Administrative Procedure 8.635 Administrative Procedure 8.635

Accounting For Leases

Administrative Procedure Chapter 8, Business and Finance
Administrative Procedure AP 8.635, Accounting for Leases
Effective Date:  March 2017
Prior Dates Amended:  This Administrative Procedure updates A8.635, Installment Contracts – Recording Assets and Liabilities, May 1997, May 1991    
Responsible Office: Office of the Vice President for Budget and Finance/Chief Financial Officer
Governing Board and/or Executive Policy: EP 1.102, Authority to Manage and Control the Operations of the Campus  
Review Date:  March 2020

To provide guidance on the appropriate accounting treatment for capital (financing) leases and operating leases when the University is the lessee.

A.  Lease – A Lease is a contractual agreement calling for the lessee (user) to pay the lessor (owner) for the use of an asset.  Property, buildings, business or industrial equipment and vehicles are common assets that are leased.

B.  Operating Lease – An Operating Lease is a Lease whose term is short compared to the useful life of the asset being leased.

C.  Capital Lease – A Capital Lease is a type of Lease in which a finance company is typically the legal owner of the asset during the duration of the Lease, while the lessee not just has operating control over the asset, but also has a substantial share of the economic risks and returns from the change in the valuation of the underlying asset.  A Lease is considered to be a Capital Lease if one or more of the following criteria is met:

    -  The Lease transfers ownership of the property to the lessee by the end of the Lease Term

    -  The Lease contains a Bargain Purchase Option

    -  The Lease Term is equal to 75% or more of the estimated economic life of the leased property.  However, if the beginning of the Lease Term falls within the last 25% of the total estimated economic life of the leased property including earlier years of use, this criterion shall not be used for purposes of classifying the Lease.Residual Value of Leased Asset

    -  The present value of the Minimum Lease Payments, excluding that portion of the payments representing executory costs such as insurance, maintenance, and taxes to be paid by the lessor, including any profit thereon, equals or exceeds 90% of the excess of the Fair Value of the Leased Property to the lessor.

D.  Bargain Purchase Option – A provision allowing the lessee, at his option, to purchase the leased property for a price which is sufficiently lower than the expected fair (market) value of the property at the date the option becomes exercisable, that exercise of the option appears, at the inception of the Lease, to be reasonably assured.

E.  Residual Value of Leased Asset – The estimated fair (market) value of the leased (asset) at the end of the Lease Term.

F.  Fair (Market) Value of the Leased Property – The price for which the property could be sold in an arm’s length transaction between unrelated parties.

G.  Interest Rate Implicit in the Lease – This is the discount rate that, when applied to the Minimum Lease Payments and any unguaranteed residual value accruing to the lessor, causes the aggregate present value to equal the Fair Value of the Leased Property to the lessor. 

H.  Lease Term – The fixed term of the Lease in months.

I.  Lessee’s Incremental Borrowing Rate – This is the rate that, at the inception of the Lease, the lessee would have incurred to borrow over a similar term the funds necessary to purchase the leased asset.

J.  Minimum Lease Payments – From the standpoint of the lessee:  The payments that the lessee is obligated to make or can be required to make in connection with the leased property.  However, a guarantee by the lessee of the lessor’s debt and the lessee’s obligation to pay (apart from the rental payments) executory costs such as insurance, maintenance, and taxes in connection with the leased property shall be excluded.  If the Lease contains a Bargain Purchase Option, only the minimum rental payments over the Lease Term and the payment called for by the Bargain Purchase Option shall be included in the Minimum Lease Payments.  Otherwise, Minimum Lease Payments include the following:

    -  The minimum rental payments over the Lease Term

    -  Any guarantee by the lessee of the Residual Value of the Leased Asset at the expiration of the Lease Term, whether or not payment of the guarantee constitutes a purchase of the leased property

    -  Any payment for failure to renew or extend the Lease at the expiration of the Lease Term

Fiscal Administrators (FA) are responsible for analyzing Lease agreements and determining whether the Lease is an Operating Lease or a Capital Lease.

A.  Operating Lease

    The Operating Lease covers the rental of an asset from a lessor.  The asset is not recorded on the University’s balance sheet and monthly payments are recorded as rental expense.

    Lease rent payments should be coded using appropriate object codes:

    5600  RENT – EQUIPMENT OTHER
    5605  RENT – EQUIP, DATA PROCESSING
    5610  RENT – EQUIP, OTHER OFF

B.  Capital Lease

    The accounting for a Capital Lease involves recording the acquisition of the asset and the recording of the corresponding Lease payment obligation on the University’s balance sheet.

    1.  The lessee shall record a Capital Lease as an asset and an obligation at an amount equal to the present value of the Minimum Lease Payments using his incremental borrowing rate, unless it is practicable for him to learn the Interest Rate Implicit in the Lease and the implicit rate is less than the Lessee’s Incremental Borrowing Rate.  However, if the amount exceeds the Fair Value of the Leased Property at the inception of the Lease, the amount recorded as the asset and obligation shall be the fair value.

    2.  The capitalized leased asset should be amortized over the term of the Lease if the term is shorter than the useful life of the asset, unless the Lease provided for transfer of title or includes a Bargain Purchase Option.

    3.  During the term of the Lease, each minimum Lease payment shall be allocated between a reduction of the obligation and interest expense so as to produce a constant periodic rate of interest on the remaining balance of the Lease obligation.

  4.  When leasing land, the Lease is classified as an Operating Lease unless it provides for transfer of title or includes a Bargain Purchase Option.

  5.  FA responsibilities:

      a.  Process monthly Lease payments

          (1)  For principal portion use:  5606  RENT-INSTALLMENT CONTR PAY
          (2)  For Interest portion use:  6201  INTEREST, INSTALLMENT PAY

      b.  Information that needs to be communicated to Capital Asset Accounting:

          (1)  Chart Code
          (2)  Account Number
          (3)  Purchase Order Number
          (4)  Amortization Schedule
          (5)  Vendor
          (6)  Manufacturer
          (7)  Model Number
          (8)  Serial Number
          (9)  Location (building and room number)
          (10)  In-service Date
          (11)  Copy of the Lease Agreement

    6.  Capital Asset Accounting Responsibilities:

      a.  Create the general ledger account (fund group 54) in the appropriate chart code

      b.  Add the liability to the general ledger account created above

          (1)  Debit: 1740  FX INSTALL CONTR-LIABILITY
          (2)  Credit: 9602  CAPITAL LEASE

      c.  Create the asset

          (1)  Create the asset in the capital asset management module in the KFS
          (2)  Assign an asset tag
          (3)  Complete a journal entry to record the asset

              Debit:  8940  EQUIPMENT
              Credit:  1643  FX INSTALL CONTR-ASSET

      d.  Record the principal payments to reduce the liability

          (1)  Debit:  9602  CAPITAL LEASE
          (2)  Credit: 1623  RETIRE OF INDEB, INSTAL CONTR

There is no administrative specific delegation of authority.

    
General Accounting, 956-8278 or 956-7516, or uhgalc@hawaii.edu
Website:  http://www.fmo.hawaii.edu/general_accounting/index.html

-  Link to superseded Executive Policies in old format https://www.hawaii.edu/policy/archives/ep/
-  Link to Administrative Procedures in old format https://www.hawaii.edu/policy/archives/apm/sysap.php

None

    Vice President for Budget and Finance/Chief Financial Officer