Leveraged Leases

e. Operating Leases

f. Summary of Lessor Classification Rules

G. Leases Involving Real Estate

H. Leases Between Related Parties

I. Sale/Assignment of Lease or Leased Property to Third Party

J. Effect of Lease Changes on Classification

IV. Structures of Leases

Introductory Material

A. In General

B. Single Investor Structure

1. Description

2. Examples

C. Participation

D. Tranched Participation

E. Syndication

F. Underwritten Lease Transaction

G. Best-Efforts Participation or Syndication

H. Club Syndication

I. Leveraged Lease

J. Credit-Tenant Leases

K. Synthetic Leases

1. Description

2. Example

L. Use of SPEs in Lease Structures

1. In General

2. FIN 46R - The Basics

3. General Effect of FIN 46R on Leasing

M. Considerations Related to Terms and Conditions

1. General Descriptions of Assets Subject to Lease

2. Lease Versus Service Contract

3. Hell and High-Water Clause

4. Right to Quiet Enjoyment

5. Maintenance Conditions

6. Asset Upgrades and Improvements

7. Asset Substitutions

8. Cancellation for Obsolescence

9. All-or-None Return Conditions

V. Accounting for Leases From the Lessee's Perspective

A. In General

B. Capital Leases

1. General Accounting Treatment

2. Examples

3. Specific Reporting Requirements

4. Effect of Changes in the Lease Provisions

C. Operating Lease

1. General Accounting Treatment

2. Examples

D. Disclosure Requirements

1. In General

2. FIN 45 Disclosure Requirements

VI. Accounting for Leases From the Lessor's Perspective

A. In General

B. Operating Lease

C. Direct Financing Lease

D. Sales-Type Lease

1. In General

2. General Accounting Treatment

3. Amendments, Renewals, and Extensions of Sales-Type Leases

E. Leveraged Lease

1. In General

2. General Accounting Treatment

F. Disclosure Requirements

Working Papers

Working Papers


Worksheet 1 Principal Acronyms Used in This Portfolio

Worksheet 2 Hierarchy of U.S. Generally Accepted Accounting Principles

Worksheet 3 Context of Lease Accounting Rules in the GAAP and GAAS

Worksheet 4 Definition - Off-Balance Sheet

Worksheet 5 Summary of Differences - IAS vs. U.S. GAAP Lease Accounting

Worksheet 6 Sample - Master Lease Purchase Agreement

Worksheet 7 Sample - Synthetic Lease

Worksheet 8 IBM Global Finance Lease Offerings

Worksheet 9 Sample Residual Value Curve for Rail Cars

Worksheet 10 Sample Disclosures of Accounting for Leases By Selected Public Companies

Worksheet 11 FSP 13-2 AMENDMENTS OF FAS 13

Worksheet 12 List of Significant Accounting Pronouncements Principally Discussed



American Institute of Public Accountants:

Financial Accounting Standards Board:

Emerging Issues Task Force:

International Accounting Standards

Accounting Textbooks, Handbooks, Articles, and Speeches: