GAP NO. 200.070
Plant & Equipment Lease Agreements

I.	General
II.	Lease Purchase Versus Lease Rental
III.	Capital Leasehold Improvements
IV.	Responsibilities
V.	Accounting Entries
	Print This GAP

I. GENERAL

Plant and equipment lease agreements are classified as either lease purchase agreements or lease rental agreements. Generally Accepted Accounting Principles and governmental regulations require that lease purchase agreements be recorded as if acquiring capital property. Lease rental agreements affect on future operations must be disclosed in the notes to the financial statements.

The purpose of this procedure is to define and distinguish between lease purchase and lease rental agreements, and to outline procedures for recording both types of transactions.

II. LEASE PURCHASE VERSUS LEASE RENTAL

Each lease agreement must be reviewed to determine if it is a true rental agreement or an agreement that transfers substantially all the benefits and risks of ownership of the property.

If, at the inception of a non-cancelable lease agreement, any of the four criteria listed below are met, then the lease should be classified as a lease purchase:

The lease transfers ownership of the property to the lessee at the end of the lease term.
The lease contains a bargain purchase option. A bargain purchase option is defined as a provision allowing the lessee to purchase the leased property for a price that is substantially lower than the expected fair value of the property at the date the option becomes exercisable.
The lease term is 75% or more of the estimated economic life of the leased property.
The present value of the minimum lease payments at the beginning of the lease term, excluding executory costs, equals or exceeds 90% of the fair value of the leased property.

Agreements, which meet any of the above criteria, will be considered a purchase of property equivalent to an installment purchase and recorded as a capital asset in the accounting records.

If the lease does not meet any of the above criteria, it is considered a lease rental agreement. The periodic payments, under the terms of the agreement, shall be recorded as rental expense.

Any lease which may be canceled at any time (with no more than nominal advance notification or the payment of no more than a nominal penalty) by either the lessor or lessee is considered a lease rental agreement.

III. CAPITAL LEASEHOLD IMPROVEMENTS

Leasehold improvements should be considered a capital purchase of property when:

The costs of such improvements amount to either 20% of the value of the property leased or $100,000, whichever is less, and
The lease is non-cancelable by either party for a period of at least five years or has renewal options which permit it to run for at least five years.

Leasehold improvements meeting this definition should be recorded as capital assets.

IV. RESPONSIBILITIES

A. PROCUREMENT SERVICES

The Procurement Services is responsible for:

Negotiating all lease agreements

Coordinating with Plant Accounting to determine classification as a lease rental or lease purchase agreement

Issuing the purchase order with the appropriate accounting charge code

Notifying Plant Accounting of any changes relating to an executed lease agreement

If a proposed lease is funded by a restricted WBS element and the lease extends beyond the term of the restricted WBS element, the requisition must be accompanied by a written statement from the department chairperson stating that unrestricted funds will be used to absorb the cost of the unexpired portion of the lease if the restricted WBS element is not renewed. The unrestricted cost center must be identified and the individual having budgetary responsibility for the code must concur; the additional expense will be substitutive rather than additive to any budget. All requisitions for leases using restricted WBS element must be authorized by the Office of Sponsored Programs prior to submission to Procurement Services.

B. PLANT ACCOUNTING

Plant Accounting is responsible for:

Coordinating with Procurement Services on appropriate classifications of lease agreements

Coordinating with Facilities Management personnel on appropriate classification of leasehold improvements

Maintaining records on capitalized leases and leasehold improvements

Preparing entries into both the Accounting and Plant Accounting systems recording each capital lease or leasehold improvement

Summarizing for the annual financial report the financial impact, by year, of future commitments on lease rental agreements on the operations of Duke

V. ACCOUNTING ENTRIES

The following describes the types of entries required to record lease transactions:

A. LEASE PURCHASE AGREEMENTS

1. INITIAL YEAR CAPITALIZATION
Record the value of the property as an asset and the related obligation as a liability. These should be recorded at the discounted amount of the future lease rental payments, excluding any payments to cover taxes and operational expenses other than depreciation.

To illustrate the calculation of the discounted amount of future lease rental payments, assume a lease with a term of ten years at $1,500 per year, with a stated interest rate of 8%. Refer to Exhibit A to obtain the present value factor of 6.7101. Multiply 6.7101 by $1,500 (the annual rental). The value obtained is $10,065.15 which represents the capitalized value of the asset.

G/L Account Debit Credit

17xxxx $10,065.15

259000 $10,065.15

The above illustration assumes the first payment on the lease is at the end of year one. If the first payment is at the beginning of year one, the factor is obtained by referring to Exhibit A, nine year lease term at 8%. Multiply the factor by the yearly rental and add $1,500 for year one:

(6.2469 X $1,500)=$9,370.35 + $1,500.00=$10,870.35.

2. PERIODIC PAYMENTS
Current Fund : Periodic payments on lease purchase agreements should be split between the amount representing interest (debit G/L account 695000, Interest Expense) and the amount representing the principal (debit G/L account 663900, Capitalized Lease Payments). Plant Accounting reviews all payments on lease purchase agreements periodically to ensure everything is recorded properly.

Example: Accounts charged for year one payment of $1500 per Exhibit B:

Cost Object G/L Account

1XXXXXX 695000 $805.21

1XXXXXX 663900 $694.79

A concurrent entry must be made to record the effect of the periodic payments on the long-term liability and net investment in plant.

G/L Account Debit Credit

259000 $694.79

292800 $694.79

3. PLANT ACCOUNTING SYSTEM
Plant Accounting will record lease purchase property in the Plant Accounting system records under the appropriate 66xxxx G/L account and depreciation class. The lease purchase property will be depreciated over the initial period of the lease rather than over estimated useful life.

When a capitalized lease terminates, if Duke does not receive title, the property should be deleted from the Plant Accounting system.

B. LEASE RENTAL AGREEMENTS

Periodic payments for lease rental agreements should be charged to the appropriate cost object using G/L account 693400, Equipment Rental, or 697200, Space Rental. Costs of leasehold improvements not considered capitalized assets should be charged to the appropriate cost object by debiting the appropriate 68xxxx G/L account (Maintenance and Repair Expense). No other entries are required for lease rental agreements.

C. LEASEHOLD IMPROVEMENTS

Leasehold improvements which should be capitalized require the following types of entries:

Record the capitalized improvements:

Debit G/L 17xxxx
Capitalized Assets and

Credit G/L 2928xx
Net Investment in Plant

Record the capitalized improvements in the Plant Accounting system under the appropriate 66xxxx G/L account.

Depreciate all capitalized leasehold improvements to both lease rental property and lease purchase property over the period of the lease.

When a lease associated with capitalized leasehold improvement terminates, if Duke does not receive title to the property, the value of the leasehold improvements should be deleted from the Plant Accounting system.

To make a copy of either of these items click on the item then click on the print button of your browser while viewing the item.

Exhibit A

Exhibit B