Access the FASB’s Codification Research System at the FASB website (WWW.fasb.org
ID: 2516026 • Letter: A
Question
Access the FASB’s Codification Research System at the FASB website (WWW.fasb.org). Determine the specific citation for accounting for each of the following items:
Required:
1. Definition of initial direct costs.
2. When a modification to a contract is reported as a separate contract (that is, separate from the original contract).
3. The disclosures required in the notes to the financial statements for a lessor.
4. The classification criteria for when a lessee classifies a lease as a finance lease and a lessor classifies a lease as a sales-type lease.
Topic Subtopic Section Paragraph
Explanation / Answer
(1):- The financial accounting term initial direct cost is used to describe those costs that are directly associated with negotiating and completing a service agreement. Initial indirect costs consist of sales commissions, legal fees, creditworthiness checks, preparation of documentation, in addition to other costs that are incremental and directly attributable to the agreement.
Accounting for initial direct costs is a topic of particular importance to the leasing industry. International Accounting Standards 17 (Leases) states initial indirect costs incurred by lessors should be capitalized and amortized over the term of the agreement. In the past, lessors had the option to treat these costs as an expense.
(2) :- Parties to a contract frequently change the price and/or scope of the contract. These changes are referred to as contract modifications, amendments, variations, or change orders. Depending on the circumstances, these changes are accounted for either as a modification to the existing contract or as a separate contract. These changes and the associated accounting treatment may affect the timing of revenue.
The process for determining proper treatment for a contract modification includes three steps:
• Determine whether a change to a contract qualifies as a contract modification.
• Determine whether the modification should be treated as a separate, standalone contract or as a modification of the original contract. If the contract is a separate contract, the entity follows the five-step model to determine how to recognize revenue. If the modification is not treated as a separate contract, the entity continues to Step 3.
• Determine appropriate accounting treatment for contract modification not accounted for as a separate contract.
==>> A contract is considered separate when both of the following are true:
• The scope of the contract has increased with the addition of distinct goods or services.
• The price of the contract increases by an amount that is comparable to the entity’s standalone selling price of the additional goods or services (including any appropriate adjustments to reflect the circumstances of the particular contract in question).
(3) :- Disclosure Requirements of the Lessor
Sales-type, direct financing and operating leases require disclosure of a general description of the lessor’s leasing arrangements.
==>> Additionally, sales-type and direct financing leases require the lessor to disclose in Note 8:
• The components of the net investment in sales-type and direct financing leases as of each financial statement date:
-- Future minimum lease payments to be received less:
• Executory costs AND Accumulated allowance for uncollectible minimum lease payments receivable.
-- Unguaranteed residual values accruing to the lessor.
--- Initial direct costs (only for direct financing leases).
---- Related liability.
• Future minimum lease payments to be received for each of the five succeeding fiscal years
• Total contingent rentals included in the income statement for each period presented.
==>> Additionally, operating leases require the lessor to disclose in Note 8:
• The cost and carrying amount, if different, of property on lease or held for leasing by major classes of property, and the amount of accumulated depreciation in total.
• Minimum future rentals on noncancelable leases in the aggregate and for each of the five succeeding fiscal years.
• Total contingent rentals for each period presented.
(4):- A lessee shall classify a lease as a finance lease and a lessor shall classify a lease as a sales-type lease when the lease meets any of the following criteria:
a. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
b. The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
c. The lease term is for the major part of the remaining economic life of the underlying asset. However, if the commencement date falls at or near the end of the economic life of the underlying asset, this criterion shall not be used for purposes of classifying the lease.
d. The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments in accordance with paragraph 842-10-30-5(f) equals or exceeds substantially all of the fair value of the underlying asset.
e. The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.