Question 15-15

Lease disclosure requirements are quite extensive for both the lessor and lessee. Virtually all aspects of the lease agreement must be disclosed. For all leases (a) a general description of the leasing arrangement is required as well as (b) minimum future payments, in the aggregate and for each of the five succeeding fiscal years. Other required disclosures are specific to the type of lease and include: residual values, contingent rentals, sublease rentals, and executory costs.

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Question 15-16

On the surface there are two separate transactions. But the seller/lessee still retains the use of the asset that it had prior to the sale-leaseback. In reality the seller/lessee has cash from the sale and a noncancelable obligation to repay a debt. In substance, the seller/lessee simply has borrowed cash to be repaid with interest over the lease term. So “substance over form” dictates that the gain on the sale of the asset not be immediately recognized, but deferred and recognized over the term of the lease. There typically is interdependency between the lease terms and the price at which the asset is sold. So the earnings process is not complete at the time of sale but is completed over the term of the lease. Viewing the sale and the leaseback as a single transaction is consistent with the revenue realization principle.

Question 15-17

The FASB specified exceptions to the general classification criteria for leases that involve land because of the unlimited useful life of land and the inexhaustibility of its inherent value through use. When title passes to the lessee – through automatic title passage or bargain purchase – these leases clearly arecapitalin nature and should be classified as such by the lessee. However, the Board felt that there would be difficulty in applying the other two criteria. Because land has essentially an infinite life, no lease term could possibly exceed 75 percent of its useful life, and the criterion was not applicable. The fourth criterion calls for comparing the present value of the lease payments with 90 percent of the property's fair value to determine if the lessor will recover its investment through the payments. When land is involved, the Board felt that the lease was not intended to recover the lessor's investment. Further, the lessor would have the land at the end of the lease term in essentially the same condition. Accordingly, the FASB concluded that leases involving material amounts of land should be classified as operating leases unless title passes automatically or as the result of a bargain purchase option.

Question 15-18

The guidelines for determining when a material amount of land is involved in a lease indicate that leases involving property where land constitutes 25 percent or more of the total value should be treated as if they aretwoleases. The portion of the lease attributable to the land should be treated as an operating lease while the portion attributable to the other property should be judged on its own characteristics and accounted for accordingly. If the land value is less than 25 percent of the total value of the property, no allocation needs to be made.

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