Leases

Under U.S. generally accepted accounting principles (GAAP), a lease conveys control over an identified asset's use for a period in exchange for consideration. Preparers interpret agreements, amendments, and operating instructions before calculating lease assets or liabilities.

A substitution right is substantive only when practical ability and economic benefit both exist throughout the use period. Contracts requiring customer consent for ordinary substitutions can therefore identify an asset despite broad replacement language elsewhere.

• When relevant decisions are predetermined, control can still exist if the customer operates the asset without supplier override.
• Alternatively, the customer may have designed the asset in a way that predetermined how and for what purpose it operates.
• Safety restrictions and protective operating limits do not, by themselves, give the supplier the right to direct use.
• Lease identification occurs at contract inception; recognition begins at commencement, when the asset becomes available for use.

A nonlease component transfers a distinct service or other good, such as maintenance accompanying equipment access.

Common mistakes

• Using collections as rental income. Merefield's receipt falls short of earned rent by $\$18{,}000-\$12{,}000=\$6{,}000$, creating an accrued rent receivable.
• Ignoring deferred selling profit. Applying the unadjusted rate gives $\$80{,}000\times10\%=\$8{,}000$, instead of $\$80{,}000\times21.9149541648\%=\$17{,}531.96$ under the effective yield.
• Capitalizing the service component. Discounting Bellmont's entire payment gives $\$53{,}240\times2.486851991=\$132{,}400$, overstating the liability by $\$132{,}400-\$99{,}300=\$33{,}100$.

Bottom line

• Lease identification requires an identified asset and customer control over its economic benefits and use.
• Any primary classification criterion establishes a finance lease for a lessee and ordinarily a sales-type lease for a lessor.
• Direct-financing classification requires the broader guaranteed-residual value test and probable collection after the primary criteria fail.
• Lessee liabilities discount unpaid lease payments; ROU assets separately reflect prepayments, qualifying initial direct costs, and incentives.

Exam shortcut

Read executed terms and amendments before valuation schedules. Mark the commencement date, payment dates, option controller, guarantor, and component election. Run the five primary criteria first. For a lessor, check the variable-payment loss exception and then the direct-financing conditions where relevant; assess recognition separately. Put every cash flow on its payment date. A commencement payment belongs outside the remaining liability, and an unguaranteed residual belongs outside the lessee's obligations.

The full lesson (about 9,684 words, 65 min read) adds 16 worked examples, all 6 common mistakes, a self-check, free in the app.

Learning objectives

• II.I1

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