Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Introduction
ACCOUNTING FOR LEASES
FASB ASC 840
Synopsis:
A lease that transfers substantially all of the benefits and risks of ownership should be accounted for
as the acquisition of an asset and the incurrence of an obligation by the lessee and as a sale or
financing by the lessor.
The chart below includes the BASIC criteria you must learn to classify leases. We will also do
more complicated examples that will require FARS research.
U.S. GAAP
CRITERIA FOR CAPITALIZATION:
FOR LESSEE AND LESSOR: (must meet at least one)
A1 - TITLE TRANSFERS. The lease transfers ownership of the property to the lessee by the end
of the lease term.
A2 - BARGAIN PURCHASE OPTION. The lease contains an option to purchase the leased
property at a bargain price.
A3 – ECONOMIC LIFE. The lease term is equal to or greater than 75% of the estimated economic
life of the leased property.
A4 – RECOVERY OF INVESTMENT. The present value of the minimum lease payments equals
or exceeds 90% of the fair value of the leased property less any investment tax credit retained
by the lessor.
FOR LESSOR ONLY: (must meet both)
B1 - COLLECTIBILITY. Collectibility of the minimum lease payments is reasonably predictable.
B2 - NO UNCERTAINTIES. No important uncertainties surround the amount of unreimburseable
costs yet to be incurred by the lessor under the lease.
We will work through a variety of examples. In some cases, we will classify the lease and do
journal entries. Those examples are contained in this file. In other cases, we will just classify the
lease. These classification examples are generally in the PowerPoint lecture slides and not included
in this file. We will not necessarily work examples in numeric order but you can find all the
solutions on the course web page.
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Introductory Examples – Lease 1A – Operating Lease
To illustrate accounting for lease transactions, we will use a simple case involving three parties:
1.
2.
3.
Farview Farms needs a small tractor (Model SX). These tractors have an expected useful life of six years with
no salvage value.
Idaho First Bank & Trust which is currently charging 12% interest on long-term equipment loans.
Troy Tractors, Inc., which manufactures the Model SX tractor at a cost of $40,000 and then sells them for
$50,000. It also has a few units for trial use which rent for $500 per week.
If Farview Farms rents a tractor for one week from Troy Tractors, the journal entries would follow
the usual pattern for a rental:
Farview Farms
Debit
Credit
Troy Tractors
Debit
Credit
Rent expense
Cash
Cash
Rental Income
Depreciation expense
Accumulated depreciation
Comments --An operating lease is, in essence, a rental agreement. The lessor retains the risks and
benefits of ownership.
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Installment Purchase Arrangement
SITUATION 1B: PURCHASE WITH LONG-TERM BANK FINANCING
Assume Farview Farms decides to purchase the tractor and borrows the full purchase price of
$50,000 from Idaho First Bank & Trust at 12% interest on the unpaid balance of the loan. The
borrower agrees to make annual payments of $10,000 for five years. Again, the journal entries
follow the normal pattern:
Farview Farms
Debit
Credit
Troy Tractors
Debit
Credit
Idaho First Bank & Trust
Debit
Credit
Cash
Note Payable to Bank
Equipment
Cash (to Troy Tractors)
At year end:
Depreciation expense
Accumulated depreciation
Interest expense
Interest payable
Cash
Sales
Cost of goods sold
Inventory
Note Receivable
Cash
At year end
Interest receivable
Interest revenue
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
SITUATION 1C - DIRECT FINANCING LEASE
For various reasons either (or both) Farview Farms and Idaho First Bank & Trust might prefer a lease
arrangement to an outright purchase/long-term loan. Assume that the bank agrees to purchase the tractor from Troy
Tractors for $50,000. It then computes the payment on the lease required for it to earn its desired rate of 12% interest if
the lease is written for five years with the first payment coming at the end of the first year (after harvest). [PVA =
50,000, n = 5, i = 12%, pymt = 13,871]. The lease agreement specifies that Farview Farms gets to keep the tractor at the
end of the lease.
0
1
2
3
4
5
----------------------------------------------------------------DATE
LEASE
INTEREST
REDUCTION
LEASE
PAYMENT
LEASE
RECBL/LIAB
50,001.85
RECBL/LIAB
BALANCE
----------------------------------------------------------------01/01/12
0.00
0.00
0.00
50,000.00
12/31/12
13,871.00
6,000.00
7,871.00
42,129.00
12/31/13
13,871.00
5,055.48
8,815.52
33,313.48
12/31/14
13,871.00
3,997.62
9,873.38
23,440.10
12/31/15
13,871.00
2,812.81
11,058.19
12,381.91
12/31/16
13,871.00
1,489.09
12,381.91
0.00
Farview Farms
Debit
Credit
Troy Tractors
Debit
Credit
Idaho First Bank & Trust
Debit
Credit
Farm Equipment
Lease obligation
At year end:
Depreciation expense
Accumulated depreciation
Interest expense
Lease obligation
Cash
Cash
Sales
Cost of goods sold
Inventory
Equipment held for lease
Cash
Net investment in lease
Equipment held for lease
Cash
Interest revenue
Net investment in lease
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
SITUATION 1D - SALES TYPE LEASE
Farview Farms may also be able to arrange a similar or better lease arrangement with the
manufacturer of the Model SX tractor. We will assume that the lease terms are the same for
purposes of illustration.
NOTE: The first step in doing lease accounting involves finding the present value of the
cash flows that are transferred between the lessee and lessor. This "present value of the minimum
lease payments" [PVMLP] will give you the SALES amount for the lessor (assuming a sales-type
lease) and the ASSET amount for the lessee.
COMPUTE PVMLP: [n = 5, i = 12%, pymt = 13,871]
Farview Farms
Debit
Credit
Debit
Credit
Farm Equipment
Lease obligation
At year end:
Depreciation expense
Accumulated depreciation
Interest expense
Lease obligation
Cash
Troy Tractors
Net investment in lease
Sales
Cost of goods sold
Inventory
At year end:
Cash
Interest revenue
Net investment in lease
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Introductory Example – Lease 1E - BARGAIN PURCHASE OPTION
1.
2.
3.
4.
5.
6.
Inception date: 1/1/12
Lessor: Troy Tractors Inc.
Fair value of tractor at 1/1/12: $50,000
Cost to manufacture tractor: $40,000
Estimated fair value at end of lease is $10,000
Fixed non-cancelable lease term: 5 years.
7.
8.
9.
10.
11.
12.
First payment due on 12/31/12
Lessee: Farview Farms
Incremental borrowing rate (lessee): 12%
Implicit interest rate (known to lessee): 12%
Option to buy at end of lease term for $5,000
Estimated useful life of tractor: 8 years
To earn its desired return of 12%, at what amount should Troy Tractors set the annual payments?
Construct an amortization table and prepare the journal entries for both parties:
Date
Payment
Interest
"Principal"
0
Balance
1
2
3
4
5
Farview Farms
Debit
Credit
Debit
Credit
At inception:
Farm Equipment
Lease liability
At year end:
Interest expense
Lease liability
Cash
Depreciation expense
Accumulated depreciation
Troy Tractors
At inception:
Lease Receivable
Sales
Cost of Goods Sold
Inventory
At year end:
Cash
Lease Receivable
Interest revenue
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Introductory Example – Lease 1F - ANNUITY DUE
Assume that Troy Tractors and Farview Farms sign a lease agreement on a SX Tractor with
the following terms:
1.
2.
3.
4.
5.
Inception date: 1/1/12
Lessor: Troy Tractors Inc.
Fair value of tractor at 1/1/12: $50,000
Estimated fair value at end of lease is $10,000
First payment due on 1/1/12
6. Lessee: Farview Farms
7. Fixed non-cancelable lease term: 6 years.
8. Option to buy at end of lease term for $2,000
9. Estimated useful life of tractor: 8 years
10. Desired rate of return for lessor and incremental
borrowing rate for lessee: 12%
With these lease terms, how much should Troy Tractors ask for the annual payments?
Construct an amortization table and prepare the journal entries for both parties:
Date
Payment
Interest
"Principal"
Balance
0
1
2
3
4
5
6
Farview Farms
Debit
Credit
Debit
Credit
At inception:
Farm Equipment
Lease liability
Cash
At year end:
Interest expense
Lease liability
Depreciation expense
Accumulated depreciation
Troy Tractors
At inception:
Cash
Lease Receivable
Sales
Cost of Goods Sold
Inventory
At year end:
Lease Receivable
Interest revenue
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
International Financial Reporting Standards (IFRS)
Leases (IAS17)
A lease is classified as a finance lease if it transfers substantially all the risks and rewards
incidental to ownership. A lease is classified as an operating lease if it does not transfer
substantially all the risks and rewards incidental to ownership.
Classification depends on the substance of the transaction rather than the form of the contract.
Examples of situations that individually or in combination would normally lead to a lease being
classified as a finance lease are:
a) the lease transfers ownership of the asset to the lessee by the end of the lease term.
b) the lessee has the option to purchase the asset at a price that is expected to be sufficiently
lower than the fair value at the date the option becomes exercisable for it to be reasonably
certain, at the inception of the lease, that the option will be exercised.
c) the lease term is for the major part of the economic life of the asset even if title is not
transferred.
d) at the inception of the lease the present value of the minimum lease payments amounts to at
least substantially all of the fair value of the leased asset.
e) the leased assets are of such a specialized nature that only the lessee can use them without
major modifications.
Other indications that it is a finance lease include:
a) if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are
borne by the lessee.
b) gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for
example, in the form of a rent rebate equalling most of the sales proceeds at the end of the
lease)
c) the lessee has the ability to continue the lease for a secondary period at a rent that is
substantially lower than market rent.
The examples and indicators (above) are not always conclusive. If it is clear from other features that
the lease does not transfer substantially all risks and rewards incidental to ownership, the lease is
classified as an operating lease.
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Lease Example #3
On January 1, 2012, Andrewson Consulting and Sun Computers sign a lease with the following terms:
1.
3.
5.
7.
9.
Term: 3 years
Implicit interest rate (known to lessee) 10%
Fair value of asset $130,000
Incremental borrowing rate: 15%
Estimated useful life of asset: 4 years
2. Payments of $47,523
4. Lessor retains ownership of asset at end of lease
6. Cost of asset $100,000
8. First payment due 1/1/12
10. No collection or cost uncertainties for lessor
FIND PRESENT VALUE OF MINIMUM LEASE PAYMENTS:
Type of lease for
Lessor
Lessee
US GAAP
IFRS
Date
1/01/12
1/01/12
1/01/13
1/01/14
0
1
2
Lessee
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Lease Payment
Interest
47,523
47,523
47,523
142,569
Debit
0
8,248
4,320
12,568
Credit
Principal
47,523
39,275
43,203
130,001
Balance
130,000
82,477
43,202
0
0
Lessor
Debit
Credit
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Lease Example #5
On March 30, 2012, Genessee Engineering, Inc. and Idaho First Bank sign a lease with the following terms:
1.
2.
3.
4.
5.
6.
7.
Inception of lease: March 30, 2012
Term: 3 years
Implicit interest rate (not known to lessee) 10%
Fair value of asset $100,000
Incremental borrowing rate: 12%
Estimated useful life of asset: 5 years
Purchase option at end of lease: $2,500
8.
9.
10.
11.
12.
13.
Payments of ______________
Est. fair value of asset at end of lease $5,000
Cost of asset $100,000
First payment due 3/30/12
No collection or cost uncertainties for lessor
Both parties have calendar-year fiscal years.
FIND THE PAYMENT WHICH IDAHO FIRST BANK SHOULD ASK TO EARN THE IMPLICIT INTEREST
RATE LISTED ABOVE:
PVMLP for Lessee:
PVMLP for Lessor:
Type of lease for
Lessor
Lessee
US GAAP
IFRS
Explain:
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Example 5 – Lessee Accounting (Capital Lease with BPO)
On March 30, 2012, Genessee Engineering, Inc. and Idaho First Bank sign a lease with the following terms:
1. Term: 3 years
2. Payments of 35,869
3. Implicit interest rate (not known to lessee) 10%
4. Est. fair value of asset at end of lease $5,000
5. Fair value of asset $100,000
6. Cost of asset $100,000
7. Incremental borrowing rate: 12%
8. First payment due 3/30/12
9. Estimated useful life of asset: 5 years
10. No collection or cost uncertainties for lessor
11. Purchase option at end of lease: $2,500
12. Both parties have calendar-year fiscal years.
Date
0
1
2
3
03/30/12
03/30/12
03/30/13
03/30/14
03/30/15
Lease
Payment
Interest
35,869
35,869
35,869
2,500
0
7,488
4,082
266
Principal
35,869
28,381
31,787
2,234
Genessee Engineering Inc.
3/30/12
Balance
98,270
62,401
34,020
2,234
0
Debit
Credit
Leased Asset
Lease obligation
Cash
12/31/12
35,869
Depreciation expense
Accumulated depreciation
Interest expense
Interest payable
3/30/13
Interest expense
Interest payable
Lease obligation
Cash
12/31/13
35,869
Depreciation expense
Accumulated depreciation
Interest expense
Interest payable
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Acct. 414 – Journal Entry Examples: Leases
Lease #5
3/30/14
Genessee Engineering Inc.
Prof. Teresa Gordon
Debit
Credit
Interest expense
Interest payable
Lease obligation
Cash
12/31/14
35,869
Depreciation expense
Accumulated depreciation
Interest expense
Interest payable
3/30/15
Interest expense
Interest payable
Lease obligation
Cash
12/31/15
2,500
Depreciation expense
Accumulated depreciation
12/31/15
Depreciation expense
Accumulated depreciation
3/30/17
Depreciation expense
Accumulated depreciation
Acc'd Depreciation
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Lease Liability
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Example 5 – Lessor Accounting (Direct Financing Lease with BPO)
Date
0
1
2
3
03/30/12
03/30/12
03/30/13
03/30/14
03/30/15
Lease
Payment
Interest
35,869
35,869
35,869
2,500
110,107
0
6,413
3,468
226
10,107
Idaho First Bank & Trust
03/30/12
Cash
Principal
35,869
29,456
32,401
2,274
100,000
Balance
100,000
64,131
34,675
2,274
0
Debit
Credit
35,869
Net investment in lease
Equipment purchased for lease
12/31/12
Interest receivable
Interest revenue
3/30/13
Cash
35,869
Interest receivable
Interest revenue
Net investment in lease
12/31/13
Interest receivable
Interest revenue
3/30/14
Cash
35,869
Interest receivable
Interest revenue
Net investment in lease
12/31/14
Interest receivable
Interest revenue
12/31/15
Cash
2,500
Interest receivable
Interest revenue
Net investment in lease
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Example 5 – FASB Style J E s - Lessor
Date
0
1
2
3
Lease
Payment
03/30/12
03/30/12
03/30/13
03/30/14
03/30/15
Interest
35,869
35,869
35,869
2,500
110,107
0
6,413
3,468
226
10,107
Principal
35,869
29,456
32,401
2,274
100,000
Idaho First Bank & Trust
3/30/12
Lease Payments Receivable
(or Gross investment in lease)
Balance
100,000
64,131
34,675
2,274
0
Debit
Credit
110,107
Equipment purchased for lease
Unearned interest revenue
Cash
35,869
Lease Payments Receivable
(or Gross investment in lease)
12/31/12
Unearned interest revenue
Interest revenue
3/30/13
Cash
35,869
Unearned interest revenue
Interest revenue
Lease Payments Receivable
(or Gross investment in lease)
Continue as above for the following dates
12/31/13
3/30/14
12/31/14
3/30/15
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
COMMENTS ON APPLYING CRITERIA
LEASE TERM:
Always ends at a bargain purchase option (including ordinary renewal periods up to BPO).
Includes renewal periods
under bargain renewal options
if there is a penalty large enough to assure renewal
if renewal or extensions is at option of lessor
during which lessee guarantees lessor's debt related to property
during which there is a loan from lessee to the lessor
Lease must be cancelable only under remote contingency, with permission of lessor, or if
lessee enters into new lease with lessor, or with there is a large penalty for cancellation that
makes cancellation unlikely.
MINIMUM LEASE PAYMENTS:
Excludes contingent rentals
Excludes executory costs paid by lessor:
maintenance
property taxes
insurance
Excludes all rental payments past date of bargain purchase option
Includes all rental payments up to date of bargain purchase option
Includes bargain purchase option
Includes renewal penalties not large enough to assure continuation of lease
Includes rents during renewal periods covered by:
bargain renewal options
nonrenewal penalty large enough to assure continuation of lease
Includes guaranteed residual value of property If guaranteed by lessee
If guaranteed by third party, only lessor includes as part of minimum lease payments
Note:
Never record the leased asset at more than its fair value!
The asset should be recorded at the lower of the PVMLP or the FMV.
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Lease Example #7
On January 1, 2012, Harris Manufacturing (lessee) and Accel Engines sign a lease with the following terms:
1.
3.
5.
7.
9.
10.
Term: 4 years
Implicit interest rate (known to lessee) 10%
Fair value of asset $300,000
Incremental borrowing rate: 12%
Estimated useful life of asset: 6 years
Est. fair value of asset at end of lease: $10,000
2.
4.
6.
8.
10.
11.
PVMLP for Lessee:
Payments of $84,079
Lessor retains ownership of asset at end of lease
Cost of asset $250,000
First payment due 1/1/12
No collection or cost uncertainties for lessor
The residual value is NOT guaranteed by lessee
PVMLP for Lessor:
Type of lease for
Lessor
Lessee
US GAAP
IFRS
Explain:
Lessee
Date
0
1
2
3
01/01/12
01/01/12
01/01/13
01/01/14
01/01/15
Lease
Payment
84,079
84,079
84,079
84,079
Interest
0
20,909
14,592
7,644
Lessor
Principal
84,079
63,170
69,487
76,435
Lessee – Harris Manufacturing
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Balance
293,171
209,092
145,922
76,435
0
Lease
Payment
Interest
84,079
84,079
84,079
84,079
10,000
Debit
0
21,593
15,344
8,470
909
Principal
84,079
62,486
68,735
75,609
9,091
Balance
300,000
215,921
153,435
84,700
9,091
0
Credit
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Lease # 7 - Lessor Accounting for Sales-Type Lease when there is an
Unguaranteed Residual Value
Date
0
1
2
3
4
Lease
Payment
01/01/12
01/01/12
01/01/13
01/01/14
01/01/15
01/01/16
Totals
84,079
84,079
84,079
84,079
10,000
346,316
Lessor – Accel Engines
Interest
Principal
0
21,593
15,344
8,470
909
46,316
Debit
Balance
300,000
215,921
153,435
84,700
9,091
0
0
84,079
62,486
68,735
75,609
9,091
300,000
Credit
1/1/12
Net Investment in Lease
(PVMLP + PV of Unguaranteed RV)
Cost of Sales
(Cost of asset - PV of Unguaranteed RV)
Inventory/Equipment
(Cost of asset)
Sales Revenue
(PVMLP)
Cash
Net Investment in Lease
12/31/12
Interest receivable
Interest Revenue
1/1/13
Cash
Interest Receivable
Net Investment in Lease
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
UNGUARANTEED RESIDUAL VALUES JOURNAL ENTRY FORMAT FOR LESSOR
(As illustrated by FASB -- use of Gross rather than Net investment in lease is optional.
Net investment in lease = GIIL - unearned income)
DIRECT FINANCING LEASE:
Gross Investment in Lease (MLP + Unguaranteed Residual Value + initial direct costs)
Equipment (Cost or carrying amount)
Unearned Income (GIIL - cost or carrying amount)
SALES TYPE LEASE:
Gross Investment in Lease (MLP + Unguaranteed Residual Value)
Cost of Sales (Cost of asset - PV of Unguaranteed Residual Value)
Inventory/Equipment (Cost of asset)
Unearned Income (GIIL -PVMLP)
Sales Revenue (PVMLP)
Where MLP = minimum lease payments exclusive of executory costs paid by the lessor
GIIL = gross investment in lease
PVMLP = present value of MLP
The “easier” method:
DIRECT FINANCING LEASE:
Net Investment in Lease (PVMLP + PV of Unguaranteed Residual Value + initial direct costs)
Equipment (Cost or carrying amount)
SALES TYPE LEASE:
Net Investment in Lease (PVMLP + PV of Unguaranteed Residual Value)
Cost of Sales (Cost of asset - PV of Unguaranteed Residual Value)
Inventory/Equipment (Cost of asset)
Sales Revenue (PVMLP)
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Lease Example #9
On January 1, 2012, Hamford Ritz Inc. and Cisco Leasing sign a lease with the following terms:
1.
3.
5.
7.
9.
11.
13.
Term: 4 years
Implicit interest rate (not known to lessee) 10%
Fair value of asset $300,000
Incremental borrowing rate: 12%
Estimated useful life of asset: 5 years
Est. fair value of asset at end of lease: $25,000
The lessor incurred initial direct costs of $1,848
related to the lease
2.
4.
6.
8.
10.
12.
Payments of $81,140
Lessor retains ownership of asset at end of lease
Cost of asset $300,000
First payment due 1/1/12
No collection or cost uncertainties for lessor
The residual value is NOT guaranteed by lessee
FIND PRESENT VALUE OF MINIMUM LEASE PAYMENTS:
Type of lease for
Lessor
Lessee
US GAAP
IFRS
Explain:
Lessee
0
1
2
3
Date
01/01/12
01/01/12
01/01/13
01/01/14
01/01/15
Lease Payment
81,140
81,140
81,140
81,140
Hamford Ritz Inc. (Lessee)
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Interest
Principal
12%
0
23,386
16,456
8,694
Debit
81,140
57,754
64,685
72,447
Balance
276,026
194,886
137,131
72,447
0
Credit
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Lease Example #9 – Lessor Accounting for Initial Direct
Costs with a Direct Financing Lease
How to arrive at adjusted interest rate:
0
1
2
3
4
Date
01/01/12
01/01/12
01/01/13
01/01/14
01/01/15
01/01/16
Lease Payment
81,140
81,140
81,140
81,140
25,000
Interest
9.56%
0
21,100
15,360
9,072
2,182
Cisco Leasing Co. (Lessor)
1/1/12
1/1/12
Initial Direct Costs – Leases
Cash
Equipment held for lease
Cash
Principal
Balance
301,848
220,708
160,667
94,887
22,818
0
81,140
60,040
65,780
72,069
22,818
Debit
Credit
1,848
1,848
300,000
300,00
Net investment in lease
Equipment purchased for lease
Initial direct costs - leases
Cash
300,000
1,848
81,140
Net investment in lease
12/31/12
Net investment in lease
Interest revenue
1/1/13
Cash
Net investment in lease
12/31/15
Net investment in lease
Interest revenue
1/1/16
Used Equipment
Net investment in lease
Loss on Leased Asset
81,140
The last “payment” the lessor will receive is the returned equipment. It should be recorded at the lower of fair value or
original estimated residual value. In other words, it may be necessary to record a loss. Lessors are supposed to evaluate
the residual values at each balance sheet date and recognize any losses in anticipated value.
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Lease Example #10
On May 1, 2012, SlumberJay, Inc. and Omaha Oscillators, Inc. sign a lease with the following terms:
1.
3.
5.
7.
9.
10.
12.
Term: 4 years
Implicit interest rate (NOT known to lessee) 10%
Fair value of asset $270,000
Incremental borrowing rate: 12%
Estimated useful life of asset: 4 years
Est. fair value of asset at end of lease: $0
Initial direct costs incurred by lessor $1,000
2.
4.
6.
8.
10.
11.
Payments of $82,434
Lessor retains ownership of asset at end of lease
Cost of asset $250,000
First payment due 5/1/12
There are collection uncertainties for lessor
The payments include $5,000 for insurance to be
paid by the lessor
FIND PRESENT VALUE OF MINIMUM LEASE PAYMENTS:
Type of lease for
Lessor
Lessee
US GAAP
IFRS
0
1
2
3
Date
Lease Payment
05/01/12
05/01/12
77,434
05/01/13
77,434
05/01/14
77,434
05/01/15
77,434
Interest
0
19,257
13,439
7,040
Lessor – Omaha Oscillators, Inc.
Principal
77,434
58,177
63,995
70,394
Balance
270,000
192,566
134,389
70,394
0
Debit
Credit
05/01/12Initial direct costs – deferred
Cash
05/01/12Cash
Unearned rental income
Prepaid Insurance
82,434
12/31/12Rental costs
Initial direct costs - deferred
Insurance expense
Prepaid insurance
Unearned rental income
Rental income
Depreciation expense
Accumulated Depreciation
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Acct. 414 – Journal Entry Examples: Leases
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Prof. Teresa Gordon
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Acct. 414 – Journal Entry Examples: Leases
Lessor – Omaha Oscillators, Inc.
05/01/13Cash
Unearned rental income
Prepaid Insurance
Prof. Teresa Gordon
Debit
Credit
82,434
12/31/13Rental costs
Initial direct costs - deferred
Insurance expense
Prepaid insurance
Unearned rental income
Rental income
Depreciation expense
Accumulated Depreciation
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Lease Example #10 - Lessee
0
1
2
3
Date
Lease Payment
05/01/12
05/01/12
77,434
05/01/13
77,434
05/01/14
77,434
05/01/15
77,434
Interest
SlumberJay, Inc. - Lessee
05/01/12Leased Asset
Prepaid Insurance
Lease Obligation
Cash
0
22,318
15,704
8,296
Principal
77,434
55,116
61,730
69,138
debit
Balance
263,417
185,983
130,867
69,137
0
credit
82,434
12/31/12Depreciation Expense
Accumulated Depreciation
Insurance expense
Prepaid insurance
Interest Expense
Interest Payable
05/01/13Lease Obligation
Interest Payable
Insurance expense
Cash
82,434
12/31/13Depreciation Expense
Accumulated Depreciation
Insurance expense
Prepaid insurance
Interest Expense
Interest Payable
01/01/14Lease Obligation
Interest Payable
Prepaid Insurance
Cash
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82,434
24
Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Lease Example #11
On June 1, 2012, Fantasia Funnels, Inc. and Idaho First Bank sign a lease with the following terms:
1.
3.
5.
7.
Term: 4 years
Interest rate used to compute payments = 12%
Fair value of asset $200,000
Incremental borrowing rate: 14%
(Lessee does not know implicit interest rate)
Estimated useful life of asset: 6 years
Est. fair value of asset at end of lease: $10,000
Initial direct costs to arrange lease: $3,000
9.
11.
13.
2.
4.
6.
8.
Payments of $61,924
Cost of asset $200,000
First payment due 6/1/12
The lessee can purchase asset for $10,000 at end
of lease, otherwise, asset is returned to lessor.
The payments include $5,000 for maintenance.
No collection or cost uncertainties for lessor
10.
12.
FIND PRESENT VALUE OF MINIMUM LEASE PAYMENTS:
Type of lease for
Lessor
Lessee
US GAAP
IFRS
Explain:
Lessee’s Amortization Schedule
0
1
2
3
Date
06/01/12
06/01/12
06/01/13
06/01/14
06/01/15
Lease Payment
Fantasia Funnels Inc. (Lessee)
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56,924
56,924
56,924
56,924
Interest
14%
0
18,502
13,123
6,991
Debit
Principal
56,924
38,422
43,801
49,933
Balance
189,081
132,157
93,735
49,933
0
Credit
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Lease Example #11
Date
Lease
Payment
Interest
Principal
Balance
6/01/12
203,000
0
6/01/12
56,924
1
6/01/13
56,924
2
6/01/14
56,924
3
6/01/15
56,924
4
6/01/16
10,000
Note: This problem is similar to Lease #9. It requires you to compute a new interest rate for the lessor so
that the initial direct costs are amortized over the life of the lease. Note that the residual value MUST be
included because the asset’s value at the end of the lease is important to the lessor since there is no title
transfer or bargain purchase option.
Remember that the lessor’s amortization table includes residual values (whether or not they are guaranteed)
if the lessor expects the leased asset to be returned at end of lease (in other words, no title transfer and no
bargain purchase option).
Idaho First Bank. (Lessor)
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Debit
Credit
26
Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
LEASE Example #12
On August 1, 2012, Hells Gate Jet Boats and Washington Leasing Co. sign a lease with the following terms:
1.
Term: 4 years with possible renewal (see #11)
2.
Payments of $49,523
3.
Implicit interest rate (NOT known to lessee) 10%
4.
Lessor retains ownership of asset at end of lease
5.
Fair value of asset $200,000
6.
Cost of asset $200,000
7.
Incremental borrowing rate: 14%
8.
First payment due 8/1/12
9.
Estimated useful life of asset: 6 years
10.
No collection or cost uncertainties for lessor
11.
At the end of the lease, HGJB can renew for one
12.
The residual value is NOT guaranteed by lessee,
more year at same annual amount of $49,523. This is
asset is expected to be worth $25,000 at end of 4
certainly no bargain. There is a $15,000 penalty for
years, and $15,000 at end of 5 years.
non-renewal of the lease. However, this amount is
probably not large enough to assure that HGJB will
renew.
WHAT ARE THE MINIMUM LEASE PAYMENTS?
FIND PRESENT VALUE:
LESSOR - Washington Leasing Co.
Date
Payment
Interest
"Principal"
Balance
0
1
2
3
4
5
Lessor - Washington Leasing Co.
Debit
Credit
Lease Example 12 (continued)
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
On August 1, 2012, Hells Gate Jet Boats and Washington Leasing Co. sign a lease with the following terms:
1.
Term: 4 years with possible renewal (see #11)
2.
Payments of $49,523
3.
Implicit interest rate (NOT known to lessee) 10%
4.
Lessor retains ownership of asset at end of lease
5.
Fair value of asset $200,000
6.
Cost of asset $200,000
7.
Incremental borrowing rate: 14%
8.
First payment due 8/1/12
9.
Estimated useful life of asset: 6 years
10.
No collection or cost uncertainties for lessor
11.
At the end of the lease, HGJB can renew for one
12.
The residual value is NOT guaranteed by lessee,
more year at same annual amount of $49,523. This is
asset is expected to be worth $25,000 at end of 4
certainly no bargain. There is a $15,000 penalty for
years, and $15,000 at end of 5 years.
non-renewal of the lease. However, this amount is
probably not large enough to assure that HGJB will
renew.
WHAT ARE THE MINIMUM LEASE PAYMENTS?
FIND PRESENT VALUE:
LESSEE - Hells Gate Jet Boats
Date
Payment
Interest
"Principal"
Balance
0
1
2
3
4
5
Lessee - Hells Gate Jet Boats
Debit
Credit
Lease #12 – continued
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
What if the lessee decided that the penalty was large enough that they would renew the lease? How
would you classify the lease in this situation?
LESSEE - Hells Gate Jet Boats
Date
Payment
Interest
"Principal"
Balance
0
1
2
3
4
5
Lessee - Hells Gate Jet Boats
Debit
Credit
Note that the implicit interest rate for the lessor would also have to be re-computed if the lessor also decided that the
penalty was going to be large enough. A new table would be required. It would still be direct financing lease since
lease term would exceed 75% of economic life.
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
LEASE Example #13
On October 1, 2012, Knightco (lessee) and Jack Dear Corp. sign a lease with the following terms:
1.
Term: 4 years, with possible renewal (see #11)
2.
Payments of $68,565
3.
Implicit interest rate (NOT known to lessee) 10% 4.
Lessor retains title to the asset at end of lease
5.
Fair value of asset $260,000
6.
Cost of asset $200,000
7.
Incremental borrowing rate: 12%
8.
First payment due 10/1/12
9.
Estimated useful life of asset: 6 years
10.
No collection or cost uncertainties for lessor
11.
Lease can be renewed for one more year at
12.
Est. fair value of asset at end of original lease term is
$17,000. The actual value is probably $25,000.
$35,000. It should be worth $15,000 at the end of 5
13.
There are no guarantees of residual value
years.
LESSOR AMORTIZATION TABLE
Date
Payment
Interest
"Principal"
Balance
Interest
"Principal"
Balance
0
1
2
3
4
5
LESSEE AMORTIZATION TABLE
Date
Payment
0
1
2
3
4
5
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Acct. 414 – Journal Entry Examples: Leases
Prof. Teresa Gordon
Lease #13
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Lessee – Knightco Inc.
Debit
Credit
Lessor – Jack Dear Corp.
Debit
Credit
31