Leases
Chapter 15
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
15-2
Accounting by the Lessor and Lessee
A lease is an agreement in which the lessor
conveys the right to use property, plant, or
equipment, usually for a stated period of time,
to the lessee.
Lessee = Renter
Lessee
Operating lease
Capital lease
Lessor = Owner of property
Lessor
Operating lease
Capital lease
Direct financing lease
Sales-type lease
Capital Leases and Installment Notes
Compared
Matrix, Inc. acquires equipment from Apex, Inc. by paying $193,878
every 6 months for the next 3 years. The interest rate associated
with the agreement is 9%. Let’s look at the arrangement as an
installment note payable and as a capital lease agreement. First,
let’s prepare an amortization schedule for the payments.
Date
Payment
Initial value . . . . . . . . . . .
1
$ 193,878
2
193,878
3
193,878
4
193,878
5
193,878
6
193,878
Effective
Decrease Outstanding
Interest
in Balance
Balance
........
$ 1,000,000
$
45,000 $ 148,878
851,122
38,300
155,578
695,544
31,300
162,578
532,966
23,983
169,895
363,071
16,338
177,540
185,532
8,346
185,532
-
15-3
15-4
Inception of the Agreement
At inception January 1
Installment Note
Equipment
Notes payable
1,000,000
Capital Lease
Leased equipment
Lease payable
1,000,000
1,000,000
1,000,000
First payment, June 30
Installment Note
Interest expense
Notes payable
Cash
45,000
148,878
Capital Lease
Interest expense
Lease payable
Cash
45,000
148,878
193,878
193,878
15-5
Classification Criteria
Operating
Lease
Capital
Lease
A capital lease must meet one of four criteria:
 Ownership transfers to the lessee at the end of the
lease term, or . . .
 A bargain purchase option (BPO) exists, or . . .
 The noncancelable lease term is equal to 75% or more
of the expected economic life of the asset, or
The PV of the minimum lease payments is 90% or more
of the fair value of the asset.
15-6
Classification Criteria
Operating
Lease
Capital
Lease
A capital lease must meet one of four criteria:
 Ownership transfers to the lessee at the end of the
lease term, or . . .
 A bargain purchase option (BPO) exists, or . . .
 The noncancelable lease term is equal to 75% or
more of the expected economic life of the asset, or
The PV of the minimum lease payments is 90% or
more of the fair value of the asset.
15-7
Classification Criteria
A bargain purchase option (BPO) gives the lessee the
right to purchase the leased asset at a price significantly
lower than the expected fair value of the property and the
exercise of the option appears reasonably assured.
The lease term is normally considered to be the noncancelable term of the lease plus any periods covered by
bargain renewal options. If the inception of the lease
occurs during the last 25% of an asset’s economic life,
this criterion does not apply.
For the lessee, a capital lease is treated as the purchase
of an asset – the lessee records both an asset and
liability at inception of the lease.
15-8
Additional Lessor Conditions
The four conditions discussed apply to both the lessee
and lessor. However, the lessor must meet two
additional conditions for the lease to be classified as
either a direct financing or sales-type lease:
1. The collectibility of the lease payments must be
reasonably predictable.
2. If any costs to the lessor have yet to be incurred, they
are reasonably predictable. Performance by the lessor is
substantially complete.
Lessor = Owner of the property subject to the lease.
15-9
U. S. GAAP vs. IFRS
15-10
Operating Leases
Lease
agreement
exists.
Record lease as
an Operating
Lease.
Criteria for a
capital lease
not met.
Capital
Lease
15-11
Operating Leases
On January 1, 2013, Sans Serif Publishers, Inc., a computer services
and printing firm, leased printing equipment from First LeaseCorp.
The lease agreement specifies four annual payments of $100,000
beginning January 1, 2013, the inception of the lease, and at each
January 1 thereafter through 2016.The useful life of the equipment is
estimated to be six years. Before deciding to lease, Sans Serif
considered purchasing the equipment for its cash price of $479,079. If
funds were borrowed to buy the equipment, the interest rate would have
been 10%.
At the End of Four Payment Dates
San Serif Publishers, Inc. (Lessee)
Prepaid rent
100,000
Cash
100,000
First LeaseCorp (Lessor)
Cash
Unearned rent revenue
100,000
100,000
15-12
Leasehold Improvements
Sometimes a lessee will make improvements to leased
property that reverts back to the lessor at the end of
the lease. Like other assets, leasehold improvement costs
are allocated as depreciation expense over its useful life
to the lessee, which is to be the shorter of the physical
life of the asset or the lease term.
15-13
Capital Leases – Lessee and Lessor
The amount recorded (capitalized) is the
present value of the minimum lease payments.
However, the amount recorded cannot exceed
the fair value of the leased asset.
In calculating the present value of the minimum
lease payments, the interest rate used by the
lessee is the lower of:
1. Its incremental borrowing rate, or
2. The implicit interest rate used by the lessor.
15-14
Capital Leases – Lessee and Lessor
If the lessor is not a manufacturer or
dealer, the fair value of the leased
asset typically is the lessor’s cost.
When the lessor is a manufacturer or
dealer, the fair value of the property at the
inception of the lease is likely to be its
normal selling price.
15-15
Capital Leases – Lessee and Lessor

On January 1, 2013, Sans Serif Publishers, Inc., leased printing equipment from First
Lease Corp. First Lease purchased the equipment from CompuDec Corporation at a
cost of $479,079.

The
lease agreement
specifies
annual payments beginning January 1, 2013, the inception
$479,079
÷ 4.79079*
= $100,000
ofpayments.
the lease, and at each December 31 thereafter through 2017.The six year lease term
*PV of an
annuity due31,
of $1:
n = 6, Iequal
= 10%to the estimated useful life of the copier.
ending
December
2018,is

First Lease routinely acquires electronic equipment for lease to other firms. The
cost
interest rate In these financing arrangements is10%.

Since the lease term is equal to the expected useful life of the equipment (>75%), the
transaction must be recorded by the lessee as a capital lease.

We believe the collectibility of the lease payments is reasonably certain and any costs
to the lessor that are yet incurred are reasonably predictable, this qualifies also as a
direct financing lease to First Lease. To achieve its objectives, First Lease must (a)
recover its $479,079 investment as well as (b) earn interest revenue at a rate of 10%.
So, the lessor determined that annual rental payments would be $100,000.
$100,000 × 4.79079* = $479,079 lessee’s
15-16
Capital Leases – Lessee and Lessor
Direct Financing Lease (January 1, 2013)
Sans Serif Publishers, Inc. (Lessee)
Leased equipment (PV of payments)
Lease payable (PV of payments)
479,079
479,079
First LeaseCorp. (Lessor)
Lease receivable (PV of payments)
479,079
Inventory of equipment (Lessor’s cost)
479,079
First Lease Payment (January 1, 2013)
Sans Serif Publishers, Inc. (Lessee)
Lease payable
Cash
100,000
First LeaseCorp. (Lessor)
Cash
Lease receivable
100,000
100,000
100,000
15-17
Capital Leases – Lessee and Lessor
Amortization Schedule for the Lease
Date
1/1/13
1/1/13
12/31/13
12/31/14
12/31/15
12/31/16
12/31/17
Payment
$ 100,000
100,000
100,000
100,000
100,000
100,000
$ 600,000
Effective
Interest
$
Decrease in
Balance
$ 100,000
37,908
62,092
31,699
68,301
24,869
75,131
17,355
82,645
9,090 *
90,910
$ 120,921
$ 479,079
Outstanding
Balance
$ 479,079
379,079
316,987
248,686
173,554
90,910
-
*Rounded.
$379,079 × 10% =
$37,908
$100,000 - $37,908 = $62,092
$379,079 - $62,092 = $316,987
15-18
Capital Leases – Lessee and Lessor
Second Lease Payment (December 31, 2013)
Sans Serif Publishers, Inc. (Lessee)
Interest expense
Lease payable
Cash
First LeaseCorp. (Lessor)
Cash
Lease receivable
Interest revenue
37,908
62,092
100,000
100,000
62,092
37,908
Depreciation Recorded at (December 31, 2013)
Sans Serif Publishers, Inc. (Lessee)
Depreciation expense
Accumulated depreciation
79,847
($479,079 ÷ 6 = $79,847 Assuming straight-line method.)
79,847
15-19
Capital Leases – Lessee and Lessor
Depreciation Period
The lessee normally should depreciate a
leased asset over the term of the lease.
However, if ownership transfers or a
bargain purchase option is present (i.e.,
either of the first two classification criteria is
met), the asset should be depreciated over
its useful life.
15-20
Sales-Type Leases
If the lessor is a manufacturer or dealer, the fair
value of the leased asset generally is higher than the
cost of the asset.
At inception of the lease, the lessor will
record the cost of goods sold as well as the
sales revenue (PV of payments).
In addition to interest revenue earned over the
lease term, the lessor receives a manufacturer’s
or dealer’s profit on the “sale” of the asset.
15-21
Sales-Type Leases
On January 1, 2013, Sans Serif Publishers, Inc., leased printing
equipment from CompuDec Corp. at a price of $479,079.
The lease agreement specifies annual payments of $100,000
beginning January 1, 2013 (the inception of the lease), and at
each December 31 thereafter through 2017. The six-year
lease term ending December 31, 2018, is equal to the
estimated useful life of the equipment.
CompuDec manufactured the equipment at a cost of
$300,000.
CompuDec’s interest rate for financing the transaction
is10%.
15-22
Sales-Type Leases
Lease Classification
1. The lease term (6-years) is equal to 100% of the useful life of
the copier, and
2. Fair market value is different from cost of the leased asset.
3. CompuDec is certain about the collectibility of the lease
payments, and
4. No costs are to be incurred by CompuDec relating to the
lease agreement,
SO
The lease agreement is classified as a sales-type lease from the
viewpoint of CompuDec (lessor) and a capital lease from the
viewpoint of Sans Serif Publishers (lessee).
15-23
Sales-Type Leases: Lessee
At Inception of the Lease – January 1, 2013
CompuDec Corp. (Lessor)
Lease receivable
Cost of goods sold
Sales revenue
Inventory of equipment
479,079
300,000
479,079
300,000
Receipt of the First Lease Payment – January 1, 2013
CompuDec Corp. (Lessor)
Cash
Lease receivable
100,000
100,000
Bargain Purchase Options
and Residual Value
A bargain purchase option (BPO) is a provision of some
lease contracts that gives the lessee the option of
purchasing the leased property at a bargain price. The
expectation that the option price will be paid effectively
adds an additional cash flow to the lease for both the
lessee and the lessor. As a result:
LESSEE adds the present value of the BPO price to the present value of
periodic rental payments when computing the amount to be recorded a
leased asset and a lease liability.
LESSOR, when computing periodic rental payments, subtracts the present
value of the BPO price from the amount to be recovered (fair value) to
determine the amount that must be recovered from the lessee through the
periodic rental payments.
15-24
15-25
Bargain Purchase Option (BPO)
On January 1, 2013, Sans Serif Publishers, Inc., leased printing equipment from
CompuDec Corporation at a price of $479,079. The lease agreement specifies
annual payments beginning January 1, 2013, the inception of the lease, and at
each December 31 there after through 2017. The estimated useful life of the
equipment is seven years. On December 31, 2018, at the end of the six-year lease
term, the equipment is expected to be worth $75,000, and Sans Serif has the
option to purchase it for $60,000 on that date. The residual value after seven
years is zero. CompuDec manufactured the equipment at a cost of $300,000 and
its interest rate for financing the transaction is10%.
Lessee's calculation of PV of MLP:
PV of periodic payments
$ 92,931 ×
Plus: PV of BPO
60,000 ×
PV of MLP
4.79079 = $ 445,211
0.56447 =
33,868
$ 479,079
Lessor's calculation of rental payments:
Fair market value of asset
$ 479,079
Less: PV of BPO
$ 60,000 × 0.56447 =
(33,868)
Amount recoverd through payments
$ 445,211
PV annuity due factor, n = 6, I = 10%
÷
4.79079
Rental payments at beginning of period
$ 92,931
15-26
Bargain Purchase Option (BPO)
Date
1/1/13
1/1/13
12/31/13
12/31/14
12/31/15
12/31/16
12/31/17
Payment
$
92,931
92,931
92,931
92,931
92,931
92,931
$ 557,586
Effective
Interest
$
38,615
33,183
27,208
20,636
13,407
$ 133,049
Decrease in
Balance
$
92,931
54,316
59,748
65,723
72,295
79,524
$ 424,537
Exercise of BPO at the end of the lease term:
$54,542 × 10% = $5,458*
$60,000 BPO payment - $5,458 = $54,542
Outstanding
Balance
$ 479,079
386,148
331,832
272,084
206,361
134,067
54,542
15-27
Bargain Purchase Option (BPO)
End of Lease – December 31, 2017
Sans Serif Publishers, Inc. (Lessee)
Depreciation expense ($479,079 ÷ 7)
Accumulated depreciation
Interest expense
Lease payable
Cash (BPO payment)
CompuDec Corporation(Lessor)
Cash
Lease receivable
Interest revenue
Refer the amortization schedule and
computations on the previous screen
68,440
68,440
5,458
54,542
60,000
60,000
54,582
5,458
15-28
Residual Value
The residual value of leased property is an estimate of what
its commercial value will be at the end of the lease term.
On January 1, 2013, Sans Serif Publishers, Inc., leased printing
equipment from CompuDec Corporation at a price of $479,079. The
lease agreement specifies annual payments beginning January 1, 2013,
the inception of the lease, and at each December 31 thereafter through
2017.The estimated useful life of the equipment is seven years. At the
end of the six-year lease term, ending December 31, 2018, the
equipment is expected to be worth $60,000. CompuDec manufactured
the equipment at a cost of $300,000 and its interest rate for financing
the transaction is10%.
15-29
Effect on the Lessee of a Residual Value
Guaranteed Residual Value
Sometimes the lease agreement includes a guarantee by the lessee
that the lessor will recover a specified residual value when custody of
the asset reverts back to the lessor at the end of the lease term. This
not only reduces the lessor’s risk but also provides incentive for the
lessee to exercise a higher degree of care in maintaining the leased
asset to preserve the residual value.
Lessee's calculation of PV of MLP:
PV of periodic payments $ 92,931 ×
Plus: PV of residual value
60,000 ×
PV of MLP
PV factor of an annuity due of $1: n=6, i=10%
4.79079 = $ 445,211
0.56447 =
33,868
$ 479,079
PV factor of $1: n=6, i=10%
15-30
Effect on the Lessee of a Residual Value
Unguaranteed Residual Value
A lease agreement may be silent as to the question of
residual value. This is referred to as an unguaranteed
residual value. In the case of unguaranteed residual
value, the lessee is not obligated to make any payments
other than the periodic rental payments. As a result, the
present value of the minimum lease payments — recorded
as a leased asset and a lease liability — is simply the
present value of periodic rental payments ($445,211). The
same is true when the residual value is guaranteed by a
third-party guarantor such as an insurance company.
Effects on the Lessor of a Residual
Value
Guaranteed Residual Value
When the residual value is guaranteed, the lessor as well as the
lessee views it as a component of minimum lease payments. In fact,
even if it is not guaranteed, the lessor still expects to receive it in the
form of property, or cash, or both.
Lessor's calculation of rental payments:
Fair market value of asset
$ 479,079
Less: PV of residual value $ 60,000 × 0.56447 =
(33,868)
Amount recoverd through payments
$ 445,211
PV annuity due factor, n = 6, I = 10%
÷
4.79079
Rental payments
$ 92,931
15-31
15-32
Residual Value Guaranteed
Let’s use our previous example of a sales-type lease and replace
the bargain purchase option with a guaranteed residual value.
Sales-Type Lease – January 1, 2013
Sans Serif Publishers, Inc. (Lessee)
Leased equipment
479,079
Lease payable
479,079
CompuDec Corporation (Lessor)
Lease receivable
479,079
Cost of goods sold
300,000
Sales revenue
Inventory of equipment
479,079
300,000
15-33
Residual Value Guaranteed
First Lease Payment – January 1, 2013
Sans Serif Publishers, Inc. (Lessee)
Lease payable
92,931
Cash
92,931
CompuDec Corporation (Lessor)
Cash
92,931
Lease receivable
92,931
15-34
Residual Value Guaranteed
December 31, 2017
Sans Serif Publishers, Inc. (Lessee)
Depreciation expense
69,847
Accumulation depreciation
69,847
Interest expense
Lease payable
Cash
Recorded cost of leased asset
$ 479,079
Guarantted residual value
(60,000)
Basis for depreciation
419,079
Useful life in years
÷
6
Annual depreciation
$ 69,847
13,407
79,524
92,931
CompuDec Corporation (Lessor)
Cash
92,931
Interest revenue
13,407
Lease receivable
79,524
See amortization
schedule
15-35
Treatment of Residual Value
Residual value in leased asset?
Lessee gets the residual value (by transfer of
title or a BPO)
Lessor gets the residual value (title does not
transfer; no BPO)
Residual value is not guaranteed.
Residual value is guaranteed by lessee.
Residual value is guaranteed by a third party.
Lessor
Computation of
Minimum Lease
Lease Payment
Payment
Lessee
Minimum Lease
Payment
No
No
No
Yes
Yes
Yes
No
Yes
Yes
No
Yes
No
15-36
Executory Costs
One of the responsibilities of ownership that is
transferred to the lessee in a capital lease is the
responsibility to pay for maintenance, insurance,
taxes, and any other costs associated with
ownership. These are referred to as executory
costs.
The lessee records executory costs as incurred:
Sans Serif Publishers, Inc. (Lessee)
Maintenance expense
2,000
Cash
2,000
15-37
Discount Rate
One rate is implicit in the lease agreement. This is the
effective interest rate the lease payments provide the
lessor over and above the price at which the asset is
sold under the lease. It is the desired rate of return the
lessor has in mind when deciding the size of the lease
payments. Usually the lessee is aware of the lessor’s
implicit rate or can infer it from the asset’s fair value.
When the lessor’s implicit rate is unknown, the lessee
should use its own incremental borrowing rate. This is
the rate the lessee would expect to pay a bank if funds
were borrowed to buy the asset.
15-38
Lessor’s Initial Direct Costs



Incremental costs incurred by the lessor in negotiating and
consummating a lease agreement.
Operating Leases − Capitalize and amortize over the lease
term by the lessor.
Direct Financing Leases − Include as part of investment
balance.
Sales-Type Leases – The initial direct costs are expensed at
the inception of the lease.
15-39
Contingent Rentals
Sometimes rental payments may be increased
(or decreased) at some future time during
the lease term, depending on whether some
specified event occurs.
Contingent rentals are not included in the
minimum lease payments. However, they are
disclosed in the notes to the financial
statements.
15-40
Lease Disclosures
Lease disclosure requirements are quite extensive for
both the lessor and lessee. Virtually all aspects of the
lease agreement must be disclosed. For all leases (a) a
general description of the leasing arrangement is
required as well as (b) minimum future payments, in the
aggregate and for each of the five succeeding fiscal
years.
15-41
Lease Disclosures
The lessor must disclose its net investment in
the lease. This amount is the present value of the gross
investment in the lease, which is the total of the minimum
lease payments (plus any unguaranteed residual value).
Other required disclosures are specific to the type of lease
and include residual values, contingent rentals, sublease
rentals, and executory costs.
Balance Sheet and
Income Statement
Lease transactions impact several financial ratios
1. Debt to equity ratio – Lease liabilities are
recorded.
2. Rate of return on assets – Lease assets are
recorded.
Whether leases are capitalized or treated as an
operating lease affects the income statement and
balance sheet. The greater impact is on the
balance sheet.
15-42
15-43
Special Leasing Arrangements
1. Sale-Leaseback Arrangements – the owner of
an asset sells it and immediately leases it back
from the new owner. Any gain on the sale of
the asset is deferred and amortized. A real loss
on the sale of the property is recognized
immediately.
2. Real Estate Leases:
• Leases of Land Only
• Leases of Land and Building
• Leases of Only Part of a Building
Summary of the Proposed
Lease Standard Update
15-45
Leases: Where We’re Headed
The FASB and the IASB are collaborating on a joint Exposure Draft of
the new leases standard update.
Even after the proposed Accounting Standard Update (proposed
ASU) is issued, previous GAAP will be relevant until the proposed ASU
becomes effective (likely not mandatory before 2016) and students
taking the CPA or CMA exams will be responsible for the previous
GAAP until six months after that effective date. Conversely, prior to
the effective date of the proposed Accounting Standard Update it is
useful for soon-to-be graduates to have an understanding of the new
guidance on the horizon.
In the right-of-use model introduced in the proposed standards
update, all leases are recorded as an asset and liability (with the
exception of short term leases as described later), and the concept of
operating leases is eliminated.
15-46
Right-of-Use Model
15-47
Lessee and Lessor Entries
15-48
Second Lease Payment
Effective Rate
[Dec. 31, 2013]
Outstanding Balance
15-49
Lease Amortization Schedule
0
No interest yet; no time
has passed.
Amortization of the Right-of-Use Asset
(Lessee)
 The
lessee amortizes its right-of-use asset over lease term (or
the useful life of the asset if it’s shorter).
 Using the asset results in an expense for the lessee.
15-50
15-51
When the Lessor Retains a Residual Asset
On January 1, 2013, Sans Serif Publishers leased printing equipment
from First LeaseCorp who purchased the equipment from
CompuDec Corporation at its fair value of $479,079.
Now assume
4 annual payments of $100,000 beginning January 1, 2013, and at
each December 31 through 2015.
Useful life of the equipment is 6 years.
Lessor calculated payments using a rate of 10%.
15-52
When the Lessor Retains a Residual Asset
Commencement of Lease [Jan. 1, 2013]
Only a portion of the right to use the asset is being transferred. Accordingly, a portion is being
retained. The portion transferred is:
15-53
When the Lessor Retains a Residual Asset
15-54
Second Lease Payment [Dec. 31, 2013]
Outstanding Balance
Effective Rate
15-55
Lease Amortization Schedule
0
No interest yet; no time
has passed.
Lessee: Amortization of ROU Asset
Lessor: Accretion of the Residual Asset


The lessee incurs an expense as it uses the asset.
The lessor will record accretion of the residual asset using the interest rate
implicit in the agreement (10%).
15-56
15-57
Accretion? Why?
Consider this:
To determine the lease payments, the lessor subtracts from fair value the present
value of the four-years-away residual value:
Asset’s residual value at
end of 4-yr lease term
How does the lessor recover its $479,079 investment?
15-58
Accretion? Why?
So, First LeaseCorp expects to recover its $479,079 investment as follows:
At
commencement of the lease, the lessor recorded its residual asset at
$130,394. At the end of the lease term, that amount will have risen to $190,911.
The process of increasing the asset’s balance is called accretion. Since $130,394
is the PV of $190,911 discounted at 10%, the balance (PV) will increase
annually by 10%.
15-59
Accretion? Why?
The residual asset accretes at the 10% discount rate to its anticipated value at
the end of the lease term:
First LeaseCorp earns a 10% rate of return on both the portion of its asset transferred
(interest revenue) and the portion retained as a residual asset (accretion revenue).
Lease’s Effect on the Income of Lessee
And Lessor
15-60
The residual asset accretes at the 10% discount rate to its anticipated value at
the end of the lease term:
When the Lessor Earns a Profit from the
Lease


15-61
All lessor entries other than this one, which now includes the profit, are precisely the
same as when there is no profit.
Accounting by the lessee is not affected by how the lessor records the lease.
When the Lessor Earns a Profit and
Retains a Residual Asset
15-62
When the Lessor Earns a Profit and
Retains a Residual Asset
6 payments of $88,218; asset’s cost $300,000; FV $479,079. The equipment is
expected to have a fair value of $100,000 at lease end.
15-63
15-64
Accretion of the Residual Asset
When there is profit in a lease, the carrying amount of the residual asset (the $35,347 portion of the
equipment retained) is less than the fair value of the residual asset ($56,447). The difference ($56,447
– 35,347 = $21,100) is the deferred profit on the portion of the asset not transferred.
To record accretion of the residual asset from its current fair value to its anticipated
fair value at the end of the lease term, first increase the balance of the residual asset from its carrying
amount to its current fair value at the commencement of the lease:
We also can view the deferred profit as the portion of the total profit if the equipment were to have
been transferred in its entirety minus the profit actually recognized currently:
Total profit (479,079 – 300,000)
$179,079
Less: Profit recognized at commencement
(157,979)
Deferred profit
$ 21,100
15-65
Accretion of the Residual Asset
CompuDec will report a “net residual asset” in the balance sheet, which is the
“gross residual asset” offset by the deferred profit. So, initially the reportable
amount is:
But since the gross amount is accreted (increased) over the term of the
lease, the reported amount (equal to the gross amount minus deferred profit)
increases as well.
15-66
Accretion of the Residual Asset
The balance in the gross residual asset accretes at the 10% discount rate to its
anticipated value at the end of the lease term.
15-67
Accretion of the Residual Asset
To help visualize the relationship among the different ways to measure the
residual asset as of the commencement of the lease:
15-68
Summary of Lessee / Lessor Accounting
Lessee
Right-of-use asset (present value of payments)
Lease liability (present value of payments)
xxx
xxx
Lessor
Lease receivable (present value of payments)
xxx
Residual asset (carrying amount of portion retained, if any *) xx
Asset (carrying amount: derecognized)
xxx
Profit (difference, if any, between the PV of lease payments
and the carrying amount transferred*) xx
* Carrying amount of asset x [Lease receivable / Fair value of asset] = Amount transferred
Carrying amount of asset – Amount transferred
= Residual asset
* In the rare instance that this is a debit difference, we would have a loss rather than profit. Also, only recognize
profit if it is “reasonably assured”. Otherwise, defer and recognize over life of lease.
15-69
Discount Rate
In calculating the PV of the payments, the discount
rate used by the lessee is:
The rate the lessor charges the lessee (rate that
causes the sum of PV of lease payments and the PV
of the residual value of the underlying asset to
equal the fair value of the asset today).
•If the lessor’s rate is not known, use the lessee’s
incremental borrowing rate.
15-70
Initial Direct Costs
 Costs associated directly with originating a
lease that would not have been incurred had
the lease agreement not occurred are.
 Include legal fees, commissions, evaluating
the prospective lessee’s financial condition,
and preparing and processing lease
documents.
 Added to the carrying amount of the right-ofuse asset if incurred by the lessee or to the
lease receivable if incurred by the lessor.
15-71
What if the Lease Term is Uncertain?
 The
lease term is the non-cancellable period, plus any
options where there is a “significant economic
incentive” to extend or not terminate the lease.
 Factors that might create an economic incentive for the
lessee include bargain renewal rates, penalty payments
for cancellation or non-renewal and economic penalties
such as significant customization or installment costs.
15-72
What if the Lease Payments are Uncertain?
Lease payments include:
 payments that depend on an index or rate
(e.g., increase with inflation rate)
 contingent
payments that are “reasonably assured.”
15-73
Guaranteed Residual Value
 If
a cash payment under a lessee-guaranteed residual value is
predicted, the present value of that payment is added to the
present value of the lease payments the lessee records as both a
right-of-use asset and a lease liability.
 Likewise, it also adds to the amount that the lessor records as a
lease receivable.
 It is simply seen as an additional lease payment.
Short-Term Leases – A Short-Cut
Method
A
lease that has a maximum possible lease term (including any options to renew)
of 12 months or less is a “short-term lease.”
 Lease-by-lease option to choose a short-cut approach.
Lessee can elect:
not to recognize a right-of-use asset or a lease liability.
to recognize lease payments as expense over the lease term.
Lessor can elect:
not to record the lease receivable or to derecognize the asset being leased.
to recognize lease payments as revenue over the lease term.
15-74
15-75
End of Chapter 15