CH 21

kieso
weygandt
warfield
INTERMEDIATE team for success
F I F T E E N T H E D I T I O N
Intermediat
Intermediat
ACCOUNTING
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Accounting
Accounting
Prepared by
Coby Harmon
Prepared by
University of California,
CobySanta
HarmonBarbaraPrepared by
Westmont
University College SantaCoby
of California, Harmon
Barbara
University of California, Santa Barbara
21-1 Westmont College
PREVIEW OF CHAPTER 21
Intermediate Accounting
15th Edition
Kieso Weygandt Warfield
21-2
21 Accounting for Leases
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Explain the nature, economic substance, 5. Describe the lessor’s accounting for direct-
and advantages of lease transactions. financing leases.
2. Describe the accounting criteria and 6. Identify special features of lease
procedures for capitalizing leases by the arrangements that cause unique accounting
lessee. problems.
3. Contrast the operating and capitalization 7. Describe the effect of residual values,
methods of recording leases. guaranteed and unguaranteed, on lease
accounting.
4. Explain the advantages and economics of
leasing to lessors and identify the 8. Describe the lessor’s accounting for sales-
classifications of leases for the lessor. type leases.
9. List the disclosure requirements for leases.
21-3
Investment in Debt Securities
Different motivations for investing:

 To earn a high rate of return.
 To secure certain operating or financing arrangements

with another company.
21-4 LO 1
The Leasing Environment
A lease is a contractual agreement between a lessor and a

lessee, that gives the lessee the right to use specific property,
owned by the lessor, for a specified period of time.
Largest group of leased equipment involves:

 Information technology equipment
 Transportation (trucks, aircraft, rail)
 Construction
 Agriculture
21-5 LO 1
The Leasing Environment Illustration 21-2
What Do Companies
Lease?
21-6 LO 1
Who Are the Players? Captive

Leasing
Banks Independents Companies
► Wells Fargo ► International ► Caterpillar
► Chase
Lease Finance Financial
Corp. Services Corp.
► Citigroup
► Ford Motor
► PNC Credit (Ford)
23% ► IBM Global

Financing
47% Market Share 26%
21-7 LO 1
Advantages of Leasing
1. 100% financing at fixed rates.
2. Protection against obsolescence.
3. Flexibility.
4. Less costly financing.
5. Tax advantages.
6. Off-balance-sheet
financing.
21-8 LO 1
21-9 LO 1
Conceptual Nature of a Lease

Capitalize a lease that transfers substantially all of the
benefits and risks of property ownership, provided the
lease is noncancelable.
Leases that do not transfer

substantially all the benefits
and risks of ownership are
operating leases.
21-10 LO 1
LEARNING OBJECTIVES
lessee. problems.
accounting.
21-11
Accounting by the Lessee
If the lessee capitalizes a lease, the lessee records an asset

and a liability generally equal to the present value of the rental
payments.
 Records depreciation on the leased asset.
 Treats the lease payments as consisting of interest and
principal.
Journal Entries for Capitalized Lease Illustration 21-2
21-12 LO 2
For a capital lease, the FASB has identified four criteria.
1. Lease transfers ownership of the property to the lessee.
2. Lease contains a bargain-purchase option.
3. Lease term is equal to 75 percent or more of the estimated

economic life of the leased property.
4. The present value of the minimum lease One or more

payments (excluding executory costs) must be met
for capital
equals or exceeds 90 percent of the fair lease
value of the leased property. accounting.
21-13 LO 2
Lease Agreement Leases that DO NOT meet

any of the four criteria are
accounted for as Operating
Leases.
Illustration 21-4
21-14 LO 2
Capitalization Criteria
Transfer of Ownership Test
 If the lease transfers ownership of the asset to the
lessee, it is a capital lease.
Bargain-Purchase Option Test

 At the inception of the lease, the difference between
the option price and the expected fair market value
must be large enough to make exercise of the option
reasonably assured.
21-15 LO 2
Economic Life Test (75% Test)
 Lease term is generally considered to be the fixed,
noncancelable term of the lease.
 Bargain-renewal option can extend this period.
 At the inception of the lease, the difference between the

renewal rental and the expected fair rental must be great
enough to make exercise of the option to renew
reasonably assured.
21-16 LO 2
Illustration: Home Depot leases Dell PCs for two years

at a rental of $100 per month per computer and
subsequently can lease them for $10 per month per
computer for another two years. The lease clearly offers a
bargain-renewal option; the lease term is considered to be
four years.
Advance slide in presentation

21-17 mode to reveal answer. LO 2
Recovery of Investment Test (90% Test)
Minimum Lease Payments:
 Minimum rental payment
 Guaranteed residual value
 Penalty for failure to renew or extend the lease
 Bargain-purchase option
Executory Costs:
Exclude from present value of
 Insurance
Minimum Lease Payment
 Maintenance
Calculation
 Taxes
21-18 LO 2
Discount Rate
Lessee computes the present value of the minimum lease
payments using its incremental borrowing rate, with one
exception.
► If the lessee knows the implicit interest rate computed

by the lessor and it is less than the lessee’s incremental
borrowing rate, then lessee must use the lessor’s rate.
21-19 LO 2
Asset and Liability Accounted for Differently

Asset and Liability Recorded at the lower of:
1. present value of the minimum lease payments
(excluding executory costs) or
2. fair-market value of the leased asset.
21-20 LO 2

Depreciation Period
 If lease transfers ownership, depreciate asset over the
economic life of the asset.
 If lease does not transfer ownership, depreciate over

the term of the lease.
21-21 LO 2

Effective-Interest Method
 Used to allocate each lease payment between principal
and interest.
Depreciation Concept
 Depreciation and the discharge of the obligation are

independent accounting processes.
21-22 LO 2
Illustration: Caterpillar Financial Services Corp. (a subsidiary of Caterpillar) and Sterling
Construction Corp. sign a lease agreement dated January 1, 2014, that calls for Caterpillar
to lease a front-end loader to Sterling beginning January 1, 2014. The terms and provisions
of the lease agreement, and other pertinent data, are as follows.
• The term of the lease is five years. The lease agreement is noncancelable, requiring
equal rental payments of $25,981.62 at the beginning of each year (annuity-due basis).
• The loader has a fair value at the inception of the lease of $100,000, an estimated
economic life of five years, and no residual value.
• Sterling pays all of the executory costs directly to third parties except for the property
taxes of $2,000 per year, which is included as part of its annual payments to Caterpillar.
• The lease contains no renewal options. The loader reverts to Caterpillar at the
termination of the lease.
• Sterling’s incremental borrowing rate is 11 percent per year.
• Sterling depreciates, on a straight-line basis, similar equipment that it owns.
• Caterpillar sets the annual rental to earn a rate of return on its investment of 10 percent
per year; Sterling knows this fact.
21-23 LO 2
What type of lease is this?

Capital Lease?
Capitalization Criteria:
1. Transfer of ownership NO
2. Bargain purchase option NO
3. Lease term = 75% of
Lease term = 5 yrs.
economic life of leased Economic life = 5 yrs.
YES
property
4. Present value of minimum
lease payments => 90% of PV = $100,000 YES
FMV of property FMV = $100,000.
21-24 LO 2
Compute present value of the minimum lease payments.
Payment $ 25,981.62
Property taxes (executory cost) - 2,000.00
Minimum lease payment 23,981.62
Present value factor (i=10%,n=5) x 4.16986 *
PV of minimum lease payments $100.000.00
Sterling uses Caterpillar’s implicit interest rate of 10 percent instead of its

incremental borrowing rate of 11 percent because (1) it is lower and (2) it
knows about it.
* Present value of an annuity due of 1 for 5 periods at 10% (Table 6-5)
21-25 LO 2
Sterling records the capital lease on its books on January 1, 2014,

as:
Leased Equipment (under capital leases) 100,000

Lease Liability 100,000
Sterling records the first lease payment on January 1, 2014, as

follows.
Property Tax Expense 2,000.00

Lease Liability 23,981.62
Cash 25,981.62
21-26 LO 2
Accounting by the Lessee Illustration 21-6
Lease Amortization
Schedule for Lessee—
Annuity-Due Basis
Sterling records accrued interest on December 31, 2014
21-27 LO 2
Lease Amortization
Annuity-Due Basis
Prepare the entry to record accrued interest at Dec. 31, 2014.

Sterling records accrued interest on December 31, 2014
Interest Expense 7,601.84
Interest Payable 7,601.84
21-28 LO 2
Prepare the required on December 31, 2014, to record depreciation

for the year using the straight-line method ($100,000 ÷ 5 years).
Depreciation Expense (capital leases) 20,000

Accumulated Depreciation—Capital Leases 20,000
The liabilities section as it relates to lease transactions at

December 31, 2014.
Illustration 21-7
21-29 LO 2
Lease Amortization
Annuity-Due Basis
Sterling
records the
lease
payment of
January 1,
2015, as
follows.
Property Tax Expense 2,000.00

Interest Payable 7,601.84
Cash 25,981.62
21-30 LO 2
Operating Method (Lessee)

The lessee assigns rent to the periods benefiting from the use of
the asset and ignores, in the accounting, any commitments to
make future payments.
Illustration: Assume Sterling accounts for the lease as an

operating lease. Sterling records the payment on January 1,
2014, as follows.
Rent Expense 25,981.62

Cash 25,981.62
21-31 LO 2
LEARNING OBJECTIVES
lessee. problems.
accounting.
21-32
Comparison of Charges
to Operations—Capital
vs. Operating Leases
Differences using a capital lease instead of an operating lease.

1. Increase in amount of reported debt.
2. Increase in amount of total assets (specifically long-lived assets).
3. Lower income early in the life of the lease.
21-33 LO 3
21-34 LO 3
LEARNING OBJECTIVES
lessee. problems.
accounting.
21-35
Accounting by the Lessor
Benefits to the Lessor

1. Interest revenue.
2. Tax incentives.
3. High residual value.
21-36 LO 4
Economics of Leasing
A lessor determines the amount of the rental, basing it on the rate
of return—the implicit rate—needed to justify leasing the asset.
If a residual value is involved (whether guaranteed or not), the

company would not have to recover as much from the lease
payments.
21-37 LO 4
E21-10 (Computation of Rental): Morgan Leasing Company signs an
agreement on January 1, 2014, to lease equipment to Cole Company. The
following information relates to this agreement.
1. The term of the non-cancelable lease is 6 years with no renewal option.
The equipment has an estimated economic life of 6 years.
2. The cost and fair value of the asset at January 1, 2014, is $245,000.
3. The asset will revert to the lessor at the end of the lease term, at which
time the asset is expected to have a residual value of $43,622, none of
which is guaranteed.
4. Cole Company assumes direct responsibility for all executory costs.
5. The agreement requires equal annual rental payments, beginning on
January 1, 2014.
6. Collectability of the lease payments is reasonably predictable. There are
no important uncertainties surrounding the amount of costs yet to be
incurred by the lessor.
21-38 LO 4
E21-10 (Computation of Rental): Assuming the lessor desires a 10% rate
of return on its investment, calculate the amount of the annual rental
payment required.
Fair market value of leased equipment $ 245,000

Present value of residual value (calculation below) (24,623)
Amount to be recovered through lease payment 220,377
PV factor of annunity due (i=10%, n=6) x 4.79079
Annual payment required $ 46,000
Residual value $ 43,622

PV of single sum (i=10%, n=6) ÷ 0.56447
PV of residual value $ 24,623
21-39 LO 4
Classification of Leases by the Lessor

a. Operating leases.
b. Direct-financing leases.
c. Sales-type leases.
21-40 LO 4

Illustration 21-10
A sales-type lease involves a manufacturer’s or dealer’s profit, and a

direct-financing lease does not.
21-41 LO 4

Illustration 21-11
A lessor may classify a lease as an operating lease but the lessee may
classify the same lease as a capital lease.
21-42 LO 4
LEARNING OBJECTIVES
lessee. problems.
accounting.
21-43
Direct-Financing Method (Lessor)

In substance the financing of an asset purchase by the
lessee.
Lessor records:
 A lease receivable instead of a leased asset.
 Receivable is the present value of the minimum lease

payments.
21-44 LO 5
E21-10: Amortization schedule for the lessor.
21-45 LO 5
E21-10:
Prepare all of the
journal entries for
the lessor for 2014
and 2015.
1/1/14 Lease Receivable 245,000

Equipment 245,000
Cash 46,000
Lease Receivable 46,000
21-46 LO 5
E21-10:
Prepare all of the
journal entries for
the lessor for 2014
and 2015.
12/31/14 Interest Receivable 19,900

Interest Revenue 19,900
1/1/15 Cash 46,000
Lease Receivable 26,100
21-47
Interest Receivable 19,900
E21-10:
Prepare all of the
journal entries for
the lessor for 2014
and 2015.
12/31/15 Interest Receivable 17,290

Interest Revenue 17,290
21-48 LO 5
Operating Method (Lessor)

 Records each rental receipt as rental revenue.
 Depreciates leased asset in the normal manner.
21-49 LO 5
Illustration: Assume Morgan accounts for the lease as an

operating lease. It records the cash rental receipt as follows:
Cash 46,000
Rental Revenue 46,000
Depreciation is recorded as follows:

($245,000 – 46,622) ÷ 6 years = $33,063
Depreciation Expense 33,063

Accumulated Depreciation 33,063
21-50 LO 5
LEARNING OBJECTIVES
lessee. problems.
accounting.
21-51
Special Lease Accounting Problems
1. Residual values.
2. Sales-type leases (lessor).
3. Bargain-purchase options.
4. Initial direct costs.
5. Current versus noncurrent classification.
6. Disclosure.
21-52 LO 6
LEARNING OBJECTIVES
lessee. problems.
accounting.
21-53
Residual Values
Meaning of Residual Value - Estimated fair value of the
leased asset at the end of the lease term.
Guaranteed versus Unguaranteed – Lessee agrees to

make up any deficiency below a stated amount that the
lessor realizes in residual value at the end of the lease
term.
21-54 LO 7
Residual Values
Lease Payments - Lessor may adjust lease payments
because of the increased certainty of recovery of a
guaranteed residual value.
Lessee Accounting for Residual Value - The minimum

lease payments, include the guaranteed residual value but
excludes the unguaranteed residual value.
21-55 LO 7
Illustration: Caterpillar Financial Services Corp. (a subsidiary of Caterpillar) and Sterling
Construction Corp. sign a lease agreement dated January 1, 2014, that calls for Caterpillar
to lease a front-end loader to Sterling beginning January 1, 2014. The terms and provisions
of the lease agreement, and other pertinent data, are as follows.
• The term of the lease is five years. The lease agreement is noncancelable, requiring
equal rental payments of $25,981.62 at the beginning of each year (annuity-due basis).
• The loader has a fair value at the inception of the lease of $100,000, an estimated
economic life of five years, and an estimated residual value of $5,000.
• Sterling pays all of the executory costs directly to third parties except for the property
taxes of $2,000 per year, which is included as part of its annual payments to Caterpillar.
• The lease contains no renewal options. The loader reverts to Caterpillar at the
termination of the lease.
• Sterling’s incremental borrowing rate is 11 percent per year.
• Sterling depreciates, on a straight-line basis, similar equipment that it owns.
• Caterpillar sets the annual rental to earn a rate of return on its investment of 10 percent
per year; Sterling knows this fact.
21-56 LO 7
Illustration: Caterpillar assumes a 10 percent return on investment

(ROI), whether the residual value is guaranteed or unguaranteed.
Caterpillar would compute the amount of the lease payments as
follows.
Illustration 21-16
Advance slide in presentation

21-57 mode to reveal answer. LO 7
Guaranteed Residual Value (Lessee Accounting)
Computation of Lessee’s capitalized amount assuming a guaranteed

residual value.
Illustration 21-17
21-58 LO 7
Guaranteed Residual Value (Lessee)
Illustration 21-18
21-59 LO 7
At the end of the lease term, before the lessee transfers the asset to
Caterpillar, the lease asset and liability accounts have the following
balances.
Illustration 21-19
Assume that Sterling depreciated the leased asset down to its residual
value of $5,000 but that the fair market value of the residual value at
December 31, 2018, was $3,000. Sterling would make the following
journal entry.
21-60 LO 7
Illustration 21-19
Loss on Capital Lease 2,000.00

Interest Expense (or Interest Payable) 454.76
Accumulated Depreciation—Capital Leases 95,000.00
Leased Equipment (under capital leases) 100,000.00
Cash 2,000.00
21-61 LO 7
Unguaranteed Residual Value (Lessee Accounting)
Assume the same facts as those above except that the $5,000 residual
value is unguaranteed instead of guaranteed. Caterpillar will recover
the same amount through lease rentals—that is, $96,895.40. Sterling
would capitalize the amount as follows:
Illustration 21-20
21-62 LO 7
Unguaranteed Residual Value (Lessee)
Illustration 21-21
21-63 LO 7
Unguaranteed Residual Value (Lessee)
At the end of the lease term, before Sterling transfers the asset to
Caterpillar, the lease asset and liability accounts have the following
balances.
Illustration 21-22
21-64 LO 7
Comparative Entries
Illustration 21-23
21-65 LO 7
Lessor Accounting for Residual Value

The lessor works on the assumption that it will realize the residual
value at the end of the lease term whether guaranteed or
unguaranteed.
Illustration: Assume a direct-financing lease with a residual value

(either guaranteed or unguaranteed) of $5,000. Caterpillar determines
the payments as follows.
Illustration 21-24
21-66 LO 7
Illustration 21-25
21-67 LO 7
Illustration 21-25
Caterpillar would
make the following
entries for this
direct-financing
lease in the first
year.
1/1/14 Lease Receivable 100,000

Equipment 100,000
21-68 LO 7
Illustration 21-25
Caterpillar would
make the following
entries for this
direct-financing
lease in the first
year.
1/1/14
Cash 25,237.09
Lease Receivable 23,237.09
Property Tax Expense/Property Taxes Payable 2,000.00
21-69 LO 7
Illustration 21-25
Caterpillar would
make the following
entries for this
direct-financing
lease in the first
year.
12/31/14 Lease Receivable 7,676.29

Interest Revenue 7,676.29
21-70 LO 7
LEARNING OBJECTIVES
lessee. problems.
accounting.
21-71
Sales-Type Leases (Lessor)

 Primary difference between a direct-financing lease and
a sales-type lease is the manufacturer’s or dealer’s
gross profit (or loss).
 Lessor records the sale price of the asset, the cost of

goods sold and related inventory reduction, and the
lease receivable.
 There is a difference in accounting for guaranteed and

unguaranteed residual values.
21-72 LO 8
Direct-Financing versus Sales-Type Leases

Illustration 21-27
21-73 LO 8
21-74 LO 8
Illustration: To illustrate a sales-type lease with a guaranteed

residual value and with an unguaranteed residual value, assume
the same facts as in the preceding direct-financing lease
situation. The estimated residual value is $5,000 (the present
value of which is $3,104.60), and the leased equipment has an
$85,000 cost to the dealer, Caterpillar. Assume that the fair
market value of the residual value is $3,000 at the end of the
lease term.
21-75 LO 8
Computation of Lease Amounts by Caterpillar

Financial—Sales-Type Lease
Illustration 21-28
21-76 LO 8
Comparative
Sales-Type Leases (Lessor) Entries
Illustration 21-29
21-77 LO 8
21-78 LO 8
Bargain Purchase Option (Lessee)

 Lessee must increase the present value of the minimum
lease payments must include the present value of the
option.
 Only difference between the accounting treatment for a

bargain-purchase option and a guaranteed residual value
of identical amounts is in the computation of the
annual depreciation.
21-79 LO 8
Initial Direct Costs (Lessor)

Accounting for initial direct costs:
 Operating leases, the lessor should defer initial direct
costs.
 Sales-type leases, the lessor expenses the initial direct

costs.
 Direct-financing lease, the lessor adds initial direct

costs to the net investment.
21-80 LO 8
Current versus Noncurrent

GAAP does not indicate how to measure the current and
noncurrent amounts.
Both the annuity-due and the ordinary-annuity situations report

the reduction of principal for the next period as a current
liability/current asset.
21-81 LO 8
Current versus Noncurrent
Illustration 21-30
The current portion of the lease liability/receivable as of December

31, 2014, would be $18,017.70.
21-82 LO 8
LEARNING OBJECTIVES
lessee. problems.
accounting.
21-83
Disclosing Lease Data

 General description of the nature of leasing arrangements.
 The nature, timing, and amount of cash inflows and outflows

associated with leases, including payments to be paid or
received for each of the five succeeding years.
 The amount of lease revenues and expenses reported in the

income statement each period.
 Description and amounts of leased assets by major balance

sheet classification and related liabilities.
 Amounts receivable and unearned revenues under lease

agreements.
21-84 LO 9
Unresolved Lease Accounting Problems
To avoid leased asset capitalization, companies design, write,

and interpret lease agreements to prevent satisfying any of the
four capitalized lease criteria.
The real challenge lies in disqualifying the lease as a capital

lease to the lessee, while having the same lease qualify as a
capital (sales or financing) lease to the lessor.
Unlike lessees, lessors try to avoid having lease arrangements

classified as operating leases.
21-85 LO 9
21-86 LO 9
21-87 LO 9
21-88 LO 9
APPENDIX 21A SALE-LEASEBACKS
The term sale-leaseback describes a transaction in which

the owner of the property (seller-lessee) sells the property to
another and simultaneously leases it back from the new
owner.
Advantages:
1. Financing
2. Taxes
21-89 LO 10 Describe the lessee’s accounting for sale-leaseback transactions.

Determining Asset Use

To the extent the seller-lessee continues to use the asset
after the sale, the sale-leaseback is really a form of financing.
 Lessor should not recognize a gain or loss on the
transaction.
If the seller-lessee gives up the right to the use of the asset,

the transaction is in substance a sale.
 Gain or loss recognition is appropriate.
21-90 LO 10
Lessee
If the lease meets one of the four criteria for treatment as a
capital lease, the seller-lessee should
 Account for the transaction as a sale and the lease as a
capital lease.
 Defer any profit or loss it experiences from the sale of the

assets that are leased back under a capital lease.
 Amortize profit over the lease term .
21-91 LO 10
Lessee
If none of the capital lease criteria are satisfied, the seller-
lessee accounts for the transaction as a sale and the lease
as an operating lease.
 Lessee defers such profit or loss and amortizes it in

proportion to the rental payments over the period when it
expects to use the assets.
21-92 LO 10
Lessor
If the lease meets one of the lease capitalization criteria in
Group I and both in Group II, the purchaser-lessor records the
transaction as a purchase and a direct-financing lease.
If the lease does not meet the criteria, the purchaser-lessor

records the transaction as a purchase and an operating lease.
21-93 LO 10
Sale-Leaseback Example
American Airlines on January 1, 2014, sells a used Boeing 757 having a carrying
amount on its books of $75,500,000 to CitiCapital for $80,000,000. American
immediately leases the aircraft back under the following conditions:
1. The term of the lease is 15 years, noncancelable, and requires equal rental
payments of $10,487,443 at the beginning of each year.
2. The aircraft has a fair value of $80,000,000 on January 1, 2014, and an
estimated economic life of 15 years.
3. American pays all executory costs.
4. American depreciates similar aircraft that it owns on a straight-line basis
over 15 years.
5. The annual payments assure the lessor a 12 percent return.
6. American’s incremental borrowing rate is 12 percent.
21-94 LO 10
Sale-Leaseback Example
This lease is a capital lease to American because the lease term
exceeds 75 percent of the estimated life of the aircraft and
because the present value of the lease payments exceeds 90
percent of the fair value of the aircraft to CitiCapital.
CitiCapital should classify this lease as a direct-financing lease.
21-95 LO 10
Illustration
21A-1
21-96
RELEVANT FACTS - Similarities
 Both GAAP and IFRS share the same objective of recording leases by
lessees and lessors according to their economic substance—that is,
according to the definitions of assets and liabilities.
 Much of the terminology for lease accounting in IFRS and GAAP is the
same.
 Under IFRS, lessees and lessors use the same general lease
capitalization criteria to determine if the risks and rewards of ownership
have been transferred in the lease.
21-97 LO 11 Compare the accounting for leases under GAAP and IFRS.
RELEVANT FACTS - Differences
 One difference in lease terminology is that finance leases are referred to
as capital leases in GAAP.
 GAAP for leases uses bright-line criteria to determine if a lease
arrangement transfers the risks and rewards of ownership; IFRS is more
general in its provisions.
 GAAP has additional lessor criteria: payments are collectible and there
are no additional costs associated with a lease.
 IFRS requires that lessees use the implicit rate to record a lease unless
it is impractical to determine the lessor’s implicit rate. GAAP requires use
of the incremental rate unless the implicit rate is known by the lessee
and the implicit rate is lower than the incremental rate.
21-98 LO 11
RELEVANT FACTS - Differences
 Under GAAP, extensive disclosure of future non-cancelable lease
payments is required for each of the next five years and the years
thereafter. Although some international companies (e.g., Nokia) provide
a year-by-year breakout of payments due in years 1 through 5. IFRS
does not require it.
 The FASB standard for leases was originally issued in 1976. The
standard (SFAS No. 13) has been the subject of more than 30
interpretations since its issuance. The IFRS leasing standard is IAS 17,
first issued in 1982. This standard is the subject of only three
interpretations. One reason for this small number of interpretations is
that IFRS does not specifically address a number of leasing transactions
that are covered by GAAP. Examples include lease agreements for
natural resources, sale-leasebacks, real estate leases, and leveraged
leases.
21-99 LO 11
ON THE HORIZON
Lease accounting is one of the areas identified in the IASB/FASB
Memorandum of Understanding. The Boards have issued proposed rules
based on “right of use,” which requires that all leases, regardless of their
terms, be accounted for in a manner similar to how finance leases are treated
today. That is, the notion of an operating lease will be eliminated, which will
address the concerns under current rules in which no asset or liability is
recorded for many operating leases. A final standard is expected in 2013. You
can follow the lease project at either the FASB (http://www.fasb.org) or IASB
(http://www.iasb.org) websites.
21-100 LO 11
IFRS SELF-TEST QUESTION
Which of the following is not a criterion for a lease to be recorded as a
finance lease?
a. There is transfer of ownership.
b. The lease is cancelable.
c. The lease term is for the major part of the economic life of the
asset.
d. There is a bargain-purchase option.
21-101 LO 11
Under IFRS, in computing the present value of the minimum lease
payments, the lessee should:
a. use its incremental borrowing rate in all cases.
b. use either its incremental borrowing rate or the implicit rate of
the lessor, whichever is higher, assuming that the implicit rate is
known to the lessee.
c. use either its incremental borrowing rate or the implicit rate of
the lessor, whichever is lower, assuming that the implicit rate is
known to the lessee.
d. use the implicit rate of the lessor, unless it is impracticable to
determine the implicit rate.
21-102 LO 11
A lease that involves a manufacturer’s or dealer’s profit is a (an):
a. direct financing lease.
b. finance lease.
c. operating lease.
d. sales-type lease.
21-103 LO 11
Copyright
Copyright © 2013 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility for
errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.
21-104

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kieso

Different motivations for investing:

 To secure certain operating or financing arrangements

A lease is a contractual agreement between a lessor and a

Largest group of leased equipment involves:

Who Are the Players? Captive

23% ► IBM Global

47% Market Share 26%

2. Protection against obsolescence.

4. Less costly financing.

Conceptual Nature of a Lease

Leases that do not transfer

If the lessee capitalizes a lease, the lessee records an asset

Journal Entries for Capitalized Lease Illustration 21-2

For a capital lease, the FASB has identified four criteria.

1. Lease transfers ownership of the property to the lessee.

2. Lease contains a bargain-purchase option.

3. Lease term is equal to 75 percent or more of the estimated

4. The present value of the minimum lease One or more

Lease Agreement Leases that DO NOT meet

Bargain-Purchase Option Test

 Bargain-renewal option can extend this period.

 At the inception of the lease, the difference between the

Illustration: Home Depot leases Dell PCs for two years

Advance slide in presentation

► If the lessee knows the implicit interest rate computed

Asset and Liability Accounted for Differently

2. fair-market value of the leased asset.

Asset and Liability Accounted for Differently

 If lease does not transfer ownership, depreciate over

Asset and Liability Accounted for Differently

 Depreciation and the discharge of the obligation are

What type of lease is this?

Compute present value of the minimum lease payments.

PV of minimum lease payments $100.000.00

Sterling uses Caterpillar’s implicit interest rate of 10 percent instead of its

* Present value of an annuity due of 1 for 5 periods at 10% (Table 6-5)

Sterling records the capital lease on its books on January 1, 2014,

Leased Equipment (under capital leases) 100,000

Sterling records the first lease payment on January 1, 2014, as

Property Tax Expense 2,000.00

Sterling records accrued interest on December 31, 2014

Prepare the entry to record accrued interest at Dec. 31, 2014.

Prepare the required on December 31, 2014, to record depreciation

Depreciation Expense (capital leases) 20,000

The liabilities section as it relates to lease transactions at

Property Tax Expense 2,000.00

Operating Method (Lessee)

Illustration: Assume Sterling accounts for the lease as an

Rent Expense 25,981.62

Differences using a capital lease instead of an operating lease.

Benefits to the Lessor

3. High residual value.

If a residual value is involved (whether guaranteed or not), the

Fair market value of leased equipment $ 245,000

Residual value $ 43,622

Classification of Leases by the Lessor

Classification of Leases by the Lessor

A sales-type lease involves a manufacturer’s or dealer’s profit, and a