INTERMEDIATE
F I F T E E N T H
E D I T I O N
Intermediat
ACCOUNTING
Intermediat
e
e
Accounting
Accounting
21-1
Prepared by
Coby Harmon
Prepared by
University of California,
BarbaraPrepared by
CobySanta
Harmon
Harmon
Westmont
College SantaCoby
University
of California,
Barbara
University of California, Santa Barbara
Westmont College
kieso
weygandt
warfield
team for success
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,
and advantages of lease transactions.
5.
Describe the lessor’s accounting for directfinancing leases.
2.
Describe the accounting criteria and
procedures for capitalizing leases by the
lessee.
6.
Identify special features of lease
arrangements that cause unique accounting
problems.
3.
Contrast the operating and capitalization
methods of recording leases.
7.
4.
Explain the advantages and economics of
leasing to lessors and identify the
classifications of leases for the lessor.
Describe the effect of residual values,
guaranteed and unguaranteed, on lease
accounting.
8.
Describe the lessor’s accounting for salestype 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:
21-5

Information technology equipment

Transportation (trucks, aircraft, rail)

Construction

Agriculture
LO 1
The Leasing Environment
21-6
Illustration 21-2
What Do Companies
Lease?
LO 1
The Leasing Environment
Who Are the Players?
Banks
► Wells Fargo
► Chase
► Citigroup
Independents
► International
Lease Finance
Corp.
Financial
Services Corp.
Credit (Ford)
23%
21-7
► Caterpillar
► Ford Motor
► PNC
47%
Captive
Leasing
Companies
Market Share
► IBM Global
Financing
26%
LO 1
The Leasing Environment
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
The Leasing Environment
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
21
Accounting for Leases
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Explain the nature, economic substance,
and advantages of lease transactions.
5.
Describe the lessor’s accounting for directfinancing leases.
2.
Describe the accounting criteria and
procedures for capitalizing leases by the
lessee.
6.
Identify special features of lease
arrangements that cause unique accounting
problems.
3.
Contrast the operating and capitalization
methods of recording leases.
7.
4.
Explain the advantages and economics of
leasing to lessors and identify the
classifications of leases for the lessor.
Describe the effect of residual values,
guaranteed and unguaranteed, on lease
accounting.
8.
Describe the lessor’s accounting for salestype leases.
9.
List the disclosure requirements for leases.
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
21-12
Illustration 21-2
LO 2
Accounting by the Lessee
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
payments (excluding executory costs)
equals or exceeds 90 percent of the fair
value of the leased property.
21-13
One or more
must be met
for capital
lease
accounting.
LO 2
Accounting by the Lessee
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
Accounting by the Lessee
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
Accounting by the Lessee
Capitalization Criteria
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
Accounting by the Lessee
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.
21-17
Advance slide in presentation
mode to reveal answer.
LO 2
Accounting by the Lessee
Capitalization Criteria
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:
21-18

Insurance

Maintenance

Taxes
Exclude from present value of
Minimum Lease Payment
Calculation
LO 2
Accounting by the Lessee
Capitalization Criteria
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
Accounting by the Lessee
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
Accounting by the Lessee
Asset and Liability Accounted for Differently
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
Accounting by the Lessee
Asset and Liability Accounted for Differently
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
Accounting by the Lessee
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
Accounting by the Lessee
What type of lease is this?
Capital Lease?
Capitalization Criteria:
1. Transfer of ownership
2. Bargain purchase option
21-24
NO
NO
3. Lease term = 75% of
economic life of leased
property
Lease term = 5 yrs.
Economic life = 5 yrs.
YES
4. Present value of minimum
lease payments => 90% of
FMV of property
PV = $100,000
FMV = $100,000.
YES
LO 2
Accounting by the Lessee
Compute present value of the minimum lease payments.
Payment
$ 25,981.62
Property taxes (executory cost)
-
Minimum lease payment
2,000.00
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
Accounting by the Lessee
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
Lease Liability
Cash
21-26
2,000.00
23,981.62
25,981.62
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
Accounting by the Lessee
Illustration 21-6
Lease Amortization
Schedule for Lessee—
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
21-28
7,601.84
LO 2
Accounting by the Lessee
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
Accounting by the Lessee
Illustration 21-6
Lease Amortization
Schedule for Lessee—
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
Lease Liability
Cash
21-30
16,379.78
25,981.62
LO 2
Accounting by the Lessee
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
Cash
21-31
25,981.62
25,981.62
LO 2
21
Accounting for Leases
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Explain the nature, economic substance,
and advantages of lease transactions.
5.
Describe the lessor’s accounting for directfinancing leases.
2.
Describe the accounting criteria and
procedures for capitalizing leases by the
lessee.
6.
Identify special features of lease
arrangements that cause unique accounting
problems.
3.
Contrast the operating and capitalization
methods of recording leases.
7.
4.
Explain the advantages and economics of
leasing to lessors and identify the
classifications of leases for the lessor.
Describe the effect of residual values,
guaranteed and unguaranteed, on lease
accounting.
8.
Describe the lessor’s accounting for salestype leases.
9.
List the disclosure requirements for leases.
21-32
Accounting by the Lessee
Illustration 21-8
Comparison of Charges
to Operations—Capital
vs. Operating Leases
Differences using a capital lease instead of an operating lease.
21-33
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.
LO 3
21-34
LO 3
21
Accounting for Leases
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Explain the nature, economic substance,
and advantages of lease transactions.
5.
Describe the lessor’s accounting for directfinancing leases.
2.
Describe the accounting criteria and
procedures for capitalizing leases by the
lessee.
6.
Identify special features of lease
arrangements that cause unique accounting
problems.
3.
Contrast the operating and capitalization
methods of recording leases.
7.
4.
Explain the advantages and economics of
leasing to lessors and identify the
classifications of leases for the lessor.
Describe the effect of residual values,
guaranteed and unguaranteed, on lease
accounting.
8.
Describe the lessor’s accounting for salestype leases.
9.
List the disclosure requirements for leases.
21-35
Accounting by the Lessor
Benefits to the Lessor
1. Interest revenue.
2. Tax incentives.
3. High residual value.
21-36
LO 4
Accounting by the Lessor
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
Accounting by the Lessor
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.
21-38
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.
LO 4
Accounting by the Lessor
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
21-39
$
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
LO 4
Accounting by the Lessor
Classification of Leases by the Lessor
a. Operating leases.
b. Direct-financing leases.
c. Sales-type leases.
21-40
LO 4
Accounting by the Lessor
Classification of Leases by the Lessor
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
Accounting by the Lessor
Classification of Leases by the Lessor
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
21
Accounting for Leases
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Explain the nature, economic substance,
and advantages of lease transactions.
5.
Describe the lessor’s accounting for directfinancing leases.
2.
Describe the accounting criteria and
procedures for capitalizing leases by the
lessee.
6.
Identify special features of lease
arrangements that cause unique accounting
problems.
3.
Contrast the operating and capitalization
methods of recording leases.
7.
4.
Explain the advantages and economics of
leasing to lessors and identify the
classifications of leases for the lessor.
Describe the effect of residual values,
guaranteed and unguaranteed, on lease
accounting.
8.
Describe the lessor’s accounting for salestype leases.
9.
List the disclosure requirements for leases.
21-43
Accounting by the Lessor
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
Accounting by the Lessor
E21-10: Amortization schedule for the lessor.
21-45
LO 5
Accounting by the Lessor
E21-10:
Prepare all of the
journal entries for
the lessor for 2014
and 2015.
1/1/14
Lease Receivable
245,000
Equipment
Cash
Lease Receivable
21-46
245,000
46,000
46,000
LO 5
Accounting by the Lessor
E21-10:
Prepare all of the
journal entries for
the lessor for 2014
and 2015.
12/31/14
Interest Receivable
19,900
Interest Revenue
1/1/15
21-47
Cash
19,900
46,000
Lease Receivable
26,100
Interest Receivable
19,900
Accounting by the Lessor
E21-10:
Prepare all of the
journal entries for
the lessor for 2014
and 2015.
12/31/15
Interest Receivable
Interest Revenue
21-48
17,290
17,290
LO 5
Accounting by the Lessor
Operating Method (Lessor)
21-49

Records each rental receipt as rental revenue.

Depreciates leased asset in the normal manner.
LO 5
Accounting by the Lessor
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
Accumulated Depreciation
21-50
33,063
33,063
LO 5
21
Accounting for Leases
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Explain the nature, economic substance,
and advantages of lease transactions.
5.
Describe the lessor’s accounting for directfinancing leases.
2.
Describe the accounting criteria and
procedures for capitalizing leases by the
lessee.
6.
Identify special features of lease
arrangements that cause unique accounting
problems.
3.
Contrast the operating and capitalization
methods of recording leases.
7.
4.
Explain the advantages and economics of
leasing to lessors and identify the
classifications of leases for the lessor.
Describe the effect of residual values,
guaranteed and unguaranteed, on lease
accounting.
8.
Describe the lessor’s accounting for salestype leases.
9.
List the disclosure requirements for leases.
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
21
Accounting for Leases
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Explain the nature, economic substance,
and advantages of lease transactions.
5.
Describe the lessor’s accounting for directfinancing leases.
2.
Describe the accounting criteria and
procedures for capitalizing leases by the
lessee.
6.
Identify special features of lease
arrangements that cause unique accounting
problems.
3.
Contrast the operating and capitalization
methods of recording leases.
7.
4.
Explain the advantages and economics of
leasing to lessors and identify the
classifications of leases for the lessor.
Describe the effect of residual values,
guaranteed and unguaranteed, on lease
accounting.
8.
Describe the lessor’s accounting for salestype leases.
9.
List the disclosure requirements for leases.
21-53
Special Lease Accounting Problems
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
Special Lease Accounting Problems
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
Special Lease Accounting Problems
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
Special Lease Accounting Problems
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
21-57
Advance slide in presentation
mode to reveal answer.
LO 7
Special Lease Accounting Problems
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
Guaranteed Residual Value (Lessee)
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
Guaranteed Residual Value (Lessee)
Illustration 21-19
Loss on Capital Lease
Interest Expense (or Interest Payable)
Lease Liability
Accumulated Depreciation—Capital Leases
Leased Equipment (under capital leases)
Cash
21-61
2,000.00
454.76
4,545.24
95,000.00
100,000.00
2,000.00
LO 7
Special Lease Accounting Problems
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
Special Lease Accounting Problems
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
Lessor Accounting for Residual Value
Illustration 21-25
21-67
LO 7
Lessor Accounting for Residual Value
Illustration 21-25
Caterpillar would
make the following
entries for this
direct-financing
lease in the first
year.
1/1/14
Lease Receivable
Equipment
21-68
100,000
100,000
LO 7
Lessor Accounting for Residual Value
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
Property Tax Expense/Property Taxes Payable
21-69
23,237.09
2,000.00
LO 7
Lessor Accounting for Residual Value
Illustration 21-25
Caterpillar would
make the following
entries for this
direct-financing
lease in the first
year.
12/31/14 Lease Receivable
Interest Revenue
21-70
7,676.29
7,676.29
LO 7
21
Accounting for Leases
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Explain the nature, economic substance,
and advantages of lease transactions.
5.
Describe the lessor’s accounting for directfinancing leases.
2.
Describe the accounting criteria and
procedures for capitalizing leases by the
lessee.
6.
Identify special features of lease
arrangements that cause unique accounting
problems.
3.
Contrast the operating and capitalization
methods of recording leases.
7.
4.
Explain the advantages and economics of
leasing to lessors and identify the
classifications of leases for the lessor.
Describe the effect of residual values,
guaranteed and unguaranteed, on lease
accounting.
8.
Describe the lessor’s accounting for salestype leases.
9.
List the disclosure requirements for leases.
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Special Lease Accounting Problems
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.

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There is a difference in accounting for guaranteed and
unguaranteed residual values.
LO 8
Sales-Type Leases (Lessor)
Direct-Financing versus Sales-Type Leases
Illustration 21-27
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LO 8
Sales-Type Leases (Lessor)
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LO 8
Sales-Type Leases (Lessor)
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.
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LO 8
Sales-Type Leases (Lessor)
Computation of Lease Amounts by Caterpillar
Financial—Sales-Type Lease
21-76
Illustration 21-28
LO 8
Sales-Type Leases (Lessor)
Comparative
Entries
Illustration 21-29
21-77
LO 8
21-78
LO 8
Special Lease Accounting Problems
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.
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LO 8
Special Lease Accounting Problems
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.
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LO 8
Special Lease Accounting Problems
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.
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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.
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LO 8
21
Accounting for Leases
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Explain the nature, economic substance,
and advantages of lease transactions.
5.
Describe the lessor’s accounting for directfinancing leases.
2.
Describe the accounting criteria and
procedures for capitalizing leases by the
lessee.
6.
Identify special features of lease
arrangements that cause unique accounting
problems.
3.
Contrast the operating and capitalization
methods of recording leases.
7.
4.
Explain the advantages and economics of
leasing to lessors and identify the
classifications of leases for the lessor.
Describe the effect of residual values,
guaranteed and unguaranteed, on lease
accounting.
8.
Describe the lessor’s accounting for salestype leases.
9.
List the disclosure requirements for leases.
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Special Lease Accounting Problems
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.
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LO 9
21-86
LO 9
21-87
LO 9
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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
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LO 10 Describe the lessee’s accounting for sale-leaseback transactions.
APPENDIX
21A
SALE-LEASEBACKS
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.

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Gain or loss recognition is appropriate.
LO 10
APPENDIX
21A
SALE-LEASEBACKS
Lessee
If the lease meets one of the four criteria for treatment as a
capital lease, the seller-lessee should
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
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 .
LO 10
APPENDIX
21A
SALE-LEASEBACKS
Lessee
If none of the capital lease criteria are satisfied, the sellerlessee 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.
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LO 10
APPENDIX
21A
SALE-LEASEBACKS
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.
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LO 10
APPENDIX
21A
SALE-LEASEBACKS
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.
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5.
The annual payments assure the lessor a 12 percent return.
6.
American’s incremental borrowing rate is 12 percent.
LO 10
APPENDIX
21A
SALE-LEASEBACKS
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.
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LO 10
APPENDIX
Illustration
21A-1
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21A
SALE-LEASEBACKS
RELEVANT FACTS - Similarities
21-97

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.
LO 11 Compare the accounting for leases under GAAP and IFRS.
RELEVANT FACTS - Differences
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
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.
LO 11
RELEVANT FACTS - Differences
21-99

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.
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.
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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.
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LO 11
IFRS SELF-TEST QUESTION
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.
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LO 11
IFRS SELF-TEST QUESTION
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.
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LO 11
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