CLFP Tax & Accounting in Leasing 2 — Questions and Answers
Question 1: Under ASC 842, what are the five criteria that would classify a lessee's lease as a finance lease?
- Transfer of ownership, purchase option likely to exercise, lease term covers major part of useful life, PV of payments equals substantially all fair value, or specialized asset with no alternative use (Correct answer)
- Payments are fixed, equipment is tangible, lease is 12+ months, lessee is a public company, and there is a guaranty
- Written agreement exists, equipment is capitalized, rate is disclosed, payments are monthly, and there is a residual
- Fair market value option exists, equipment is moveable, term is under 5 years, lessee has good credit, and UCC is filed
Correct answer: Transfer of ownership, purchase option likely to exercise, lease term covers major part of useful life, PV of payments equals substantially all fair value, or specialized asset with no alternative use
Under ASC 842, any one of these five bright-line tests (ownership transfer, bargain purchase option, major economic life, substantially all fair value, or specialized asset) triggers finance lease classification.
Question 2: What is 'operating lease' income recognition for a lessor under ASC 842?
- Straight-line rent income over the lease term, with the leased asset remaining on the lessor's balance sheet and depreciated (Correct answer)
- Interest income calculated using the effective interest method
- Front-loaded income recognized at lease inception
- Recognized only upon equipment return and sale
Correct answer: Straight-line rent income over the lease term, with the leased asset remaining on the lessor's balance sheet and depreciated
For lessor operating leases under ASC 842, rental income is recognized on a straight-line basis over the lease term, and the underlying asset stays on the lessor's books and continues to be depreciated.
Question 3: What is 'sale-leaseback' and what accounting issues does it raise?
- A transaction where the owner sells an asset and immediately leases it back from the buyer, raising questions about whether a true sale occurred (Correct answer)
- A method of financing equipment by selling receivables to a bank
- A government program allowing asset recycling for public entities
- A way to finance two pieces of equipment with one agreement
Correct answer: A transaction where the owner sells an asset and immediately leases it back from the buyer, raising questions about whether a true sale occurred
In a sale-leaseback, the seller/lessee monetizes equity in an asset while retaining use; ASC 842 requires analysis of whether control was truly transferred to determine sale recognition.
Question 4: What is 'income from continuing involvement' in the context of a leveraged lease?
- The lessor's equity earnings recognized using the net investment method over the lease term, allocating income to periods of positive net investment (Correct answer)
- Rental income earned after the initial lease term ends
- Profit from selling equipment at lease termination
- Income from servicing fees on sold lease portfolios
Correct answer: The lessor's equity earnings recognized using the net investment method over the lease term, allocating income to periods of positive net investment
Under leveraged lease accounting (now legacy under ASC 842 for new leases), income is recognized in proportion to the net investment's positive balance, creating front-loaded losses and later income.
Question 5: What is the 'alternative minimum tax' (AMT) concern historically related to equipment leasing tax benefits?
- Accelerated MACRS depreciation and other tax preference items could trigger AMT, reducing the after-tax benefit of tax-oriented leases for corporate lessors (Correct answer)
- Lessees with AMT exposure cannot deduct lease payments
- AMT applies a flat tax rate on all lease income
- AMT eliminated bonus depreciation for all entities
Correct answer: Accelerated MACRS depreciation and other tax preference items could trigger AMT, reducing the after-tax benefit of tax-oriented leases for corporate lessors
The corporate AMT added back tax preferences like accelerated depreciation, reducing the effective tax benefit of leveraged leases and impacting the economics of tax-oriented lease transactions.
Question 6: What does 'unguaranteed residual value' mean for a lessor under ASC 842?
- The portion of the equipment's residual value that is not guaranteed by the lessee or a third party, which remains a risk to the lessor (Correct answer)
- The total residual value of all returned equipment
- Residual value covered by the vendor's buyback agreement
- The depreciation-adjusted book value of the equipment
Correct answer: The portion of the equipment's residual value that is not guaranteed by the lessee or a third party, which remains a risk to the lessor
The unguaranteed residual represents the lessor's retained risk—if the equipment is worth less than this amount at lease end, the lessor absorbs that loss.
CLFP Tax & Accounting in Leasing 2
Under ASC 842, what are the five criteria that would classify a lessee's lease as a finance lease?