Chapter 15 Leasestestbankeasy.eu/sample/Solution Manual for Intermediate... · Web view2016. 10. 29. · Chapter 15 Leases . QUESTIONS FOR REVIEW OF KEY TOPICS. Question 15-1. Regardless

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QUESTIONS FOR REVIEW OF KEY TOPICSRegardless of the legal form of the agreement, a lease is accounted

for as either a rental agreement or a purchase/sale accompanied by debt financing depending on the substance of the leasing arrangement. Capital leases are agreements that are formulated outwardly as leases, but that are in reality installment purchases. Professional judgment is needed to differentiate between leases that represent “rental agreements” and those that in reality are “installment purchases/sales.” The FASB provides guidance for distinguishing between the two fundamental types of leases.

Periodic interest expense is calculated by the lessee as the effective interest rate times the amount of the outstanding lease payable during

the period. This same principle applies to the flip side of the transaction, i.e., the lessor’s lease receivable (net investment). The approach is the same regardless of the specific form of the debt – that is, whether in the form of notes, bonds, leases, pensions, or other debt instruments.

Leases and installment notes are very similar. The fundamental nature of the transaction remains the same regardless of whether it is

negotiated as an installment purchase or as a lease. In return for providing financing, the borrower (lessee) pays interest over the maturity (lease term). Conceptually, leases and installment notes are accounted for in precisely the same way.

Current GAAP does allow airlines' balance sheets to appear as if the companies don't have airplanes. That’s because most airlines

extensively use operating leases to “acquire” airplanes. Under current rules, under operating leases, unlike capital leases, neither the leased asset nor the lease payable is reported in the balance sheet.

The criteria are: (1) the agreement specifies that ownership of the asset transfers to the lessee, (2) the agreement contains a bargain purchase option, (3) the lease term is equal to 75% or more of the expected economic life of the asset, or (4) the present value of the minimum lease payments is equal to or greater than 90% of the fair value of the leased asset.

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Chapter 15 Leases

Question 15-1

Question 15-2

Question 15-3

Question 15-4

Answers to Questions (continued)

Question 15-5

A bargain purchase option is a provision in the lease contract that gives the lessee the option of purchasing the leased property at a

“bargain” price – defined as a price sufficiently lower than the expected fair value of the property when the option becomes exercisable that the exercise of the option appears reasonably assured at the inception of the lease. Because exercise of the option appears reasonably assured, transfer of ownership is expected.

The lease is a capital lease to Seminole because the present value of the minimum lease payments ($5.2 million) is greater than 90% of the

fair value of the asset (90% x $5.6 million = $5.04 million). Since the additional lessor conditions also are met, it is a capital lease to Lukawitz. Furthermore, it is a sales-type lease because the present value of the minimum lease payments exceeds the lessor’s cost.

Yes. The minimum lease payments for the lessee exclude any residual value not guaranteed by the lessee. On the other hand, the

lessor includes any residual value not guaranteed by the lessee but guaranteed by a third-party guarantor. Even when minimum lease payments are the same, their present values will differ if the lessee uses a discount rate different from the lessor’s implicit rate. This would occur if the lessee is unaware of the implicit rate or if the implicit rate exceeds the lessee’s incremental borrowing rate.

The way a bargain purchase option is included in determining minimum lease payments is precisely the same way that a lessee-guaranteed residual value is included. The expectation that the option price will be paid effectively adds an additional cash flow to the lease. That additional payment is included as a component of minimum lease payments. It therefore is included in the computation of the amount to be capitalized (as an asset and liability) by the lessee. But, a residual value not guaranteed by the lessee is ignored.

Executory costs are costs usually associated with ownership of an asset such as maintenance, insurance, and taxes. These are

responsibilities of ownership that we assume are transferred to the lessee in a capital lease. When paid by the lessee, these expenditures are expensed by the lessee as incurred. When paid by the lessor, lease payments usually are inflated for this reason. These executory costs, including any lessor profit thereon, are excluded in

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Question 15-6

Question 15-7

Question 15-8


Question 15-9

Question 15-10

Full file at http://testbankeasy.eu/Solution-Manual-for-Intermediate-Accounting,-8th-Edition---Spicelandetermining the minimum lease payments and still are expensed by the lessee, even though paid by the lessor.

The lessor’s discount rate 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. When the lessor’s implicit rate is unknown, the lessee should use its own incremental borrowing rate. When the lessor’s implicit rate is known, the lessee should use the lower of the two rates. This is the rate the lessee would be expected to pay a bank if funds were borrowed to buy the asset.

Contingent rentals are not included in minimum lease payments but are reported in disclosure notes by both the lessor and lessee. This is because they are not determinable at the inception of the lease. They are included as components of income when (and if) the payments occur. However, increases or decreases in lease payments that are dependent only upon the passage of time are not contingent rentals; these are part of minimum lease payments.

The costs of negotiating and consummating a completed lease transaction incurred by the lessor that are associated directly with

originating a lease and are essential to acquire that lease are referred to as initial direct costs. They include legal fees, evaluating the prospective lessee's financial condition, commissions, and preparing and processing lease documents.

In an operating lease initial direct costs are recorded as prepaid expenses (assets) and amortized as an operating expense (usually

straight-line) over the lease term. This approach is due to the nature of operating leases in which rental revenue is earned over the lease term. Initial direct costs are recorded, along with depreciation and other associated costs, in the same periods as the rent revenues they help generate.

In a direct financing lease initial direct costs are amortized over the lease term. This is accomplished by offsetting lease receivable by the initial direct costs. This recognizes the initial direct costs at the same rate (that is, proportionally), as the


Question 15-11


Question 15-12

Question 15-13

Question 15-14

interest revenue to which it is related. The nature of the lease motivates this treatment. The only revenue a direct financing lease generates for the lessor is interest revenue, which is recognized over the lease term. So, initial direct costs are recorded proportionally over the term of the lease.

In a sales-type lease, GAAP requires that initial direct costs be expensed in the period of “sale” – that is, at the inception of the lease. This treatment implicitly assumes that in a sales-type lease the primary reason for incurring these costs is to facilitate the sale of the leased asset.

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. Other required disclosures are specific to the type of lease and include: residual values, contingent rentals, sublease rentals, and executory costs.

On the surface there are two separate transactions. But the seller/lessee still retains the use of the asset that it had prior to the

sale-leaseback. In reality the seller/lessee has cash from the sale and a noncancelable obligation to repay a debt. In substance, the seller/lessee simply has borrowed cash to be repaid with interest over the lease term. So “substance over form” dictates that the gain on the sale of the asset not be immediately recognized, but deferred and recognized over the term of the lease. There typically is interdependency between the lease terms and the price at which the asset is sold. Viewing the sale and the leaseback as a single transaction is consistent with the way revenue is recognized.

The FASB specified exceptions to the general classification criteria for leases that involve land because of the unlimited useful life of land and the inexhaustibility of its inherent value through use. When title passes to the lessee – through automatic title passage or bargain purchase – these leases clearly are capital in nature and should be classified as such by the lessee. However, the Board felt that there would be difficulty in applying the other two criteria. Because land has essentially an infinite life, no

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Question 15-15

Question 15-16


Question 15-17

Full file at http://testbankeasy.eu/Solution-Manual-for-Intermediate-Accounting,-8th-Edition---Spicelanlease term could possibly exceed 75 percent of its useful life, and the criterion was not applicable. The fourth criterion calls for comparing the present value of the lease payments with 90 percent of the property's fair value to determine if the lessor will recover its investment through the payments. When land is involved, the Board felt that the lease was not intended to recover the lessor's investment. Further, the lessor would have the land at the end of the lease term in essentially the same condition. Accordingly, the FASB concluded that leases involving material amounts of land should be classified as operating leases unless title passes automatically or as the result of a bargain purchase option.

The guidelines for determining when a material amount of land is involved in a lease indicate that leases involving property where land

constitutes 25 percent or more of the total value should be treated as if they are two leases. The portion of the lease attributable to the land should be treated as an operating lease while the portion attributable to the other property should be judged on its own characteristics and accounted for accordingly. If the land value is less than 25 percent of the total value of the property, no allocation needs to be made.

A leveraged lease involves significant long-term, nonrecourse financing by a third-party creditor. The lessor serves the role of a mortgage broker and earns income by serving as an agent between a company needing to acquire property and a lender looking for an investment. The lender provides enough cash to the lessor to acquire the property. The leased property is then leased to the lessee under a capital lease with lease payments applied to the note held by the lender.

A lessee accounts for a leveraged lease the same way as a nonleveraged lease. A lessor records its investment (receivable) net of the nonrecourse debt and reports income from the lease only in those years when the receivable exceeds the liability.

We can find authoritative guidance for accounting for leases under IFRS in “Leases,” International Accounting Standard No. 17, IASCF.

Yes. A finance lease under IFRS might be classified as an operating lease under U.S. GAAP. U.S. GAAP has precise guidelines

while IFRS are more “principles-based.” For instance, if the present value of minimum lease payments is 89% of the leased asset’s fair value, the lease would be


Question 15-18


Question 15-19

Question 15-20

Question 15-21

classified as an operating lease under U.S. GAAP because lease payments are less than 90% of the asset’s fair value, but 89% might be a “major portion” of the asset’s fair value and the lease classified as a finance lease under IAS No. 17.

In general, IFRS is considered to be more principles-based while U.S. GAAP is more rules-based. For example, under IFRS one situation that normally indicates a finance lease is if the noncancelable lease term is for a major portion of the expected economic life of the asset. Another is if the present value of the minimum lease payments is equal to or greater than substantially all of the fair value of the asset. With regard to lease classification, U.S. GAAP provides more precise guidelines. The lines are brighter between a capital lease and an operating lease. Meeting any one of four criteria qualify a lease as a capital lease under U.S. GAAP. Also, the specification of what constitutes a “major portion” of the useful life of an asset is much more precise. We presume, quite arbitrarily, that 75% or more of the expected economic life of the asset is an appropriate threshold point for this purpose. Often, we might consider a “major portion” to be less than 75% and classify a lease as a finance lease under IFRS that would be an operating lease under U.S. GAAP. Similarly, what constitutes “substantially all” of the fair value of the leased asset also is more precise under U.S. GAAP. The lessee is considered to have in substance purchased the asset when the present value of the minimum lease payments is equal to or greater than 90% of the fair value of the asset at the inception of the lease. IFRS does not provide a specific percentage for determining what constitutes “substantially all” of the leased asset’s fair value. Also, IFRS provides (a) a fifth indicator of a finance lease that normally leads to a finance lease and (b) three indicators that might lead to a finance lease.

The IASB and FASB are collaborating on a joint project with the intent of revising accounting standards for leases. As of 2014, the

Boards have agreed on a “right of use” model. Under this approach, the lessee recog-nizes an asset representing the right to use the leased asset for the lease term and also recognizes a corresponding liability for the lease rentals, whatever the term of the lease. The new standard might result in most, if not all, leases being recorded as an intangible asset for the right of use and a liability for the present value of the lease payments. It may eliminate operating leases. The impact of any changes will be sig-nificant; U.S. companies alone have over $1.25 trillion in operating lease obligations.

15–6

Answers to Questions (concluded)

Question 15-22

Question 15-23


When we look beyond the “form” of some lease transactions and focus on their “substance,” we find them to be, in reality, more like purchases of assets to be paid for with installment payments. When the lessee is deemed to have received the risks and rewards of ownership, we classify the arrangement as a Type A lease; otherwise, it’s a Type B lease.

Even when the risks and rewards of ownership are not transferred to the lessee, the lessee acquires the right to use the asset and will record a right-of-use (ROU) asset and lease payable for the present value of the payments (just as in a Type A lease).

A lessor records a Type B lease as if it were an operating lease under current GAAP. In a Type B lease, the lessor records no lease receivable and does not remove from its balance sheet the asset being leased. So, it records no asset and no liability, or anything that affects the balance sheet.

When accounting for a Type A lease, as lease payments are made over the term of the lease, the lessee records interest expense and the lessor records interest revenue at the effective interest rate. The lessee also records amortization expense on its right-of-use asset over the term of the lease. Because the lessor removes the asset from its books at the beginning of the lease, it would not have depreciation to record.

When accounting for a Type B lease, both the lessee and lessor record total lease expense (lessee) and lease revenue (lessor) on a straight-line basis. The lessor, having recorded no entry affecting its balance sheet at the beginning of the lease, simply records lease payments as lease revenue on a straight-line basis. The lessor continues to record depreciation on the asset being leased, which the lessor continues to report on its balance sheet in a Type B lease.


SUPPLEMENT QUESTIONS FOR REVIEW OF KEY TOPICS

Question 15-24

Question 15-25

Question 15-26

Question 15-27


Question 15-28

The lessee records its total lease expense on a straight-line basis over the term of the lease. This is accomplished by recording interest the normal way (at the effective interest rate) and then “plugging” the right-of-use asset amortization at whatever amount is needed for interest plus amortization to equal the straight-line lease payment amount. Those two components (interest and amortization) comprise a single lease expense amount reported in the income statement.

As with capital leases in current GAAP, in a Type A lease, the lessee records more expense and the lessor records more revenue early in the life of the lease. This “front loading” of lease expense and revenue occurs due to the fact that interest is higher initially than it is in the later stages of a lease (constant interest rate times a declining lease balance), while amortization expense for the lessee’s right-of-use asset remains the same straight-line amount each period. (The lessor has no depreciation expense in a Type A lease because the asset is removed from its books.)

This “front loading” is avoided in a Type B lease because both the lessee and lessor record total lease expense (lessee) and interest revenue (lessor) on a straight-line basis. The lessee records its total lease expense on a straight-line basis over the term of the lease. This is accomplished by recording interest the normal way (at the effective interest rate) and then “plugging” its right-of-use asset amortization at whatever amount is needed for interest plus amortization to equal the straight-line lease payment. The lessor, having recorded no entry affecting its balance sheet at the beginning of the lease, simply records lease payments as lease revenue on a straight-line basis. (The lessor continues to record depreciation on the asset that it does not remove from its records in a Type B lease.)

The right to use a leased asset can provide the lessee with a significant benefit. The lessee reports this benefit as a right-of-use asset in its balance sheet. Similarly, the obligation to make the lease payments can be a significant liability that the lessee also reports in its balance sheet.

When a lessee has a short-term lease it’s acceptable to use a short-cut approach and forego recording the right-of-use asset and the lease payable. The lessee simply

15–8

Question 15-29


Question 15-30

Question 15-31

Full file at http://testbankeasy.eu/Solution-Manual-for-Intermediate-Accounting,-8th-Edition---Spicelanrecognizes lease payments as expense over the lease term. This is essentially the same as accounting for an operating lease in current GAAP.

Because none of the four classification criteria is met,

this is an operating lease. Accordingly, LTT will record rent expense for each of the

four $25,000 payments, reducing its earnings by $100,000 each year.

Because none of the four classification criteria is met,

this is an operating lease. Accordingly, Lakeside will record rent revenue for each of

the four $25,000 payments, increasing its earnings by $100,000 each year. In addition

Lakeside, as owner of the asset, will record depreciation. Assuming straight-line

depreciation of the $2 million cost over the 25-year life, that’s $80,000 depreciation

expense each year. So, earnings are increased by a net $20,000 ($100,000 – 80,000).

Because this is an operating lease, Ward will record rent

expense for each of the $5,000 payments. The advance payment also represents rent,

recorded initially as prepaid rent and allocated equally over the ten years of the lease.

As a result, Ward’s rent expense for the year reduces its earnings by $70,000 each

year.

$5,000 x 12 = $60,000$100,000 / 10 = 10,000

$70,000


BRIEF EXERCISES

Brief Exercise 15-1

Brief Exercise 15-2

Brief Exercise 15-3

The lease is a capital lease to Athens because the present

value of the minimum lease payments ($20.4 million) is

greater than 90% of the fair value of the asset (90% x $22.4 million = $20.16 million).

None of the other three classification criteria is met.

The present value of the minimum lease payments ($20.4

million) is greater than 90% of the fair value of the asset (90% x $22.4 million =

$20.16 million). Since the additional lessor conditions also are met, it is a capital

lease to Corinth. Furthermore, it is a sales-type lease because the present value of the

minimum lease payments exceeds the lessor’s cost ($16 million).

In direct financing leases, the lessor records a receivable

for the present value of the lease payments to be received ($1,531,000 for Sonic). The

difference between the total of the lease payments ($1,701,000 for Sonic) and the

present value of the lease payments to be received over the term of the lease

represents interest. Over the term of the leases, Sonic will report this amount

($1,701,000 minus $1,531,000 = $170,000) as interest revenue, determined as the

effective interest rate times the outstanding balance (net investment) each period.

The amount of interest expense the lessee would record in conjunction with the second quarterly payment at October 1 is $2,892:

Initial balance, July 1 (given)................................... $150,000Reduction for first payment, January 1.................... (5,376 )

15–10

Brief Exercise 15-4

Brief Exercise 15-5

Brief Exercise 15-6

Brief Exercise 15-7


Balance................................................................... $144,624

Interest expense October 1: 2% x $144,624 = $2,892

Journal entries (not required):July 1Leased asset (given)............................................ 150,000

Lease payable................................................ 150,000

Lease payable ................................................... 5,376Cash (lease payment)......................................... 5,376

Oct. 1Interest expense (2% x [$150,000 – 5,376])............... 2,892Lease payable (difference).................................... 2,484

Cash (lease payment)......................................... 5,376

The amount of interest revenue the lessor would record in conjunction with the

second quarterly payment at October 1 also is $2,892, determined in the same manner.

The lease payable in the balance sheet will be $113,731:

Initial balance, January 1 (calculated below)............. $140,000Reduction for first payment, January 1.................... (26,269 ) December 31, net liability....................................... $113,731

$26,269 x 5.32948 = $140,000(rounded)

present value of an annuity due of $1: n=6, i=5%

The liability for interest on the lease payable in the balance sheet will be $5,687:

Interest expense (5% x [$140,000 – 26,269])............... 5,687Interest payable................................................... 5,687


Brief Exercise 15-8

Pretax earnings will be reduced by $29,020 as calculated below:

January 1 interest expense....................................... $ 0Dec. 31, interest expense (5% x [$140,000* – 26,269]) 5,687Interest expense for the year.................................... $ 5,687

Depreciation expense ($140,000* / 6 years).............. 23,333 Total expenses...................................................... $29,020

*$26,269 x 5.32948 = $140,000(rounded)


The price at which the lessor is “selling” the asset being leased is the present value of the lease payments:

*$26,269 x 5.32948 = $140,000(rounded)


The lessor’s income statement will report an increase of $20,687 as calculated below:

January 1, interest revenue...................................... $ 0Dec. 31, interest revenue (5% x [$140,000* – 26,269]) 5,687Interest revenue for the year.................................... $ 5,687

Sales revenue*........................................................... 140,000Cost of goods sold..................................................... (125,000 ) Income effect.......................................................... $ 20,687

15–12

Brief Exercise 15-9

Brief Exercise 15-10


Journal entry (not required):Lease receivable (present value)..................................... 140,000Cost of goods sold (lessor’s cost).................................... 125,000

Sales revenue (present value)...................................... 140,000Inventory of equipment (lessor’s cost)........................ 125,000

$100,000 ÷ 16.67846** = $5,996fair lease

value payments

** present value of an annuity due of $1: n=20, i=2%

Amount to be recovered (fair value) $600,000

Less: Present value of the BPO price ($100,000 x .74726*) (74,726 )

Amount to be recovered through periodic lease payments $525,274_____________________

Lease payments at the beginning of each of the next 5 years: ($525,274 ÷ 4.46511**) $117,640

* present value of $1: n=5, i=6%** present value of an annuity due of $1: n=5, i=6%


Less: Present value of the residual value ($100,000 x .82270*) (82,270 )

Amount to be recovered through periodic lease payments $617,730





_______________________Lease payments at the end of each of the next 4 years: ($617,730 ÷ 3.54595**) $174,207

* present value of $1: n=4, i=5%** present value of an ordinary annuity of $1: n=4, i=5%

Under U.S. GAAP, this would not be a capital lease because none of the four classification criteria is met. The lease term is less than 75% of the economic life of the asset, and the present value of the minimum lease payments is less than 90% of the asset’s fair value. We don’t have these “bright line” rules under IFRS. If the term of the lease constitutes a “major portion” of the useful life of an asset a finance lease normally is indicated. Is 73% (8/11) a major portion? Perhaps so. This is a matter of professional judgment which may differ depending on the presence or absence of other indicators that the risks and rewards of ownership have been transferred to the lessee.

Another situation that normally indicates a finance lease is if the present value of the minimum lease payments is equal to or greater than substantially all of the fair value of the asset. Is 89% (40/45) a major portion? Perhaps so. This also is a matter of professional judgment. When we consider this and the previous indicator in combination, it’s very likely the conclusion would be that the risks and rewards of ownership have been transferred to the lessee and this would be considered a finance (capital) lease.

Income Statement:Interest expense (10% x [($25,000 x 6.33493) – 25,000]) $13,337*Amortization expense ($158,373 ÷ 9 years) 17,597 **

15–14


SUPPLEMENT BRIEF EXERCISES Brief Exercise 15-15


Decrease in earnings (pretax) $30,934 present value of an ordinary annuity due of $1: n=9, i=10%

Journal entries (not required):January 1, 2016 Right-of-use asset.............................................. 158,373

Lease payable ($25,000 x 6.33493).................. 158,373


Lease payable (difference).................................... 25,000Cash (lease payment)......................................... 25,000

December 31, 2016 Interest expense (10% x [$158,373 – 25,000])........... 13,337*Lease payable (difference).................................... 11,663


Amortization expense ($158,373 ÷ 9 years).............. 17,597**Right-of-use asset.......................................... 17.597

Income Statement:Interest (10% x [$25,000 x 5.33493 )......................... $13,337*Amortization ($25,000 – 13,337)...................................... 11,663 ** Lease expense; decrease in earnings (pretax)....... $25,000


In a Type B lease, the lessee records interest the normal way (at the effective interest rate) and then “plugs” the right-of-use asset amortization at the amount is needed for interest plus amortization to equal the straight-line lease payment. The lessee records that amount as a single lease expense in the income statement.




Lease payable ($25,000 x 6.33493).................. 158,373





Amortization expense ($25,000 – 13,337)................ 11,663**Right-of-use asset.......................................... 11,663

Income Statement:Lease revenue (straight-line amount)........................... $25,000*Depreciation ($176,000 ÷ 12 years).................................. ( 14,667 ) ** Increase in earnings (pretax).............................. $10,333

In a Type B lease, the lessor records lease revenue on a straight-line basis. The lessor, having recorded no entry affecting its balance sheet at the beginning of the lease, simply records lease payments as lease revenue on a straight-line basis and records depreciation on the asset it doesn’t remove from its records.

15–16



Journal entries (not required):January 1, 2016

[No entry to record receivable or to derecognize asset]

Cash (lease payment).................................................. 25,000Deferred lease revenue ........................................... 25,000*

December 31, 2016 Deferred lease revenue............................................ 25,000

Lease revenue .......................................................... 25,000*

Cash (second lease payment)........................................ 25,000Deferred lease revenue ........................................... 25,000*

Depreciation expense ($176,000 ÷ 12 years).................. 14,667**Accumulated depreciation– equipment.............. 14,667

Balance Sheet: Lease Payable

Initial balance $158,373 Jan. 1, 2016 reduction (first lease payment) (25,000) Dec. 31, 2016 reduction ($25,000 – (10% x [$158,373 – 25,000])) (11,663)*End-of-year balance $121,710

Right-of-Use Asset Initial balance $158,373Amortization for the year ($158,373 ÷ 9 years) (17,597 ) ** End-of-year balance $140,776




Lease payable ($25,000 x 6.33493).................. 158,373



December 31, 2016 Interest expense (10% x [$158,373 – 25,000])........... 13,337Lease payable (difference).................................... 11,663*


Amortization expense ($158,373 ÷ 9 years).............. 17,597**Right-of-use asset.......................................... 17.597

Lease Payable Initial balance $158,373 Jan. 1, 2016 reduction (first lease payment) (25,000) Dec. 31, 2016 reduction ($25,000 – 10% x [$158,373 – 25,000]) (11,663)*End-of-year balance $121,710

Right-of-Use Asset Initial balance $158,373Amortization for the year (11,663 ) ** End-of-year balance $146,710

15–18




Lease payable ($25,000 x 6.33493).................. 158,373





Amortization expense ($25,000 – 13,337)................ 11,663**Right-of-use asset.......................................... 11,663


The lease payable in the balance sheet will be $113,731:

Initial balance, January 1 (calculated below)............. $140,000*Reduction for first payment, January 1.................... (26,269 ) December 31, lease payable.................................... $113,731

$26,269 x 5.32948 = $140,000* (rounded)


The liability for interest on the lease payable in the balance sheet will be $5,687:



Interest expense (5% x [$140,000* – 26,269]).............. 5,687Interest payable................................................... 5,687

Pretax earnings will be reduced by $29,020 as calculated below:

January 1 interest expense.......................................... $ 0Dec. 31, interest expense (5% x [$140,000* – 26,269]). 5,687Interest expense for the year....................................... $ 5,687

Amortization expense ($140,000* ÷ 6 years)................ 23,333** Total expenses.......................................................... $29,020

$26,269 x 5.32948 = $140,000*(rounded)


** Amortization expense ($140,000* ÷ 6 years)..... 23,333 Right-of-use asset.................................... 23,333

The price at which the lessor is “selling” the asset being leased is the present value of the lease payments:

$26,269 x 5.32948 = $140,000*(rounded)

Present value of an annuity due of $1: n = 6, i = 5%

Pretax earnings will be increased by $20,687 as calculated below:

January 1, interest revenue...................................... $ 0Dec. 31, interest revenue (5% x [$140,000* – 26,269]) 5,687Interest revenue for the year.................................... $ 5,687

Profit ($140,000* – 125,000)**................................... 15,000 Income effect.......................................................... $20,687

15–20


Brief Exercise 15–22


Journal entry (not required):Lease receivable (present value)....................................... 140,000

Inventory of equipment (lessor’s cost).......................... 125,000Profit......................................................................... 15,000**

End of fiscal yearInterest receivable........................................................ 5,687 Interest revenue (5% x [$140,000* – 26,269])........... 5,687*

** A company might choose to separate this profit into its two components: Sales revenue ($140,000) and cost of goods sold ($125,000), which is the gross method demonstrated for “sales-type” leases in the main chapter.

The amount of interest expense the lessee would record in conjunction with the second quarterly payment on October 1 is $2,892:

Initial balance, July 1 (given)................................... $150,000Reduction for first payment, January 1.................... (5,376 ) Balance................................................................... $144,624

Interest expense October 1: 2% x $144,624 = $2,892

Journal entries (not required):July 1Lease payable ................................................... 5,376


Oct. 1Interest expense (2% x [$150,000 – 5,376])............... 2,892Lease payable (difference).................................... 2,484


The amount of interest revenue the lessor would record in conjunction with the second quarterly payment on October 1 also is $2,892, determined in the same manner.



A lease that has a lease term (including options to terminate or renew that are reasonably certain) of twelve months or less is considered a “short-term lease.”

A lessee that has a short-term lease has the option to not record the right-of-use asset and the liability to make lease payments and instead to simply record lease expense for the amount of each lease payment.

King Cone’s earnings will be reduced by the $10,000 per month lease expense, $80,000 for the eight-month term, ignoring taxes.

Journal entries (not required):Beginning of leaseNo entry

End of each of 8 monthsLease expense.................................................... 10,000


(a) Nath-Langstrom Services, Inc. (Lessee)

June 30, 2016Rent expense.................................. 10,000

Cash .......................................... 10,000

December 31, 2016Rent expense.................................. 10,000

Cash .......................................... 10,000

(b) ComputerWorld Corporation (Lessor)

June 30, 2016

15–22


EXERCISES Exercise 15-1


Cash............................................... 10,000Rent revenue.............................. 10,000

December 31, 2016Cash............................................... 10,000

Rent revenue.............................. 10,000

Depreciation expense ($90,000 ÷ 6 years) 15,000Accumulated depreciation.......... 15,000

January 1, 2016Prepaid rent (advance payment)....................... 96,000

Cash ........................................................ 96,000

Prepaid rent (annual rent payment)................... 80,000Cash ........................................................ 80,000

Leasehold improvements............................. 180,000Cash ........................................................ 180,000

December 31, 2016Rent expense (annual rent)............................. 80,000

Prepaid rent ............................................. 80,000

Rent expense (advance payment allocation)....... 32,000Prepaid rent ($96,000 ÷ 3).......................... 32,000

Depreciation expense ($180,000 ÷ 3 years)....... 60,000Accumulated depreciation........................ 60,000


Exercise 15-2

15–24


Present Value of Minimum Lease Payments:

($15,000 x 7.47199*) = $112,080lease present

payments value* present value of an annuity due of $1: n=8, i=2%

[i = 2% (8% ÷ 4) because the lease calls for quarterly payments]

Lease Amortization ScheduleLease Effective Decrease Outstanding

Payments Interest in Balance Balance2% x Outstanding Balance

112,0801 15,000 15,000 97,0802 15,000 .02 (97,080) = 1,942 13,058 84,0223 15,000 .02 (84,022) = 1,680 13,320 70,7024 15,000 .02 (70,702) = 1,414 13,586 57,1165 15,000 .02 (57,116) = 1,142 13,858 43,2586 15,000 .02 (43,258) = 865 14,135 29,1237 15,000 .02 (29,123) = 582 14,418 14,7058 15,000 .02 (14,705) = 295 * 14,705 0

120,000 7,920 112,080

* adjusted for rounding of other numbers in the schedule

January 1, 2016Leased equipment (calculated above)..................... 112,080

Lease payable (calculated above)....................... 112,080

Lease payable ................................................... 15,000Cash (lease payment)......................................... 15,000

April 1, 2016


Exercise 15-3

Exercise 15-3 (concluded)

Interest expense (2% x [$112,080 – 15,000])............. 1,942Lease payable (difference).................................... 13,058


July 1, 2016Interest expense (2% x $84,022: from schedule)........ 1,680Lease payable (difference).................................... 13,320


October 1, 2016Interest expense (2% x $70,702: from schedule)........ 1,414Lease payable (difference).................................... 13,586


December 31, 2016Interest expense (2% x $57,116: from schedule)........ 1,142

Interest payable ............................................. 1,142

Depreciation expense ($112,080 ÷ 2 years).............. 56,040Accumulated depreciation.............................. 56,040

January 1, 2017Interest payable (from adjusting entry)...................... 1,142Lease payable (difference).................................... 13,858


15–26




112,0801 15,000 15,000 97,0802 15,000 .02 (97,080) = 1,942 13,058 84,0223 15,000 .02 (84,022) = 1,680 13,320 70,7024 15,000 .02 (70,702) = 1,414 13,586 57,1165 15,000 .02 (57,116) = 1,142 13,858 43,2586 15,000 .02 (43,258) = 865 14,135 29,1237 15,000 .02 (29,123) = 582 14,418 14,7058 15,000 .02 (14,705) = 295 * 14,705 0

120,000 7,920 112,080


January 1, 2016Lease receivable (fair value)................................. 112,080

Inventory of equipment (lessor’s cost).............. 112,080

Cash (lease payment)............................................. 15,000Lease receivable ............................................ 15,000

April 1, 2016Cash (lease payment)............................................. 15,000

Lease receivable (difference) ........................... 13,058Interest revenue (2% x [$112,080 – 15,000])......... 1,942

July 1, 2016Cash (lease payment)............................................. 15,000

Lease receivable (difference)............................ 13,320Interest revenue (2% x $84,022: from schedule).... 1,680


Exercise 15-4


October 1, 2016Cash (lease payment)............................................. 15,000

Lease receivable (difference)............................ 13,586Interest revenue (2% x $70,702: from schedule).... 1,414

December 31, 2016Interest receivable ............................................. 1,142

Interest revenue (2% x $57,116: from schedule).... 1,142

January 1, 2017Cash (lease payment)............................................. 15,000

Lease receivable (difference)............................ 13,858Interest receivable (from adjusting entry)........... 1,142

15–28


Requirement 1

Lessor’s Calculation of Lease Payments Amount to be recovered (fair value) $112,080

__________________Lease payments at the beginning of each of eight quarters: ($112,080 ÷ 7.47199**) $15,000


Requirement 2 January 1, 2016Lease receivable (fair value / present value)............ 112,080Cost of goods sold (lessor’s cost).......................... 85,000

Sales revenue (fair value / present value)............. 112,080Inventory of equipment (lessor’s cost).............. 85,000

Cash (lease payment)............................................. 15,000Lease receivable ............................................ 15,000

April 1, 2016Cash (lease payment)............................................. 15,000

Lease receivable (difference)............................ 13,058Interest revenue (2% x [$112,080 – 15,000])......... 1,942

Situation 1 Since none of the criteria is met, this is an operating lease to the lessee:


Exercise 15-5

Exercise 15-6

Lessee’s Application of Classification Criteria 1 Does the agreement specify that

ownership of the asset transfers to the lessee? NO

2 Does the agreement contain a bargain purchase option? NO

3 Is the lease term equal to 75% or more of the expected NOeconomic life of the asset? {4 yrs. < 75% of 6 yrs.}

4 Is the present value of the minimum lease payments equalto or greater than 90% of the NOfair value of the asset? {$37,2331 < 90% of $44,000 = $39,600}

1$10,000 x 3.72325*= $37,233* present value of an annuity due of $1: n=4, i=5%

Situation 2 Since at least one (two in this case: #2 and #3) classification criterion is met, this

is a capital lease.

15–30

Exercise 15-6 (continued)




2 Does the agreement contain a bargain purchase option? YES

3 Is the lease term equal to 75% or more of the expected YESeconomic life of the asset? {4 yrs. > 75% of 5 yrs.}

4 Is the present value of the minimum lease payments equalto or greater than 90% of the NOfair value of the asset? {$35,4561 < 90% of $43,000 = $38,700}

1$10,000 x 3.54595*= $35,456* present value of an ordinary annuity of $1: n=4, i=5%

Situation 3 Since at least one (#4 in this case) classification criterion is met, this is a capital

lease.







4 Is the present value of the minimum lease payments equalto or greater than 90% of the YESfair value of the asset? {$37,2331 > 90% of $41,000 = $36,900}

1$10,000 x 3.72325*= $37,233* present value of an annuity due of $1: n=4, i=5%

Situation 4 Since at least one (#4 in this case) classification criterion is met, this is a capital

lease.

15–32







4 Is the present value of the minimum lease payments equalto or greater than 90% of the YESfair value of the asset? {$35,4601 > 90% of $39,000 = $35,100}

1$10,000 x 3.54595*= $35,460* present value of an ordinary annuity of $1: n=4, i=5%

Requirement 1 January 1, 2016Leased assets..................................................... 4,000,000

Lease payable................................................ 4,000,000

Requirement 2

$4,000,000 ÷ 3.16987** = $1,261,881present leasevalue payment

** present value of an ordinary annuity of $1: n=4, i=10%


Exercise 15-7



4,000,0002016 1,261,881 .10 (4,000,000) = 400,000 861,881 3,138,1192017 1,261,881 .10 (3,138,119) = 313,812 948,069 2,190,0502018 1,261,881 .10 (2,190,050) = 219,005 1,042,876 1,147,1742019 1,261,881 .10 (1,147,174) = 114,707 * 1,147,174 0

5,047,524 1,047,524 4,000,000


Requirement 3 December 31, 2016

Interest expense (10% x outstanding balance).......... 400,000Lease payable (difference).................................... 861,881

Cash (payment determined above)........................ 1,261,881


Interest expense (10% x outstanding balance).......... 219,005Lease payable (difference).................................... 1,042,876


1. Calculation of the present value of lease payments

$562,907 x 5.32948 = $3,000,000(rounded)


2. Liability at December 31, 2016Initial balance, June 30, 2016.................................. $3,000,000June 30, 2016 reduction.......................................... (562,907)*Dec. 31, 2016 reduction.......................................... (441,052 ) **December 31, 2016 net liability.............................. $1,996,041

Asset at December 31, 2016Initial balance, June 30, 2016.................................. $3,000,000

15–34

Exercise 15-8


Accumulated depreciation at Dec. 31, 2016............ (500,000 ) ** December 31, 2016........................................... $2,500,000

3. Expenses for year ended December 31, 2016June 30, 2016 interest expense................................ $ 0*Dec. 31, 2016 interest expense................................ 121,855**Interest expense for 2016........................................ $121,855

Depreciation expense for 2016................................ 500,000 Total expenses...................................................... $621,855

Calculations:June 30, 2016*Leased equipment (calculated in req. 1)........................... 3,000,000

Lease payable (calculated in req. 1)............................. 3,000,000

Lease payable ............................................................... 562,907Cash (lease payment).................................................. 562,907

December 31, 2016**Interest expense (5% x [$3 million – 562,907])................ 121,855Lease payable (difference).............................................. 441,052

Cash (lease payment).................................................. 562,907

Depreciation expense ($3 million / 3 years x ½ year).... 500,000Accumulated depreciation......................................... 500,000

1. Receivable at December 31, 2016

$562,907 x 5.32948 = $3,000,000(rounded)


NetReceivable

Initial balance, June 30, 2016............ $3,000,000June 30, 2016 reduction..................... (562,907)*Dec. 31, 2016 reduction..................... (441,052 ) **December 31, 2016 net receivable..... $1,996,041

The receivable replaces the $3,000,000 machine on the balance sheet.


Exercise 15-9

2. Interest revenue for year ended December 31, 2016

June 30, 2016 interest revenue................................ $ 0*Dec. 31, 2016 interest revenue................................ 121,855**Interest revenue for 2016........................................ $121,855

Calculations:June 30, 2016Lease receivable (present value calculated above)............ 3,000,000

Inventory of equipment (lessor’s cost)........................ 3,000,000

Cash (lease payment)...................................................... 562,907Lease receivable*...................................................... 562,907

December 31, 2016Cash (lease payment)...................................................... 562,907

Lease receivable (difference)**.................................. 441,052Interest revenue (5% x [$3,000,000 – 562,907])........... 121,855

1. Calculation of the present value of lease payments (“selling price”)

$562,907 x 5.32948 = $3,000,000(rounded)


2. Receivable at December 31, 2016Receivable

Initial balance, June 30, 2016............ $3,000,000June 30, 2016 reduction..................... (562,907)*Dec. 31, 2016 reduction..................... (441,052 ) **December 31, 2016 receivable........... $1,996,041

The receivable replaces the $2,500,000 machine on the balance sheet.

3. Income effect for year ended December 31, 2016

June 30, 2016 interest revenue................................ $ 0*Dec. 31, 2016 interest revenue................................ 121,855**

15–36

Exercise 15-10


Interest revenue for 2016........................................ $ 121,855

Sales revenue*........................................................... 3,000,000Cost of goods sold*................................................... (2,500,000 ) Income effect.......................................................... $ 621,855

Calculations:

June 30, 2016*Lease receivable (present value calculated above)............ 3,000,000Cost of goods sold (lessor’s cost)...................................... 2,500,000

Sales revenue (present value calculated above)............. 3,000,000Inventory of equipment (lessor’s cost)........................ 2,500,000

Cash (lease payment).................................................... 562,907Lease receivable........................................................ 562,907

December 31, 2016**Cash (lease payment)...................................................... 562,907

Lease receivable (difference)...................................... 441,052Interest revenue (5% x [$3,000,000 – 562,907])........... 121,855

Requirement 1 a. Transfer of ownership is one of four criteria any of which is sufficient to qualify

this as a capital lease. b. A bargain purchase option is one of four criteria any of which is sufficient to

qualify this as a capital lease because, by definition, ownership is expected to transfer.

c. Whether the term of the lease constitutes 75% of the useful life of an asset is one of four criteria any of which is sufficient to qualify this as a capital lease. 70% (14/20) does not meet this criterion.

d. Whether the present value of the minimum lease payments is equal to or greater than 90% of the fair value of the asset is one of four criteria any of which is sufficient to qualify this as a capital lease. 89% (8.9 ÷ 10) does not meet this criterion.

e. If the leased asset is of a specialized nature such that only the lessee can use it without major modifications being made, that normally would suggest that one of the four classification criteria might be met. But, this, by itself is not a specified criterion under U.S. GAAP for a lease to be classified as a capital lease.


Exercise 15-11

Requirement 2

a. Transfer of ownership normally is an indicator of a finance lease. b. A bargain purchase option normally is an indicator of a finance lease because,

by definition, ownership is expected to transfer.c. If the term of the lease constitutes a “major portion” of the useful life of an asset

a finance lease normally is indicated. Is 70% (14/20) a major portion? Perhaps so. This is a matter of professional judgment which may differ depending on the presence or absence of other indicators that the risks and rewards of ownership have been transferred to the lessee.

d. One situation that normally indicates a finance lease is if the present value of the minimum lease payments is equal to or greater than substantially all of the fair value of the asset. Is 89% (8.9 ÷ 10) a major portion? Perhaps so. This is a matter of professional judgment which may differ depending on the presence or absence of other indicators that the risks and rewards of ownership have been transferred to the lessee.

e. One situation that normally indicates a finance lease is if the leased asset is of a specialized nature such that only the lessee can use it without major modifications being made. Could another airline use the aircraft without modification or with non-major modification? That information is not specified. With additional information, this is a matter of professional judgment which may differ depending on the presence or absence of other indicators that the risks and rewards of ownership have been transferred to the lessee.

Situation 1(a) $600,000 ÷ 6.53705** = $91,785fair lease

value payments** present value of an annuity due of $1: n=10, i=11%

(b) $91,785 x 6.53705** = $600,000 (rounded)lease leased asset/

payments lease payable** present value of an annuity due of $1: n=10, i=11%

15–38


Exercise 15-12

Full file at http://testbankeasy.eu/Solution-Manual-for-Intermediate-Accounting,-8th-Edition---SpicelanSituation 2

(a) $980,000 ÷ 9.95011** = $98,491fair lease

value payments** present value of an annuity due of $1: n=20, i=9%

(b) $98,491 x 9.95011** = $980,000 (rounded)lease leased asset/


Situation 3(a) $185,000 ÷ 3.40183** = $54,382

fair leasevalue payments


(b) $54,382 x 3.44371** = $187,276lease leased asset/


But since this amount exceeds the asset’s fair value, the lessee must capitalize the $185,000 fair value instead.

Situation 1(a) $600,000 ÷ 5.88923** = $101,881fair lease

value payments** present value of an ordinary annuity of $1: n=10, i=11%

(b) $101,881 x 5.88923** = $600,000* lease leased asset/

payments lease payable* rounded** present value of an ordinary annuity of $1: n=10, i=11%


Exercise 15-13

Situation 2(a) $980,000 ÷ 9.12855** = $107,355



(b) $107,355 x 9.12855** = $980,000‡ lease leased asset/

payments lease payable** present value of an ordinary annuity of $1: n=20, i=9%‡ rounded for convenience

Situation 3(a) $185,000 ÷ 3.03735** = $60,908



(b) $60,908 x 3.10245** = $188,964lease leased asset/

payments lease payable** present value of an ordinary annuity of $1: n=4, i=11%

But since this amount exceeds the asset’s fair value, the lessee must capitalize the $185,000 fair value instead.

Situation 1Amount to be recovered (fair value) $50,000

___________________Lease payments at the beginning of each of the next 4 years: ($50,000 ÷ 3.48685**) $ 14,340





15–40

Exercise 15-14


_______________________Lease payments at the beginning of each of the next 7 years: ($325,917 ÷ 5.23054**) $ 62,310




Amount to be recovered through periodic lease payments $70,450______________________

Lease payments at the beginning of each of the next 5 years: ($70,450 ÷ 4.23972**) $ 16,617




Amount to be recovered through periodic lease payments $446,825______________________

Lease payments at the beginning of each of the next 8 years: ($446,825 ÷ 5.56376**) $ 80,310


Situation 1 2 3 4

A. The lessor’s:1. Minimum lease payments1 $700,000 $750,000 $800,000 $840,0002. Gross investment in the lease2 700,000 750,000 850,000 900,000



Exercise 15-15

3. Net investment in the lease3 548,592 547,137 610,168 596,764B. The lessee’s:

4. Minimum lease payments4 700,000 750,000 800,000 840,0005. Leased asset5 548,592 547,137 586,842 572,5316. Lease payable6 548,592 547,137 586,842 572,531

1 ($100,000 x number of payments) + residual value guaranteed by lessee and/or by third party; for situation 4: ($100,000 x 8) + ($40,000).

2 Minimum lease payments plus unguaranteed residual value; for situation 4: ($840,000 + 60,000).

3 Present value of gross investment (discounted at lessor’s rate); for situation 4: ($100,000 x 5.56376) + ($100,000 x .40388).

4 ($100,000 x number of payments) + residual value guaranteed by lessee; for situation 4: ($100,000 x 8) + $40,000.

5 Present value of minimum lease payments (discounted at lower of lessor’s rate and lessee’s incremental borrowing rate); should not exceed fair value; for situation 4: ($100,000 x 5.56376) + ($40,000 x .40388).

6 Present value of minimum lease payments (discounted at lower of lessor’s rate and lessee’s incremental borrowing rate); should not exceed fair value; for situation 4: ($100,000 x 5.56376) + ($40,000 x .40388).

Situation 1Amount to be recovered (fair value)

$60,000



15–42

Exercise 15-16


_____________________Lease payments at the beginning of each of the next 5 years: ($54,326 ÷ 4.03735**) $13,456







Note: Since a BPO is expected to be exercised, the lease term ends for accounting purposes when the option becomes exercisable.






Note: Since a BPO is expected to be exercised, the lease term ends for accounting purposes when the option becomes exercisable.



Requirement 1

Note:Because exercise of the option appears at the inception of the lease to be reasonably assured, payment of the option price ($45,000) is expected to occur when the option becomes exercisable (at the end of the third year).

Present value of annual lease payments ($36,000 x 2.69005**) $ 96,842

Plus: Present value of the BPO price ($45,000 x .71178*) 32,030

Present value of minimum lease payments $128,872* present value of $1: n=3, i=12%** present value of an annuity due of $1: n=3, i=12%

Requirement 2

Lease Amortization ScheduleEffective Decrease Outstanding


128,8721/1/16 36,000 36,000 92,87212/31/16 36,000 .12 (92,872) = 11,145 24,855 68,01712/31/17 36,000 .12 (68,017) = 8,162 27,838 40,17912/31/18 45,000 .12 (40,179) = 4,821 40,179 0

153,000 24,128 128,872

15–44

Exercise 15-17


Requirement 3

January 1, 2016Leased equipment (calculated above)...................... 128,872

Lease payable (calculated above)........................ 128,872

Lease payable ..................................................... 36,000Cash (annual payment)........................................ 36,000

December 31, 2016Depreciation expense ($128,872 ÷ 6 years*).............. 21,479

Accumulated depreciation............................... 21,479

Interest expense (12% x [$128,872 – 36,000])............ 11,145Lease payable (difference: from schedule)................ 24,855

Cash (annual payment)........................................ 36,000



Interest expense (12% x $68,017: from schedule)........ 8,162Lease payable (difference: from schedule)................ 27,838

Cash (annual payment)........................................ 36,000



Interest expense (12% x $40,179: from schedule)........ 4,821Lease payable (difference: from schedule)................ 40,179

Cash (BPO price)............................................... 45,000

* Because title passes with the expected exercise of the BPO, depreciation is for the entire six-year useful life of the asset. The depreciation entry will be recorded for three years after the completion of the lease term.



Requirement 1




Lease payments at the beginning each of three years: ($21,884 ÷ 2.73554**) $8,000


Requirement 2



30,900 1/1/16 8,000 8,000 22,90012/31/16 8,000 .10 (22,900) = 2,290 5,710 17,19012/31/17 8,000 .10 (17,190) = 1,719 6,281 10,90912/31/18 12,000 .10 (10,909) = 1,091 10,909 0

36,000 5,100 30,900

Requirement 3 January 1, 2016Lease receivable (PV of lease payments + PV of BPO)......... 30,900

15–46

Exercise 15-18



Inventory of equipment (lessor’s cost).......................... 30,900

Cash (lease payment)........................................................ 8,000Lease receivable........................................................ 8,000

December 31, 2016Cash (lease payment)........................................................ 8,000

Lease receivable (difference)....................................... 5,710Interest revenue (10% x [$30,900 – 8,000])........................ 2,290

December 31, 2017Cash (lease payment)........................................................ 8,000

Lease receivable........................................................ 6,281Interest revenue (10% x $17,190: from schedule)............... 1,719

December 30, 2018Cash (BPO price)............................................................. 12,000

Lease receivable (account balance)............................... 10,909Interest revenue (10% x $10,909: from schedule)............... 1,091

Requirement 1

January 1, 2016Brand Services (Lessee)Leased equipment (present value of lease payments)............ 316,412

Lease payable (present value of lease payments).............. 316,412

Lease payable (payment less executory costs)...................... 50,000Maintenance expense (2016 fee)............................................ 5,000

Cash (annual payment).................................................. 55,000

NRC Credit (Lessor)Lease receivable (present value of lease payments).............. 316,412


Exercise 15-19


Cash (annual payment)...................................................... 55,000Maintenance fee payable [or cash]............................ 5,000Lease receivable ....................................................... 50,000

Requirement 2

December 31, 2016Brand Services (Lessee)Interest expense (12% x [$316,412 – 50,000])........................ 31,969Lease payable (difference)............................................... 18,031Prepaid maintenance (2017 fee)............................................. 5,000

Cash (lease payment).................................................... 55,000

Depreciation expense ($316,412 ÷ 10 years)......................... 31,641Accumulated depreciation......................................... 31,641

NRC Credit (Lessor)Cash (lease payment)........................................................ 55,000

Lease receivable (difference)....................................... 18,031Maintenance fee payable [or cash]............................ 5,000Interest revenue (12% x [$316,412 – 50,000]).................... 31,969

15–48


December 31, 2016

Brand Services (Lessee)Interest expense (12% x [$316,412 – 50,000])........................ 31,969Lease payable (difference)............................................... 18,031Prepaid maintenance (2017 fees plus lessor profit)................ 5,950



NRC Credit (Lessor)Cash (lease payment)........................................................ 55,950

Lease receivable (to balance)....................................... 18,031Maintenance fee payable .......................................... 5,000Insurance premium payable ...................................... 700Deferred miscellaneous revenue (2017 fee)................. 250Interest revenue (12% x [$316,412 – 50,000]).................... 31,969

Requirement 1 January 1Cash.............................................................................. 20,873

Deferred rent revenue*.............................................. 20,873

Deferred initial direct cost............................................. 2,062Cash.......................................................................... 2,062


Exercise 15-20

Exercise 15-21

December 31Deferred rent revenue.................................................... 20,873

Rent revenue*............................................................ 20,873

Lease expense ($2,062 ÷ 3 years)...................................... 687Deferred initial direct cost......................................... 687

Depreciation expense ($100,000 ÷ 6 years)........................ 16,667Accumulated depreciation......................................... 16,667

* Alternatively, Rent revenue. Either way, an adjusting entry is needed at the end of the reporting period to assure that the earned portion of the payment is recorded in Rent revenue and the deferred portion in Deferred rent revenue

Requirement 2

January 1Proof that new effective rate is 9% (not required):

$102,062 ÷ 4.88965** = $20,873lessor’s lease

net investment payments** present value of an annuity due of $1: n=6, i=9%

January 1Lease receivable (fair value / present value)........................ 100,000


Lease receivable............................................................ 2,062Cash (initial direct costs)............................................... 2,062


December 31Interest receivable......................................................... 7,307

Interest revenue (9% x [$100,000 + 2,062 – 20,873])....... 7,307

15–50


Full file at http://testbankeasy.eu/Solution-Manual-for-Intermediate-Accounting,-8th-Edition---SpicelanRequirement 3

January 1Lease receivable (fair value / present value)........................ 100,000Cost of goods sold (lessor’s cost)..................................... 85,000

Sales revenue (fair value / present value)........................ 100,000Inventory of equipment (lessor’s cost).......................... 85,000

Selling expense............................................................. 2,062Cash (initial direct costs)............................................... 2,062


December 31Interest receivable......................................................... 7,913

Interest revenue (10% x [$100,000 – 20,873])................. 7,913

January 1, 2016, 2017, 2018Cash.............................................................................. 137,000

Rent revenue............................................................. 137,000

Deferred initial direct cost............................................. 2,400Cash.......................................................................... 2,400

December 31, 2016, 2017, 2018Lease expense ($2,400 ÷ 3 years)...................................... 800

Deferred initial direct cost......................................... 800



Exercise 15-22

1. January 1, 2016Lease receivable (fair value / present value)........................ 500,000




2. Effective rate of interest revenue:

The initial direct costs increase the net investment: $500,000 + 4,242. The new effective rate is the discount rate that equates the net investment and the future lease payments:

$504,242 ÷ ? ** = $184,330lessor’s lease

net investment payments** present value of an annuity due of $1: n=3, i=?%

Rearranging algebraically: $504,242 ÷ $184,330= 2.73554.

When you consult the present value table for an annuity due, you search row 3 (n=3) for this value and find it in the 10% column. So the effective interest rate is 10%. The net investment is amortized at the new rate.

3. December 31, 2016

Interest receivable......................................................... 31,991Interest revenue (10% x [$500,000 + 4,242 – 184,330]).... 31,991

15–52

Exercise 15-23


Requirement 1

Inception of the Lease, January 1, 2016Lease receivable (fair value)............................................ 300,000Cost of goods sold (lessor’s cost)..................................... 265,000

Sales revenue (fair value)............................................. 300,000Inventory of equipment (lessor’s cost).......................... 265,000



Requirement 2

December 31, 2016Interest receivable......................................................... 18,434

Interest revenue (8% x [$300,000 – 69,571).................... 18,434


Exercise 15-24

List A List B

j_ 1. Effective rate times balance. a. PV of BPO price. k_ 2. Revenue recognition issues. b. Lessor’s net investment. c_ 3. Minimum lease payments plus c. Lessor’s gross investment.

unguaranteed residual value. d. Operating lease. l_ 4. Periodic lease payments plus e. Depreciable assets.

lessee-guaranteed residual value. f. Loss to lessee. b_ 5. PV of minimum lease payments plus g. Executory costs.

PV of unguaranteed residual value. h. Depreciation longer than lease term. n_ 6. Initial direct costs. i. Disclosure only. d_ 7. Rent revenue. j. Interest expense. m_8. Bargain purchase option. k. Additional lessor conditions. e_ 9. Leasehold improvements. l. Lessee’s minimum lease payments f_10. Cash to satisfy residual value m. Purchase price less than fair

guarantee. value. g_11. Capital lease expense. n. Sales-type lease selling expense. a_12. Deducted in lessor’s computation o. Lessor’s minimum lease payments.

of lease payments. h_13. Title transfers to lessee. i_14. Contingent rentals. o_15. Lease payments plus lessee-guaranteed

and third-party-guaranteed residual value.

15–54

Exercise 15-25


Requirement 1

Present value of periodic lease payments* ($102,771 x 7.49236**) $770,000 *

* rounded** present value of an annuity due of $1: n=13, i=11%

The lease meets at least one (actually 3 of 4 in this case) criteria for classification as a capital lease.

January 1, 2016Cash (given).................................................................... 770,000

Airplanes (book value)................................................. 620,000Deferred gain on sale-leaseback (difference)............... 150,000

Leased airplane (present value of lease payments)................... 770,000Lease payable (present value of lease payments).............. 770,000

Lease payable ............................................................... 102,771 Cash.......................................................................... 102,771

Requirement 2

December 31, 2016Interest expense (11% x [$770,000 – 102,771])...................... 73,395

Interest payable ........................................................ 73,395

Depreciation expense ($770,000 ÷ 15 years*).................... 51,333 Accumulated depreciation......................................... 51,333

Deferred gain on sale-leaseback ($150,000 ÷ 15 years)....... 10,000Depreciation expense ............................................... 10,000

* The airplane is depreciated over its remaining useful life rather than the lease term because title transfers to the lessee.


Exercise 15-26

When the leaseback is a finance (capital) lease, the gain is recognized over the useful life of the asset under U.S. GAAP as shown in the previous exercise. But, under IAS No. 17, the gain is recognized over the lease term as shown below (13 years rather than 15 years).

Present value of periodic lease payments* ($102,771 x 7.49236**) $770,000 *

* rounded** present value of an annuity due of $1: n=13, i=11%

The lease meets at least one (actually 3 of 4 in this case) criteria for classification as a capital lease.

January 1, 2016Cash (given).................................................................... 770,000

Airplanes (book value)................................................. 620,000Deferred gain on sale-leaseback (difference)............... 150,000

Leased airplane (present value of lease payments)................... 770,000Lease payable (present value of lease payments).............. 770,000

Lease payable ............................................................... 102,771 Cash.......................................................................... 102,771

December 31, 2016Interest expense (11% x [$770,000 – 102,771])...................... 73,395

Interest payable ........................................................ 73,395


Deferred gain on sale-leaseback ($150,000 ÷ 13 years).... 11,538Depreciation expense ............................................... 11,538

* The airplane is depreciated over its remaining useful life rather than the lease term because title transfers to the lessee.

15–56

Exercise 15-27


Requirement 1

January 1, 2016Cash (given).................................................................... 800,000Accumulated depreciation (cost – book value).................. 350,000

Building (original cost)................................................. 1,000,000Deferred gain on sale-leaseback (difference)............... 150,000

Requirement 2

December 31, 2016Rent expense............................................................................ 100,000


Deferred gain on sale-leaseback ($150,000 ÷ 12 years)...... 12,500Rent expense ............................................................ 12,500

When the leaseback is an operating lease, the gain is amortized over the lease term under U.S. GAAP. But, under IAS No. 17, the gain is recognized immediately:

January 1, 2016Cash (given).................................................................... 800,000Accumulated depreciation (cost – book value).................. 350,000

Building (original cost)................................................. 1,000,000Gain on sale-leaseback (difference)............................. 150,000

December 31, 2016Rent expense............................................................................ 100,000



Exercise 15-28

Exercise 15-29

Requirement 1

The specific citation that specifies the disclosure requirements pertaining to a seller-lessee in a sale-leaseback transaction is FASB ASC 840–40–50–1: “Leases–Sales-Leaseback Transactions–Disclosure.”

Requirement 2The financial statements of a seller-lessee should include a description of the terms of the sale-leaseback transaction, including future commitments, obligations, provisions, or circumstances that require or result in the seller-lessee's continuing involvement.

FASB ASC 840–40–50–1 also indicates that the lessee should disclose a general description of its leasing arrangements including, but not limited to, the basis on which contingent rental payments are determined, terms of renewal or purchase options and escalation clauses, and restrictions imposed by lease agreements.

15–58

Exercise 15-30

http://asc.fasb.org/glossarysection&trid=2208939&id=SL2294694-112694

http://asc.fasb.org/glossarysection&trid=2208939&id=SL2290502-112694


Note:Because exercise of the option appears at the inception of the lease to be reasonably assured, payment of the option price ($100,000) is expected to occur when the option becomes exercisable (at the end of the 10th year). When the leased property includes both land and a building and the lease is expected to transfer ownership by exercise of a BPO, the lessee should record each leased asset separately. The present value of the minimum lease payments is allocated between the leased land and leased building accounts on the basis of their relative fair values.

Present value of lease payments ($200,000 x 6.75902**) $1,351,804


Present value of minimum lease payments $1,390,358* present value of $1: n=10, i=10%** present value of an annuity due of $1: n=10, i=10%

January 1, 2016Leased land (fair value)................................................... 400,000Leased building ($1,390,358 – 400,000)............................ 990,358

Lease payable (calculated above).................................. 1,390,358

Lease payable................................................................ 200,000Cash (annual lease payment).......................................... 200,000


Exercise 15-31

December 31, 2016Depreciation expense ([$990,358 – 150,000] ÷ 20 years)...... 42,018

Accumulated depreciation – leased building.............. 42,018

Interest expense ([$1,390,358 – 200,000] x 10%)................... 119,036Interest payable ........................................................ 119,036

The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is:

1. Definition of a bargain purchase option:

FASB ASC 840–10–20: “Leases–Overall–Glossary.” Also found in Master Glossary.

2. Lessor’s gross investment in a sales-type lease:

FASB ASC 840–30–30–6: “Leases–Capital Leases–Initial Measurement–Gross Investment in a Sales-Type Lease or Direct Financing Lease–Gross Investment in a Sales-Type Lease or Direct Financing Lease.

3. The disclosures required in the notes to the financial statements for an

operating lease.

FASB ASC 840–20–50: “Leases–Operating Leases–Disclosure.” FASB ASC 840–20–50–1: "Leases–Operating Leases–Disclosure–Lessees"

4. The additional disclosures necessary in the notes to the financial statements if the operating lease has a lease term greater than one year.

FASB ASC 840–20–50–2: "Leases–Operating Leases–Disclosure–Lessee”

15–60

Exercise 15-32


Present Value of Lease Payments:

($15,000 x 7.47199*) = $112,080lease present



Because the lease term is equal to the expected useful life of the asset and the present value of the lease payments is equal to the asset’s fair value, we can assume the risks and rewards of ownership are transferred to the lessee, so it’s a Type A lease.



112,0801 15,000 15,000 97,0802 15,000 .02 (97,080) = 1,942 13,058 84,0223 15,000 .02 (84,022) = 1,680 13,320 70,7024 15,000 .02 (70,702) = 1,414 13,586 57,1165 15,000 .02 (57,116) = 1,142 13,858 43,2586 15,000 .02 (43,258) = 865 14,135 29,1237 15,000 .02 (29,123) = 582 14,418 14,7058 15,000 .02 (14,705) = 295 * 14,705 0

120,000 7,920 112,080



SUPPLEMENT EXERCISES Exercise 15-33

January 1, 2016Right-of-use equipment (present value calculated above) 112,080

Lease payable (present value calculated above). . . . 112,080

Lease payable.................................................... 15,000Cash (lease payment)......................................... 15,000

March 31, 2016Interest expense (2% x [$112,080 – 15,000])............. 1,942Lease payable (difference).................................... 13,058


Amortization expense ($112,080 ÷ 8 quarters)......... 14,010Right-of-use equipment.................................. 14,010

June 30, 2016Interest expense (2% x $84,022: from schedule)........ 1,680Lease payable (difference).................................... 13,320



September 30, 2016Interest expense (2% x $70,702: from schedule)........ 1,414Lease payable (difference).................................... 13,586



15–62



December 31, 2016Interest expense (2% x $57,116: from schedule)........ 1,142Lease payable (difference).................................... 13,858




($15,000 x 7.47199*) = $112,080lease present



Because the lease term is equal to the expected useful life of the asset and the present value of the lease payments is equal to the asset’s fair value, we can assume the risks and rewards of ownership are transferred to the lessee, so it’s a Type A lease.


Exercise 15-34



112,0801 15,000 15,000 97,0802 15,000 .02 (97,080) = 1,942 13,058 84,0223 15,000 .02 (84,022) = 1,680 13,320 70,7024 15,000 .02 (70,702) = 1,414 13,586 57,1165 15,000 .02 (57,116) = 1,142 13,858 43,2586 15,000 .02 (43,258) = 865 14,135 29,1237 15,000 .02 (29,123) = 582 14,418 14,7058 15,000 .02 (14,705) = 295 * 14,705 0

120,000 7,920 112,080


January 1, 2016Lease receivable (present value calculated above). . . . 112,080

Inventory of equipment (lessor’s cost).............. 112,080

Cash (lease payment)............................................. 15,000Lease receivable............................................. 15,000

March 31, 2016Cash (lease payment)............................................. 15,000

Interest revenue (2% x [$112,080 – 15,000])......... 1,942Lease receivable............................................. 13,058

No depreciation

June 30, 2016

15–64



Cash (lease payment)............................................. 15,000Interest revenue (2% x $84,022: from schedule).... 1,680Lease receivable............................................. 13,320

No depreciation

September 30, 2016Cash (lease payment)............................................. 15,000

Interest revenue (2% x $70,702: from schedule).... 1,414Lease receivable............................................. 13,586

No depreciation

December 31, 2016Cash (lease payment)............................................. 15,000

Interest revenue (2% x $57,116: from schedule).... 1,142Lease receivable............................................. 13,858

No depreciation



($15,000 x 7.47199*) = $112,080lease present



January 1, 2016Right-of-use equipment (present value calculated above) 112,080

Lease payable (present value calculated above). . . . 112,080

Lease payable.................................................... 15,000Cash (lease payment)......................................... 15,000

March 31, 2016Interest expense (2% x [$112,080 – 15,000])............. 1,942Lease payable (difference).................................... 13,058


Amortization expense ($15,000 – 1,942).................. 13,058Right-of-use equipment.................................. 13,058


15–66

Exercise 15-35



($15,000 x 7.47199*) = $112,080lease present



January 1, 2016(Type B lease)No entry to record a lease receivable or to derecognize the leased asset.

Cash (lease payment)............................................. 15,000Interest revenue..................................................... 15,000

March 31, 2016Cash (lease payment)............................................. 15,000

Interest revenue..................................................... 15,000

In a Type B lease, the lessor records interest revenue equal the straight-line lease payment.

Requirement 1

January 1, 2016Right-of-use asset ............................................. 4,000,000

Lease payable................................................ 4,000,000

Requirement 2


Exercise 15-36

Exercise 15-37

$4,000,000 ÷ 3.16987** = $1,261,881present leasevalue payment




4,000,0002016 1,261,881 .10 (4,000,000) = 400,000 861,881 3,138,1192017 1,261,881 .10 (3,138,119) = 313,812 948,069 2,190,0502018 1,261,881 .10 (2,190,050) = 219,005 1,042,876 1,147,1742019 1,261,881 .10 (1,147,174) = 114,707 * 1,147,174 0

5,047,524 1,047,524 4,000,000* adjusted for rounding of other numbers in the schedule


Interest expense (10% x outstanding balance).......... 400,000Lease payable (difference).................................... 861,881


Amortization expense ($4 million ÷ 4 years). . . . 1,000,000Right-of-use asset......................................... 1,000,000


Interest expense (10% x outstanding balance).......... 219,005Lease payable (difference).................................... 1,042,876


15–68



Amortization expense ($4 million ÷ 4 years). . . . 1,000,000Right-of-use asset......................................... 1,000,000

A lease that has a maximum possible lease term (including options to terminate or renew that are reasonably certain) of twelve months or less is considered a “short-term lease.”

A lessee that has a short-term lease has the option to not record a right-of-use asset or lease payable and simply record lease payments as periodic expense.

January 1, 2016No entry to record a right-of-use asset and liability

Lease expense.................................................... 15,000Cash (lease payment)......................................... 15,000

March 31, 2016Lease expense.................................................... 15,000


June 30, 2016Lease expense.................................................... 15,000


September 30, 2016Lease expense.................................................... 15,000


Note: These payments technically could be recorded as prepaid expenses at the beginning of each quarter. Then, at the end of each quarter, we would need to credit prepaid lease expense and debit lease expense.


Exercise 15-38

CPA / CMA REVIEW QUESTIONSCPA Exam Questions

1. b. The 4 year lease term is greater than 75% of the asset's 5 year life making this a capital lease.

2. b. $111,500

Present value at 1/1/2016 $112,500Payment made 12/30/2016 $10,000Interest portion for 2016 (8% × $112,500) (9,000 ) Portion applied to the liability (1,000 )

Capital lease liability 12/31/2016 $111,5003. a. The key point is to first calculate the annual payments required by

the lease. Use the basic present value formula: Annual Payments × Present Value Factor = Present Value of Future Payments. Therefore: Annual Payments × 4.313 = $323,400; Annual payments = $323,400/4.313; Annual payments = $75,000. Then multiply the customer's $75,000 annual payment by 5 years for a total of $375,000. This figure represents Glade Co.'s gross Lease Receivable. The difference between the gross Lease Receivable and the present value of the future payments is the total amount of Interest Revenue that will be recognized over the life of the lease ($375,000 – 323,400 = $51,600).

4. c. The profit on the sale is the difference between the cash selling price and the book value, $3,520,000 – 2,800,000 = $720,000. The interest is computed as follows:

Present value of minimum lease payments and lease obligation, 7/1/2016 $3,520,000Initial payment made 7/1/2016 (600,000 ) Liability balance $2,920,000

Interest rate 10% = $292,000For one-half year = $146,000

15–70

Full file at http://testbankeasy.eu/Solution-Manual-for-Intermediate-Accounting,-8th-Edition---SpicelanCPA Exam Questions (concluded)

5. a. In a capital lease with a bargain purchase option, the lessee will control the asset for its total useful life. Therefore, the depreciation should be allocated over the 8-year life of the asset. $240,000 cost – 20,000 salvage value = 220,000 / 8 years = $27,500 per year.

6. a. The guaranteed residual value is a promise made by the lessee that the lessor can sell the leased asset at the end of the lease for a guaranteed amount. Since this promise is a potential future payment, it must be included in the calculation of the present value of the lessee's future lease payments.

7. a. The capitalized lease liability should be the annual lease payments less the executory cost (real estate taxes) times the present value factor for an ordinary annuity of 1 for nine years at 9%. The calculation would be: ($52,000 – 2,000) × 6.0 = $300,000. The real estate taxes are a period cost and should be charged to expense.

8. a. Since the machine is being leased back for a minor part (present value of rentals is less than 10% of the value of the property at the date of the sale-leaseback), the sale and the lease are viewed separately and the entire $30,000 profit is recognized.

9. b. In making the distinction between an operating lease and a capital/finance lease, more judgment, less specificity is applied using IFRS.

10. d. When recording a capital lease (usually called a finance lease under IFRS) a lessee using U.S. GAAP uses the lower of the implicit rate and its own incremental borrowing rate. Under IFRS if the lessee is aware of the implicit interest rate used by the lessor to calculate lease payments, that’s the rate it uses.

11. b. When a sale-leaseback transaction occurs, if the leaseback is considered to be an operating lease, and the lease payments and sales price are at fair value, any gain on the sale is recognized immediately by a company using IFRS.


1. d. For both sales-type and direct-financing leases, the lessor’s gross investment in the lease

is the amount of the minimum lease payments (which include periodic payments plus guaranteed residual value) plus any amounts of unguaranteed residual value. The net investment in the lease is equal to the gross investment, plus any unamortized initial direct costs, minus deferred income. The unguaranteed residual value is the expected value of the lease asset in excess of the guaranteed residual value at the end of the lease term.

2. d. A lessee records a lease as a capital lease if it meets any one of four criteria. Existence of a bargain purchase option is one of these criteria. If a lease involving land and a building contains a bargain purchase option or if the lease transfers ownership to the lessee at the end of its term, the lessee separately capitalizes the land and the building.

3. b. Initial direct costs have two components: (1) the lessor’s external costs to originate a lease incurred in dealings with independent third parties and (2) the internal costs directly related to specified activities performed by the lessor for that lease. In a sales-type lease, the cost, or book value if different, plus any initial direct costs, minus the present value of any unguaranteed residual value, is charged against income in the same period that the present value of the minimum lease payments is credited to sales. The result is the recognition of a net profit or loss on the sales-type lease.

December 31, 2020Rent expense ($10,000 + [$500 x 20 ÷ 2])*......................... 15,000

Deferred rent expense payable (difference).................. 3,000Cash ($10,000 + [$500 x 4]) .......................................... 12,000

15–72

CMA Exam Questions

PROBLEMS Problem 15-1


December 31, 2027Rent expense ($10,000 + [$500 x 20 ÷ 2])*......................... 15,000Deferred rent expense payable (difference)...................... 2,000

Cash ($10,000 + [$500 x 14]) ........................................ 17,000

* This is the average rent over the 20-year period.

Also: ($10,000 + 20,000) ÷ 2 Beg. Rent Ending Rent

1. NIC’s lease payable at the inception of the lease

$172,501: [$192,501 – 20,000] (present value of minimum lease payments or initial lease balance minus first payment)

2. Leased asset

$192,501 (present value of minimum lease payments; initial lease balance)

3. Lease term in years

20 years

4. Asset’s residual value expected at the end of the lease term

$35,000

5. Residual value guaranteed by the lessee

$35,000 (would not be part of lessee’s minimum lease payments unless lessee-guaranteed)

6. Effective annual interest rate

10%: ($17,250 ÷ $172,501)

7. Total of minimum lease payments


Problem 15-2

$435,000: [$20,000 x 20 years] + $35,000

8. Total effective interest expense over the term of the lease

$242,499: [$435,000 – 192,501]

Requirement 1

Capital lease to lessee; Direct financing lease to lessor.

Since the present value of minimum lease payments (same for both the lessor and the lessee) is greater than 90% of the fair value of the asset, the 90% recovery criterion is met.

Calculation of the Present Value of Minimum Lease Payments

Present value of periodic lease payments$130,516 x 15.32380** = $2,000,000

(rounded)** present value of an annuity due of $1: n=20, i=3%

The 75% of useful life criterion is met also. Both additional lessor conditions are met for a capital lease. There is no dealer’s profit because the fair value equals the lessor’s cost.

Requirement 2

Mid-South Urologists Group (Lessee)January 1, 2016Leased equipment (calculated above)................................ 2,000,000


Lease payable ............................................................... 130,516 Cash (lease payment).................................................... 130,516

15–74

Problem 15-3


April 1, 2016Interest expense (3% x [$2 million – 130,516])....................... 56,085Lease payable (difference)............................................... 74,431


Physicians’ Leasing (Lessor)

January 1, 2016Lease receivable (present value calculated above).......... 2,000,000

Inventory of equipment (lessor’s cost).................... 2,000,000

Cash (lease payment).................................................. 130,516Lease receivable ................................................. 130,516

April 1, 2016Cash (lease payment).................................................. 130,516

Lease receivable (difference)................................. 74,431Interest revenue (3% x [$2 million – 130,516])........... 56,085

Requirement 3 Rand Medical (Lessor)January 1, 2016Lease receivable (present value calculated above).......... 2,000,000Cost of goods sold (lessor’s cost)..................................... 1,700,000

Sales revenue (present value calculated above)................ 2,000,000Inventory of equipment (lessor’s cost).......................... 1,700,000

Cash (lease payment)........................................................ 130,516Lease receivable ....................................................... 130,516

April 1, 2016Cash (lease payment)........................................................ 130,516

Lease receivable (difference)....................................... 74,431Interest revenue (3% x [$2 million – 130,516]).................. 56,085


Problem 15-3 (concluded)

[Note: This problem is the lease equivalent of Problem 14-12, which deals with a parallel situation in which the machine was acquired with an

installment note.]

1. Effective rate of interest implicit in the agreement

$6,074,700 ÷ $2,000,000 = 3.03735 present lease present valuevalue payment table amount

This is the ordinary annuity present value table amount for n = 4, i = ? In row 4 of the present value table, the number 3.03735 is in the 12% column. So, 12% is the implicit interest rate.

2. Inception of the lease

Leased asset (fair value).................................................. 6,074,700 Lease payable (present value)....................................... 6,074,700


Interest expense (12% x $6,074,700)...................................... 728,964Lease payable (difference)............................................... 1,271,036

Cash (lease payment).................................................... 2,000,000


Interest expense (12% x [$6,074,700 – 1,271,036])................ 576,440Lease payable (difference)............................................... 1,423,560

Cash (lease payment).................................................... 2,000,000

5. Inception of the lease

$2,000,000 x 3.10245** = $6,204,900lease present

payment value


Leased asset ................................................................. 6,204,900Lease payable............................................................ 6,204,900

15–76

Problem 15-4



$391,548 x 15.32380 = $6,000,000(rounded)


2. Liability at December 31, 2016Initial balance, September 30, 2016........................ $6,000,000Sept. 30, 2016 reduction......................................... (391,548)*Dec. 31, 2016 reduction.......................................... (223,294 ) **December 31, 2016 net liability.............................. $5,385,158

The current and noncurrent portions of the liability would be reported separately.

Asset at December 31, 2016Initial balance, September 30, 2016........................ $6,000,000Accumulated depreciation at Dec. 31, 2016............ (300,000 ) ** December 31, 2016........................................... $5,700,000

3. Expenses for year ended December 31, 2016

Sept. 30, 2016 interest expense............................... $ 0*Dec. 31, 2016 interest expense................................ 168,254**Interest expense for 2016........................................ $168,254

Depreciation expense for 2016................................ 300,000 Total expenses...................................................... $468,254


Problem 15-5


4. Statement of cash flows for year ended December 31, 2016

Werner would report the $6,000,000* investment in the protein analyzer and its financing with a capital lease as a significant noncash investing and financing activity in the disclosure notes to the financial statements.

The $783,096 ($391,548 x 2) cash lease payments are divided into the interest portion and the principal portion. The interest portion, $168,254**, is reported as cash outflows from operating activities. The principal portion, $391,548 + 223,294**, is reported as cash outflows from financing activities.

Note: By the indirect method of reporting cash flows from operating activities, we would add back to net income the $300,000 depreciation expense since it didn’t actually reduce cash. The $168,254 interest expense that reduced net income actually did reduce cash [the interest portion of the $783,096 ($391,548 x 2) cash lease payments], so for it, no adjustment to net income is necessary.

Calculations:September 30, 2016*Leased equipment (calculated in req. 1)........................... 6,000,000

Lease payable (calculated in req. 1)............................. 6,000,000

Lease payable ............................................................... 391,548Cash (lease payment).................................................. 391,548

December 31, 2016**Interest expense (3% x [$6 million – 391,548])................ 168,254Lease payable (difference).............................................. 223,294

Cash (lease payment).................................................. 391,548

Depreciation expense ($6 million ÷ 5 years x ¼ year). . . . 300,000Accumulated depreciation......................................... 300,000

15–78



Calculation of the present value of lease payments$391,548 x 15.32380 = $6,000,000

(rounded) present value of an annuity due of $1: n=20, i=3%

Receivable Initial balance, September 30, 2016.. . $6,000,000Sept. 30, 2016 reduction.................... (391,548)*Dec. 31, 2016 reduction..................... (223,294 ) **December 31, 2016 receivable........... $5,385,158

The receivable replaces the $6,000,000 machine in the balance sheet.

2. Interest revenue for year ended December 31, 2016

Sept. 30, 2016 interest revenue............................... $ 0*Dec. 31, 2016 interest revenue................................ 168,254**Interest revenue for 2016........................................ $168,254


Abbott would report the $6,000,000* direct financing lease of the protein analyzer as a significant noncash investing activity (acquiring one asset and disposing of another) in the disclosure notes to the financial statements.

The $783,096 ($391,548 x 2) cash lease payments are divided into the interest portion and the principal portion. The interest portion, $168,254**, is reported as cash inflows from operating activities. The principal portion, $391,548 + 223,294**, is reported as cash inflows from investing activities.

Note: By the indirect method of reporting cash flows from operating activities, the $168,254 interest revenue that increased net income actually did increase cash [the interest portion of the $783,096 ($391,548 x 2) cash lease payments], so no adjustment to net income is necessary.


Problem 15-6


Calculations:September 30, 2016*Lease receivable (present value calculated above)............ 6,000,000

Inventory of equipment (lessor’s cost)........................ 6,000,000

Cash (lease payment)...................................................... 391,548Lease receivable........................................................ 391,548



1. Calculation of the present value of lease payments (“selling price”)

$391,548 x 15.32380 = $6,000,000(rounded)



Receivable Initial balance, September 30, 2016.. . $6,000,000Sept. 30, 2016 reduction.................... (391,548)*Dec. 31, 2016 reduction..................... (223,294 ) **December 31, 2016 net receivable..... $5,385,158

The receivable replaces the $5,000,000 machine in inventory in the balance sheet.

* First payment has zero interest.** $6,000,000 minus first payment $391,548 = $5,608,542

15–80

Problem 15-7


$5,608,542 x .03 = $168,254 interest $391,548 payment minus $168,254 interest = $223,294 reduction of receivable

3. Income effect for year ended December 31, 2016

Sept. 30, 2016 interest revenue............................... $ 0*Dec. 31, 2016 interest revenue................................ 168,254**Interest revenue for 2016........................................ $ 168,254

Sales revenue*........................................................... 6,000,000Cost of goods sold*................................................... (5,000,000 ) Income effect.......................................................... $1,168,254


Problem 15-7 (continued)


NutraLabs would report the $6,000,000* sales-type lease of the protein analyzer as a significant noncash activity in the disclosure notes to the financial statements.

The $783,096 ($391,548 x 2) cash lease payments are considered to be cash flows from operating activities. A sales-type lease differs from a direct financing lease in that we assume the lessor is actually selling its product, an operating activity. Thus, both the interest portion, $168,254**, and the principal portion, $391,548 + 223,294**, are reported as cash inflows from operating activities.

Note: By the indirect method of reporting cash flows from operating activities, the $1,000,000 (Sales revenue: $6,000,000 – Cost of goods sold: $5,000,000) dealer’s profit must be deducted from net income because it is included in net income but won’t increase cash flows until the lease payments are collected over the next five years. This addition, however, occurs automatically as we make the usual adjustments for the change in receivables (to adjust sales to cash received from customers) and for the change in inventory (to adjust cost of goods sold to cash paid to suppliers).

The $168,254 interest revenue that increased net income actually did increase cash [the interest portion of the $783,096 ($391,548 x 2) cash lease payments], so for it, no adjustment to net income is necessary. The principal portion, $391,548 + 223,294, must be added because it is not otherwise included in net income. This, too, though, occurs automatically as we make the usual adjustments for the change in receivables (to adjust sales to cash received from customers).

Noncash adjustments to convert net income to cash flows from operating activities:

Increase in lease receivable...................................... ($6,000,000)Decrease in inventory of equipment......................... 5,000,000Decrease in lease receivable, Sept. 30...................... 391,548Decrease in lease receivable, Dec. 31....................... 223,294

15–82

Full file at http://testbankeasy.eu/Solution-Manual-for-Intermediate-Accounting,-8th-Edition---SpicelanProblem 15-7 (concluded)

Calculations:September 30, 2016*Lease receivable (present value calculated above)............ 6,000,000Cost of goods sold (lessor’s cost).................................... 5,000,000

Sales revenue (present value calculated above)............. 6,000,000Inventory of equipment (lessor’s cost)........................ 5,000,000

Cash (lease payment)...................................................... 391,548Lease receivable........................................................ 391,548




Requirement 1

Lessor’s Calculation of Lease payments


Less: Present value of the guaranteed residual value ($25,000 x .68301*) (17,075 )


Lease payments at the beginning of each of four years: ($348,685 ÷ 3.48685**) $100,000


Requirement 2

The lessee’s incremental borrowing rate (12%) is more than the lessor’s implicit rate (10%). So, both parties’ calculations should be made using a 10% discount rate:

15–84

Problem 15-8


Application of Classification Criteria

1 Does the agreement specify that ownership of the asset transfers to the lessee? NO


3 Is the lease term equal to 75% or more of the expected NOeconomic life of the asset? {4 yrs < 75% of 6 yrs}

4 Is the present value of the minimum lease payments equalto or greater than 90% of the YESfair value of the asset? {$365,760b > 90% of $365,760}

b See calculation below.

Present Value of Minimum Lease Payments

Present value of periodic lease payments ($100,000 x 3.48685**) $348,685Plus: Present value of the lessee-guaranteed residual value ($25,000 x .68301*) 17,075

Present value of minimum lease payments $365,760* present value of $1: n=4, i=10%** present value of an annuity due of $1: n=4, i=10%



(a) By Western Soya Co. (the lessee)

Since at least one criterion is met, this is a capital lease to the lessee. Western Soya records the present value of minimum lease payments as a leased asset and a lease payable.

(b) By Rhone-Metro (the lessor)

Since the fair value equals the lessor’s book value, there is no dealer’s profit, making this a direct financing lease.

Requirement 3

December 31, 2016

Western Soya Co. (Lessee)Leased equipment (calculated above)................................ 365,760

Lease payable (calculated above).................................. 365,760

Lease payable................................................................ 100,000Cash (lease payment).................................................... 100,000

Rhone-Metro (Lessor)Lease receivable (calculated above).................................. 365,760



15–86



Requirement 4

Since both use the same discount rate and since the residual value is lessee-guaranteed, the same amortization schedule applies to both the lessee and lessor:


Dec. Payments Interest in Balance Balance31 10% x Outstanding Balance

2016 365,7602016 100,000 100,000 265,7602017 100,000 .10 (265,760) = 26,576 73,424 192,3362018 100,000 .10 (192,336) = 19,234 80,766 111,5702019 100,000 .10 (111,570) = 11,157 88,843 22,7272020 25,000 .10 (22,727) = 2,273 22,727 0

425,000 59,240 365,760


Western Soya Co. (Lessee)Interest expense (10% x [$365,760 – 100,000])...................... 26,576Lease payable (difference)............................................... 73,424


Depreciation expense ([$365,760 – 25,000] ÷ 4 years).......... 85,190Accumulated depreciation......................................... 85,190

Rhone-Metro (Lessor)Cash (lease payment)........................................................ 100,000

Lease receivable (difference)....................................... 73,424Interest revenue (10% x [$365,760 – 100,000]).................. 26,576



Requirement 6

December 31, 2020Western Soya Club (Lessee)Depreciation expense ([$365,760 – 25,000] ÷ 4 years)........ 85,190

Accumulated depreciation......................................... 85,190

Interest expense (10% x 22,727: from schedule)..................... 2,273Lease payable (difference: from schedule).......................... 22,727Accumulated depreciation ($365,760 – 25,000)................. 340,760Loss on residual value guarantee ($25,000 – 1,500)............ 23,500

Leased equipment (account balance)............................. 365,760Cash ($25,000 – 1,500)................................................. 23,500

Rhone-Metro (Lessor)Inventory of equipment (actual residual value)................... 1,500Cash ($25,000 – 1,500)..................................................... 23,500


15–88



Requirement 1



Less: Present value of the unguaranteed residual value ($25,000 x .68301*) (17,075 ) Amount to be recovered through periodic lease payments $348,685

_____________________Lease payments at the beginning of each of four years: ($348,685 ÷ 3.48685**) $100,000Plus: Executory costs 4,000Lease payments including executory costs $104,000


Requirement 2 The lessee’s incremental borrowing rate (12%) is more than the lessor’s implicit

rate (10%). So, both parties’ calculations should be made using a 10% discount rate:


Problem 15-9





3 Is the lease term equal to 75% or more of the expected NOeconomic life of the asset? {4 yrs < 75% of 6 yrs}

4 Is the present value of the minimum lease payments equalto or greater than 90% of the YESfair value of the asset? {$348,685a > 90% of $365,760}

a See calculation below.


Present value of periodic lease payments excluding executory costs of $4,000 ($100,000* x 3.48685**) $348,685


* Since the residual value is not guaranteed, it is excluded from both the lessor’s and the lessee’s minimum lease payments and therefore does not affect the 90% of fair value test.

(a) by Western Soya Co. (the lessee)

Since at least one criterion is met, this is a capital lease to the lessee. Western Soya records the present value of minimum lease payments as a leased asset and a lease payable.

15–90



(b) by Rhone-Metro (the lessor)

Since the fair value exceeds the lessor’s book value, the equipment is being “sold” at a profit, making this a sales-type lease:

Fair value $365,760 minusBook value (300,000 ) equalsDealer’s profit $ 65,760




Lease payable................................................................ 100,000Prepaid operating expense (2017 expenses)...................... 4,000


Rhone-Metro (Lessor)Lease receivable (fair value)............................................ 365,760Cost of goods sold ($300,000 – [$25,000 x .68301]).............. 282,925

Sales revenue ($365,760 – [$25,000 x .68301])................ 348,685Inventory of equipment (lessor’s cost).......................... 300,000

Cash (lease payment)........................................................ 104,000Payable (maintenance, insurance, etc.)...................... 4,000Lease receivable........................................................ 100,000


Requirement 4

Lessee (unguaranteed residual value excluded):



2016 348,6852016 100,000 100,000 248,6852017 100,000 .10 (248,685) = 24,869 75,131 173,5542018 100,000 .10 (173,554) = 17,355 82,645 90,9092019 100,000 .10 (90,909) = 9,091 90,909 0

400,000 51,315 348,685

Lessor (unguaranteed residual value included):



2016 365,7602016 100,000 100,000 265,7602017 100,000 .10 (265,760) = 26,576 73,424 192,3362018 100,000 .10 (192,336) = 19,234 80,766 111,5702019 100,000 .10 (111,570) = 11,157 88,843 22,7272020 25,000 .10 (22,727) = 2,273 22,727 0

425,000 59,240 365,760

15–92



Requirement 5

December 31, 2017Western Soya Co. (Lessee)Depreciation expense ([$348,685] ÷ 4 years)......................... 87,171


Operating expense (2017 expenses).................................. 4,000Prepaid operating expense (paid in 2016)..................... 4,000

Interest expense (10% x [$348,685 – 100,000])...................... 24,869Lease payable (difference)............................................... 75,131Prepaid operating expense (2018 expenses)...................... 4,000



Payable (maintenance, insurance, etc.)...................... 4,000Lease receivable (difference)....................................... 73,424Interest revenue (10% x [$365,760 – 100,000]).................. 26,576



Requirement 6

December 31, 2020Western Soya Co. (Lessee)Operating expense (2020 expenses).................................. 4,000

Prepaid operating expense (paid in 2019)..................... 4,000

Depreciation expense ([$348,685] ÷ 4 years)......................... 87,171Accumulated depreciation......................................... 87,171

Accumulated depreciation (account balance).................... 348,685Leased equipment (account balance)............................. 348,685

Rhone-Metro (Lessor)Inventory of equipment (actual residual value)................... 1,500Loss on leased assets ($25,000 – 1,500)............................ 23,500


15–94



Requirement 1



Less: Present value of the BPO price ($10,000 x .75131*) (7,513 ) Amount to be recovered through periodic lease payments $358,247

_____________________Lease payments at the beginning of each of three years: ($358,247 ÷ 2.73554**) $130,960Plus: Executory costs 4,000Lease payments including executory costs $134,960


Requirement 2



Problem 15-10



2 Does the agreement contain a bargain purchase option? YES

3 Is the lease term equal to 75% or more of the expected NOeconomic life of the asset? {3 yrsa < 75% of 6 yrs}

4 Is the present value of the minimum lease payments equalto or greater than 90% of the YESfair value of the asset? {$365,760b > 90% of $365,760}

a The lease term is considered to end at the date a BPO becomes exercisable.b See calculation below.


Present value of periodic lease payments excluding executory costs of $4,000 ($130,960 x 2.73554**) $358,247***


Present value of minimum lease payments $365,760* present value of $1: n=3, i=10%** present value of an annuity due of $1: n=3, i=10%*** rounded

Note: The BPO price is included in both the lessor’s and the lessee’s minimum lease payments. Also the lease term ends for accounting purposes after 3 years, when the BPO becomes exercisable.

15–96




(a) by Western Soya Co. (the lessee)

Since at least one (two in this case) classification criterion is met, this is a capital lease to the lessee. Western Soya records the present value of minimum lease payments as a leased asset and a lease payable.

(b) by Rhone-Metro (the lessor)

Since the fair value exceeds the lessor’s book value, the equipment is being “sold” at a profit, making this a sales-type lease:


Requirement 3

December 31, 2016



Lease payable................................................................ 130,960Prepaid maintenance expense (2017 executory costs)......... 4,000


Rhone-Metro (Lessor)Lease receivable (present value of minimum lease payments) 365,760Cost of goods sold (lessor’s cost)..................................... 300,000

Sales revenue (present value of minimum lease payments). 365,760Inventory of equipment (lessor’s cost).......................... 300,000

Cash (lease payment)........................................................ 134,960Payable (maintenance, insurance, etc.)...................... 4,000Lease receivable........................................................ 130,960


Requirement 4

Lessee and lessor (BPO included):

Since both use the same discount rate and since the bargain purchase option is included as an additional payment for both, the same amortization schedule applies to both the lessee and lessor. The lease term ends for accounting purposes after 3 lease payments, because the BPO becomes exercisable before the fourth:



2016 365,7602016 130,960 130,960 234,8002017 130,960 .10 (234,800) = 23,480 107,480 127,3202018 130,960 .10 (127,320) = 12,732 118,228 9,0922019 10,000 .10 (9,092) = 908 * 9,092 0

402,880 37,120 365,760


Requirement 5

December 31, 2017

15–98




Western Soya Co. (Lessee)Depreciation expense ($365,760 ÷ 6 years*)......................... 60,960


Maintenance expense (2017 executory costs)..................... 4,000Prepaid maintenance expense (paid in 2016)................ 4,000

Interest expense (10% x [$365,760 – 130,960])...................... 23,480Lease payable (to balance)............................................... 107,480Prepaid maintenance expense (2018 executory costs)......... 4,000



Payable (maintenance)............................................... 4,000Lease receivable (to balance)....................................... 107,480Interest revenue (10% x [$365,760 – 130,960]).................. 23,480

* If ownership transfers (a) by contract or (b) by the expected exercise of a bargain purchase option, the asset should be depreciated over the asset's useful life. This reflects the fact that the lessee anticipates using the leased asset for its full useful life. In this case, the equipment is expected to be useful for 6 years.


Requirement 6

December 31, 2019Western Soya Club (Lessee)Depreciation expense ($365,760 ÷ 6 years)........................... 60,960


Interest expense (10% x $9,092: from schedule[rounded])..... 908Lease payable (from schedule)......................................... 9,092

Cash (BPO price)......................................................... 10,000

Maintenance expense (2019 executory costs)..................... 4,000Prepaid maintenance expense (paid in 2018)................ 4,000

Prepaid maintenance expense (2020 executory costs)*....... 4,000Cash (paid to lessor or supplier of services)....................... 4,000

Equipment .................................................................... 365,760Leased equipment ..................................................... 365,760

Rhone-Metro (Lessor)Cash (BPO price)............................................................. 10,000

Lease receivable (difference)....................................... 9,092Interest revenue (10% x $9,092: from schedule[rounded]). 908

Cash (assuming executory costs continue to be paid by lessor). . 4,000Payable (maintenance)............................................... 4,000

* If paid to suppliers of services, the payments and this entry may occur in 2020.

15–100



Requirement 1



Less: Present value of the third-party-guaranteed residual value* ($150,000 x .75131*) (112,697 ) Amount to be recovered through periodic lease payments $547,108

_____________________Lease payments at the beginning of each of three years: ($547,108 ÷ 2.73554**) $200,000


Note: Since the residual value is guaranteed to the lessor, it is included in the lessor’s minimum lease payments and therefore affects the 90% of fair value test.

Requirement 2 Since [1] title to the conveyer does not transfer to the lessee, [2] there is no BPO,

and [3] the lease term (3 years) is less than 75% of the estimated useful life (6 years), the critical classification criterion is [4] whether the present value of minimum lease payments exceeds 90% of the fair value of the conveyer ($659,805). The present value is influenced by the fact that the residual value is (a) relatively large and (b) guaranteed, but by a third-party, not the lessee. The residual value, if guaranteed (by the lessee or by a third party guarantor), is included in the minimum lease payments by the lessor when applying the 90% of fair value criterion and thus increases the likelihood that it is met. However, when the residual value is guaranteed by a third-party guarantor and not by the lessee, it is not included in the lessee’s minimum lease payments. So, if a residual value is sufficiently large and guaranteed by a third-party guarantor, it may cause the 90% of fair value criterion to be met by the lessor, but not by the lessee.

For the lessor, the criterion is met: The present value of minimum lease payments ($659,805) is more than 90%

of the fair value ($659,805 x 90% = $593,825). Also, since the fair value exceeds the


Problem 15-11


lessor’s book value, the conveyer is being “sold” at a profit, making this a sales-type lease:

Fair value $659,805 minusBook value (450,000 ) equalsDealer’s profit $209,805

Lessee’s Calculation of the Present Value of Minimum Lease Payments

Present value of periodic lease payments*

($200,000 x 2.73554**) $547,108** present value of an annuity due of $1: n=3, i=10%

* Since the residual value is not guaranteed by the lessee, it is excluded from the lessee’s minimum lease payments and therefore does not affect the 90% of fair value test.

For the lessee, the criterion is not met: The present value of minimum lease payments ($547,108) is less than 90% of the fair value ($659,805 x 90% = $593,825). So, this is an operating lease to the lessee.

15–102


Requirement 3

December 31, 2016

Poole (Lessee)Prepaid rent (2016 payment; 2017 expense)......................... 200,000


Allied (Lessor)Lease receivable (present value of minimum lease payments) 659,805Cost of goods sold (lessor’s cost)..................................... 450,000

Sales revenue (present value of minimum lease payments). 659,805Inventory of equipment (lessor’s cost).......................... 450,000


Requirement 4 Since the lessee records the lease as an operating lease, interest expense is not

recorded and an amortization schedule is not applicable.

Lessor (third-party-guaranteed residual value included):



2016 659,8052016 200,000 200,000 459,8052017 200,000 .10 (459,805) = 45,981 154,019 305,7862018 200,000 .10 (305,786) = 30,579 169,421 136,3652019 150,000 .10 (136,365) = 13,635 * 136,365 0

750,000 90,195 659,805* rounded



Requirement 5

December 31, 2017

Poole (Lessee)Rent expense................................................................. 200,000

Prepaid rent (2016 payment; 2017 expense)..................... 200,000

Prepaid rent................................................................... 200,000Cash (2017 payment; 2018 expense)................................ 200,000

Allied (Lessor)Cash (lease payment)........................................................ 200,000


December 31, 2018Poole (Lessee)Rent expense................................................................. 200,000


Prepaid rent................................................................... 200,000Cash (2018 payment; 2019 expense)................................ 200,000

Allied (Lessor)Cash (lease payment)........................................................ 200,000

Lease receivable........................................................ 169,421Interest revenue (10% x $305,786: from schedule)............. 30,579

15–104



December 31, 2019Poole (Lessee)Rent expense................................................................. 200,000


Allied (Lessor)Inventory of equipment (actual residual value)................... 105,000Cash ($150,000 – 105,000: from 3rd party guarantor)............. 45,000

Lease receivable (account balance)............................... 136,365Interest revenue (10% x $136,365: from schedule)............. 13,635

Situation 1 2 3 4

A. The lessor’s:1. Minimum lease payments1 $40,000 $44,000 $44,000 $40,0002. Gross investment in the lease2 40,000 44,000 44,000 44,0003. Net investment in the lease3 34,437 37,072 37,072 37,072

B. The lessee’s:4. Minimum lease payments4 40,000 44,000 40,000 40,0005. Leased asset5 34,437 37,072 34,437 34,4376. Lease payable6 34,437 37,072 34,437 34,437

1 ($10,000 x number of payments) + Residual value guaranteed by lessee and/or by third party.

2 Minimum lease payments plus unguaranteed residual value.3 Present value of gross investment.4 ($10,000 x number of payments) + Residual value guaranteed by lessee.5 Present value of minimum lease payments; should not exceed fair value.6 Present value of minimum lease payments; should not exceed fair value.

Situation 1 2 3 4



Problem 15-12

Problem 15-13

A. The lessor’s:1. Minimum lease payments1 $400,000 $553,000 $640,000 $510,0002. Gross investment in the lease2 $430,000 553,000 675,000 550,0003. Net investment in the lease3 369,175 433,809 533,685 451,1374. Sales revenue4 N/A N/A 512,816 423,8175. Cost of goods sold5 N/A N/A 479,131 372,6806. Dealer’s profit6 N/A N/A 33,685 51,137

B. The lessee’s:7. Minimum lease payments7 $400,000 553,000 640,000 460,0008. Leased asset8 353,129 449,896 512,816 389,6669. Lease payable9 353,129 449,896 512,816 389,666

Note: Since executory costs are excluded from minimum lease payments, they have no effect on any of the calculated amounts.

1 ($100,000 x Number of payments) + Residual value guaranteed by lessee and/or by third party; for situation 4: ($100,000 x 4) + ($60,000 + 50,000)

2 Minimum lease payments plus unguaranteed residual value; for situation 4: ($510,000 + 40,000)3 Present value of gross investment (discounted at lessor’s rate); for situation 4: ($100,000 x

3.48685) + ($150,000 x .68301)4 Present value of minimum lease payments; also, Net investment – Present value of unguaranteed

residual value; for situation 4: ($100,000 x 3.48685) + ($110,000 x .68301); also, $451,137 – 27,320 ($40,000 x .68301)

5 Lessor’s cost – Present value of unguaranteed residual value; for situation 4: ($400,000 – 40,000 x .68301)

6 Sales revenue – cost of goods sold; also, Net investment – Lessor’s cost ; for situation 4: ($423,817 – 372,680); also, ($451,137 – 400,000)

7 ($100,000 x number of payments) + Residual value guaranteed by lessee; for situation 4: ($100,000 x 4) + $60,000

8 Present value of minimum lease payments (discounted at lower of lessor’s rate and lessee’s incremental borrowing rate); should not exceed fair value; for situation 4: ($100,000 x 3.48685) + ($60,000 x .68301)

9 Present value of minimum lease payments (discounted at lower of lessor’s rate and lessee’s incremental borrowing rate); should not exceed fair value; for situation 4: ($100,000 x 3.48685) + ($60,000 x .68301)

15–106


Requirement 1 Branson Construction (Lessee)Interest expense (10% x [$936,500 – 100,000])...................... 83,650Lease payable (difference)............................................... 16,350


Maintenance expense............................................................. 3,000Cash (2017 expenses as incurred).................................... 3,000


Branif Leasing (Lessor)Cash (lease payment)........................................................ 100,000


Requirement 2 Branson Construction (Lessee)Interest expense (10% x [$936,500 – 100,000])...................... 83,650Lease payable (to balance)............................................... 16,350Maintenance expense (annual fee)*....................................... 3,000



* This debit to maintenance expense is the net effect of (a) expensing the current year’s costs that were prepaid with the first lease payment the last day of 2016 and (b) prepaying next year’s expense with the 2017 payment:

Maintenance expense (2017 costs).............................................. 3,000Prepaid maintenance expense (paid in 2016).......................... 3,000

Interest expense (10% x [$936,500 – 100,000]).......................... 83,650Lease payable (difference).......................................................... 16,350Prepaid maintenance expense (2018 costs).................................. 3,000

Cash (lease payment).............................................................. 103,000


Problem 15-14


Lease receivable (to balance)....................................... 16,350Maintenance fee payable [or cash]............................ 3,000Interest revenue (10% x [$936,500 – 100,000]).................. 83,650

Requirement 3 Branson Construction (Lessee)Interest expense (10% x [$936,500 – 100,000])...................... 83,650Lease payable (to balance)............................................... 16,350Maintenance expense (annual fee)*....................................... 3,300



* This debit to maintenance expense is the net effect of (a) expensing the current year’s costs that were prepaid with the first lease payment the last day of 2016 and (b) prepaying next year’s expense with the 2017 payment:Maintenance expense (2017 costs).............................................. 3,300

Prepaid maintenance expense (paid in 2016).......................... 3,300

Interest expense (10% x [$936,500 – 100,000]).......................... 83,650Lease payable (difference).......................................................... 16,350Prepaid maintenance expense (2018 costs).................................. 3,300

Cash (lease payment).............................................................. 103,300


Maintenance fee payable [or cash]............................ 3,000Miscellaneous revenue.............................................. 300Lease receivable (to balance)....................................... 16,350Interest revenue (10% x [$936,500 – 100,000]).................. 83,650

15–108



Requirement 1

Note:Because exercise of the option appears at the inception of the lease to be reasonably assured, payment of the option price ($6,000) is expected to occur when the option becomes exercisable (at the end of the eighth quarter). Also, the lease contract specifies that the BPO becomes exercisable before the designated lease term ends. Since a BPO is expected to be exercised, the lease term ends for accounting purposes when the option becomes exercisable (after two years of the three-year lease term).

Present value of quarterly lease payments ($3,000 x 7.23028**) $21,691

Plus: Present value of the BPO price ($6,000 x .78941*) 4,736Present value of minimum lease payments $26,427


“Selling price” $26,427 minusTruck’s cost (25,000 ) equalsDealer’s profit $ 1,427


Problem 15-15

Not required in the problem, but helpful to see that the present value calculation is precisely the reverse of the lessor’s calculation of quarterly payments:



Amount to be recovered through quarterly lease payments $21,691_____________________

Lease payments at the beginning each of the next eight quarters: ($21,691 ÷ 7.23028**) $3,000


Requirement 2 September 30, 2016

Anything Grows (Lessee)Leased equipment ......................................................... 26,427

Lease payable (present value of minimum lease payments) 26,427

Lease payable ............................................................... 3,000Cash (lease payment).................................................... 3,000

Mid-South Auto Leasing (Lessor)Lease receivable (calculated above).................................. 26,427Cost of goods sold (lessor’s cost)..................................... 25,000

Sales revenue (calculated above)................................... 26,427Inventory of equipment (lessor’s cost).......................... 25,000


15–110



Requirement 3

Since both use the same discount rate, the amortization schedule for the lessee and lessor is the same:


Date Payments Interest in Balance Balance3% x Outstanding Balance

9/30/16 26,4279/30/16 3,000 3,000 23,427

12/31/16 3,000 .03 (23,427) = 703 2,297 21,1303/31/17 3,000 .03 (21,130) = 634 2,366 18,7646/30/17 3,000 .03 (18,764) = 563 2,437 16,3279/30/17 3,000 .03 (16,327) = 490 2,510 13,817

12/31/17 3,000 .03 (13,817) = 415 2,585 11,2323/31/18 3,000 .03 (11,232) = 337 2,663 8,5696/30/18 3,000 .03 (8,569) = 257 2,743 5,826

9/29/18 6,000 .03 (5,826) = 174 * 5,826 030,000 3,573 26,427




Requirement 4 December 31, 2016Anything Grows (Lessee)Depreciation expense ([$26,427 ÷ 4 years*] x 1/4 year)......... 1,652


Interest expense (3% x [$26,427 – 3,000]: from schedule)..... 703Lease payable (difference: from schedule).......................... 2,297


Mid-South Auto Leasing (Lessor)Cash (lease payment)........................................................ 3,000

Lease receivable (difference : from schedule).................. 2,297Interest revenue (3% x [$26,427 – 3,000]).......................... 703

* Because title passes with the expected exercise of the BPO, depreciation is over the full 4-year useful life.

Requirement 5 September 29, 2018

Anything Grows (Lessee)Depreciation expense ([$26,427 ÷ 4 years*] x 3/4 year)........ 4,955


Interest expense (3% x $5,826 : from schedule)...................... 174Lease payable (difference: from schedule).......................... 5,826

Cash (BPO price)......................................................... 6,000

Mid-South Auto Leasing (Lessor)Cash (BPO price)............................................................. 6,000

Lease receivable (difference: from schedule).................. 5,826Interest revenue (3% x $5,826: from schedule)................... 174

* Because title passes with the expected exercise of the BPO, depreciation is over the full 4-year useful life.

Requirement 1 Since at least one (exactly one in this case) criterion is met, this is a capital lease

to the lessee:

15–112


Problem 15-16


Lessee’s Application of Classification Criteria



3 Is the lease term equal to 75% or more of the expected YESeconomic life of the asset? {4 yrs > 75% of 5 yrs}

4 Is the present value of the minimum lease payments equalto or greater than 90% of the NOfair value of the asset? {$39,564a < 90% of $45,114 = $40,603}

a See schedule 1 below.

The lessee’s incremental borrowing rate (9%) is less than the lessor’s implicit rate (10%). So, calculations should be made using a 9% discount rate.


Schedule 1: Lessee’s Calculation of the Present Value of Minimum Lease Payments

Present value of periodic lease payments excluding executory costs of $1,000 ($10,000 x 3.53129**) $35,313

Plus: Present value of the lessee-guaranteed residual value ($6,000 x .70843*) 4,251

Present value of lessee’s minimum lease payments $39,564* present value of $1: n=4, i=9%** present value of an annuity due of $1: n=4, i=9%

Requirement 2

Present value of lessee’s minimum lease payments, calculated in Schedule 1 above: $39,564

The leased asset should not be recorded at more than its fair value (not a factor in this case).

Requirement 3

Since at least one (two in this case) classification criterion and both additional lessor conditions are met, this is a capital lease to the lessor.

15–114







4 Is the present value of the minimum lease payments equalto or greater than 90% of the YESfair value of the asset? {$42,382a > 90% of $45,114=$40,603}

a See schedule 2 below.

Schedule 2: Lessor’s Calculation of the Present Value of Minimum Lease Payments

Present value of periodic lease payments ($10,000 x 3.48685**) $34,869 Plus: Present value of the guaranteed residual value ($11,000*** x .68301*) 7,513

Present value of lessor’s minimum lease payments $42,382* present value of $1: n=4, i=10%** present value of an annuity due of $1: n=4, i=10%*** includes $6,000 guaranteed by the lessee and $5,000 guaranteed by a third-party

guarantor



Since the fair value exceeds the lessor’s book value, the asset is being “sold” at a profit, making this a sales-

type lease:


also:

Sales revenue $42,382 (Lessor’s PV of minimum lease Minus payments per sch.2)

Cost of goods sold (37,268 ) ($40,000 – [$4,000* x .68301]) equalsDealer’s profit $ 5,114

* This is the unguaranteed residual value: $15,000 – 11,000.

Requirement 4

Lessor’s Calculation of Lease Payments



Amount to be recovered through periodic lease payments $34,869 _____________________

Lease payments at the beginning of each of the next four years: ($34,869 ÷ 3.48685**) $10,000Plus: Executory costs 1,000Lease payments including executory costs $11,000


15–116



Requirement 5

Present value of lessor’s minimum lease payments, calculated in Schedule 2 above: $42,382


Yard Art Landscaping (Lessee)Leased equipment (calculated in requirement 1).................. 39,564

Lease payable (calculated requirement 1)........................ 39,564

Lease payable (payment less executory costs)...................... 10,000Prepaid maintenance expense (2017 fee)............................. 1,000


Branch Motors (Lessor)Lease receivable (to balance)........................................... 45,114Cost of goods sold ($40,000 – [$4,000a x .68301]).............. 37,268

Sales revenue (calculated in Schedule 2)......................... 42,382Inventory of equipment (lessor’s cost).......................... 40,000

Cash (lease payment)........................................................ 11,000Maintenance fee payable [or prepaid maintenance*]. 1,000Lease receivable (payment less executory costs).............. 10,000

a This is the unguaranteed residual value: $15,000 – 11,000.* If paid previously.



Requirement 7

Lessee’s Amortization ScheduleEffective Decrease Outstanding


39,5642016 10,000 10,000 29,5642017 10,000 .09 (29,564) = 2,661 7,339 22,2252018 10,000 .09 (22,225) = 2,000 8,000 14,2252019 10,000 .09 (14,225) = 1,280 8,720 5,5052020 6,000 .09 (5,505) = 495 5,505 0

46,000 6,436 39,564

Requirement 8

Lessor’s Amortization ScheduleEffective Decrease Outstanding


45,1142016 10,000 10,000 35,1142017 10,000 .10 (35,114) = 3,511 6,489 28,6252018 10,000 .10 (28,625) = 2,863 7,137 21,4882019 10,000 .10 (21,488) = 2,149 7,851 13,6372020 15,000 .10 (13,637) = 1,363 * 13,637 0

55,000 9,886 45,114


Requirement 9

15–118




December 31, 2017Yard Art Landscaping (Lessee)Maintenance expense (2017 fee)............................................ 1,000

Prepaid maintenance expense (paid in 2016)................... 1,000

Interest expense (9% x [$39,564 – 10,000])............................ 2,661Lease payable (difference)............................................... 7,339Prepaid maintenance expense (2018 fee)............................. 1,000


Depreciation expense ([$39,564 – 6,000] ÷ 4 years)............ 8,391Accumulated depreciation......................................... 8,391

Branch Motors (Lessor)Cash (lease payment)........................................................ 11,000

Maintenance fee payable [or prepaid maintenance*]. 1,000Lease receivable (payment less executory costs).............. 6,489Interest revenue (10% x [$45,114 – 10,000])...................... 3,511

* If paid previously.

Requirement 10

December 31, 2019



Yard Art Landscaping (Lessee)Maintenance expense (2019 fee)............................................ 1,000


Interest expense (9% x $14,225: from schedule)..................... 1,280Lease payable (difference: from schedule).......................... 8,720Prepaid maintenance expense (2020 fee)............................. 1,000



Branch Motors (Lessor)Cash (lease payment)........................................................ 11,000

Maintenance fee payable [or prepaid maintenance*]. 1,000Lease receivable (payment less executory costs).............. 7,851Interest revenue (10% x $21,488: from schedule)............... 2,149

* If paid previously.

Requirement 11

December 31, 2020

15–120



Yard Art Landscaping (Lessee)Maintenance expense (2020 fee)............................................ 1,000



Interest expense (9% x $5,505 : from schedule)...................... 495Lease payable (difference : from schedule)......................... 5,505Accumulated depreciation (account balance).................... 33,564Loss on residual value guarantee ($6,000 – 4,000)............ 2,000

Leased equipment (account balance)............................. 39,564Cash ($6,000 – 4,000)................................................... 2,000

Branch Motors (Lessor)Inventory of equipment (actual residual value)................... 4,000Cash ($11,000 – 4,000)..................................................... 7,000*Loss on leased assets ($15,000 – 11,000).......................... 4,000


* $2,000 from lessee and $5,000 from third-party guarantor


Problem 15-17Calculation of interest expense for the year ended December 31, 2016

Bonds payable $91,384 [1]Notes payable 49,500 [2]Capital lease 9,947 [3]

Total interest expense $150,831

[1] $1,827,681 x 10% x ½ = $91,384

Interest $90,000¥ x 17.15909 * = $1,543,581Principal $2,000,000 x 0.14205 ** 284,100 Present value (price) of the note $1,827,681¥ 9% x ½ x $2,000,000* present value of an ordinary annuity of $1: n=40, i=5%** present value of $1: n=40, i=5%

[2] June 30: $500,000 x 10% x ½ = $25,000 Dec. 31: ($500,000 – [$60,000 – 25,000 – 25,000]) x 10% x ½ = 24,500 2016 interest $49,500

Relevant journal entries:December 31, 2015 (adjusting entry)Interest expense ($500,000 x 10% x ½) 25,000

Interest payable 25,000

June 30, 2016Interest expense ($500,000 x 10% x ½) 25,000Interest payable (from adjusting entry) 25,000Note payable (difference) 10,000

Cash (annual payment) 60,000

December 31, 2016Interest expense ([$500,000 – 10,000] x 10% x ½) 24,500

Interest payable 24,500

15–122



[3] 10% x $99,474 ($139,474* – 40,000) = $9,947

* $40,000 x 3.48685** = $139,474lease present

payment value


Requirement 1




3 Is the lease term equal to 75% or more of the expected YESeconomic life of the asset? {8 yrs. > 75% of 8 yrs}





Problem 15-18

Present value of minimum lease payments ($110,000 x 5.86842**) $645,526


(a) Since at least one (two in this case) classification criterion and both additional lessor conditions are met, this is a capital lease to the lessor (Bidwell Leasing). Since the fair value is the lessor’s cost, there is no dealer’s profit, making this a direct financing lease:

(b) Since at least one (two in this case) criterion is met, this is a capital lease to the lessee. Red Baron records the present value of minimum lease payments as a leased asset and a lease payable.

Requirement 2

January 1, 2016

Red Baron Flying Club (Lessee)Leased equipment (calculated above)................................ 645,526



Bidwell Leasing (Lessor)Lease receivable (calculated above).................................. 645,526

15–124






Requirement 3



645,526 1/1/16 110,000 110,000 535,52612/31/16 110,000 .10 (535,526) = 53,553 56,447 479,07912/31/17 110,000 .10 (479,079) = 47,908 62,092 416,98712/31/18 110,000 .10 (416,987) = 41,699 68,301 348,68612/31/19 110,000 .10 (348,686) = 34,869 75,131 273,55512/31/20 110,000 .10 (273,555 = 27,356 82,644 190,91112/31/21 110,000 .10 (190,911) = 19,089* 90,911 100,00012/31/22 110,000 .10 (100,000) = 10,000 100,000 0

880,000 234,474 645,526




Requirement 4

With the initial direct costs, the lease payments are the same, but the net investment is higher: $645,526 + 18,099 = $663,625. The new effective rate is the discount rate that equates the net investment and the future lease payments:

$663,625 ÷ ?** = $110,000lessor’s lease

investment payments** present value of an annuity due of $1: n=8, i=?

Rearranging algebraically we find that the present value table value is $663,625 ÷ $110,000 = 6.03295. When you consult the present value table, you search row 8 (n=8) for this value and find it in the 9% column. So the effective interest rate has declined from 10% to 9%.

The net investment is amortized at the 9% rate.

Requirement 5

15–126





663,625 1/1/16 110,000 110,000 553,62512/31/16 110,000 .09 (553,625) = 49,826 60,174 493,45112/31/17 110,000 .09 (493,451) = 44,411 65,589 427,86212/31/18 110,000 .09 (427,862) = 38,508 71,492 356,37012/31/19 110,000 .09 (356,370) = 32,073 77,927 278,44312/31/20 110,000 .09 (278,443) = 25,060 84,940 193,50312/31/21 110,000 .09 (193,503) = 17,415 92,585 100,91812/31/22 110,000 .09 (100,918) = 9,082* 100,918 0

880,000 216,375 663,625


Requirement 6

December 31, 2016Red Baron Flying Club (Lessee)Interest expense (10% x [$645,526 – 110,000])...................... 53,553Lease payable (difference)............................................... 56,447



Bidwell Leasing (Lessor)Cash (lease payment)........................................................ 110,000

Lease receivable (difference)....................................... 60,174Interest revenue (9% x [$663,625 – 110,000]).................... 49,826



Requirement 7

December 31, 2022Red Baron Flying Club (Lessee) Interest expense (10% x $100,000: from schedule)................. 10,000Lease payable (difference)............................................... 100,000



Bidwell Leasing (Lessor) Cash (lease payment)........................................................ 110,000

Lease receivable (difference)....................................... 100,918Interest revenue (9% x $100,918: from schedule)............... 9,082

Requirement 1

15–128

Problem 15-19


Application of Classification Criteria 1 Does the agreement specify that







Present value of minimum lease payments ($110,000 x 5.86842**) $645,526


(a) Since at least one (two in this case) classification criterion and both additional lessor conditions are met, this is a capital lease to the lessor (Bidwell Leasing).

Since the fair value exceeds the lessor’s book value, the plane was “sold” at a profit, making this a sales-type lease:

Fair value $645,526



minusBook value (400,000 ) equalsDealer’s profit $ 245,526

(b) Since at least one (two in this case) criterion is met, this is a capital lease to the lessee. Red Baron records the present value of minimum lease payments as a leased asset and a lease payable.

Requirement 2

January 1, 2016

Red Baron Flying Club (Lessee)Leased equipment (calculated above)................................ 645,526



Bidwell Leasing (Lessor)Lease receivable (calculated above).................................. 645,526Cost of goods sold (lessor’s cost)..................................... 400,000

Sales revenue (calculated above)................................... 645,526Inventory of equipment (lessor’s cost).......................... 400,000



15–130


Requirement 3



645,526 1/1/16 110,000 110,000 535,52612/31/16 110,000 .10 (535,526) = 53,553 56,447 479,07912/31/17 110,000 .10 (479,079) = 47,908 62,092 416,98712/31/18 110,000 .10 (416,987) = 41,699 68,301 348,68612/31/19 110,000 .10 (348,686) = 34,869 75,131 273,55512/31/20 110,000 .10 (273,555) = 27,356 82,644 190,91112/31/21 110,000 .10 (190,911) = 19,089* 90,911 100,00012/31/22 110,000 .10 (100,000) = 10,000 100,000 0

880,000 234,474 645,526


Requirement 4

December 31, 2016Red Baron Flying Club (Lessee) Interest expense (10% x [$645,526 – 110,000])...................... 53,553Lease payable (difference)............................................... 56,447







Requirement 5

December 31, 2022Red Baron Flying Club (Lessee) Interest expense (10% x $100,000: from schedule)................. 10,000Lease payable (difference)............................................... 100,000




Lease receivable (difference)....................................... 100,000Interest revenue (10% x $100,000: from schedule)............. 10,000

Requirement 1

Present value of periodic lease payments ($88,492 x 5.65022**) $500,000 *

* rounded** present value of an ordinary annuity of $1: n=10, i=12%

January 1, 2016Cash ............................................................................. 500,000Accumulated depreciation (cost – book value).................. 600,000

Buildings (original cost)............................................... 1,000,000Deferred gain on sale-leaseback (difference)............... 100,000

Leased building (present value of lease payments).................. 500,000Lease payable (present value of lease payments).............. 500,000

15–132


Problem 15-20


Note: Because the title transfers to the lessee, this is a capital lease.

December 31, 2016Interest expense (12% x $500,000)......................................... 60,000Lease payable (difference)............................................... 28,492



Deferred gain on sale-leaseback ($100,000 ÷ 12 years*)..... 8,333Depreciation expense ............................................... 8,333

* The building is depreciated over its remaining useful life rather than the lease term because title transfers to the lessee. The remaining useful life can be calculated as:

total life x book value/cost = 30 years x $400,000/$1,000,000 = 12 years


Requirement 2

BALANCE SHEET

Assets:Leased asset........................................................ $500,000 less: accumulated depreciation.......................... (41,667) less: deferred gain ($100,000 – 8,333)................... (91,667 )

$366,666Liabilities: Current:Lease payable ($88,492 – {12% x [$500,000 – 28,492]}) $31,911

Noncurrent:Lease payable ($500,000 – 28,492 – 31,911)............. $439,597

INCOME STATEMENT

Interest expense................................................... $60,000Depreciation expense ($41,667 – 8,333)................. 33,334

$93,334

Portion of Amortization Schedule – not required, but verifies several amounts:


Date Payments Interest in Balance Balance12% x Outstanding Balance

1/1/16 500,00012/31/16 88,492 .12 (500,000) = 60,000 28,492 471,50812/31/17 88,492 .12 (471,508) = 56,581 31,911 439,597

~ ~ ~ ~ ~ ~~ ~ ~ ~ ~ ~

15–134



Requirement 1

Since the fair value of the land ($400,000) is more than 25% of the combined fair value ($1,450,000), both the lessee and the lessor treat the land and building as two separate leases. The land lease is an operating lease, and the building lease is, in this case, a capital lease. Since land could be rented without the building for $59,000, the portion of the annual rental attributable to the building is $200,000 – 59,000 = $141,000.

Present value of lease payments ($141,000 x 6.75902**) $953,022** present value of an annuity due of $1: n=10, i=10%

January 1, 2016Leased building (calculated above).................................... 953,022


Rent expense (given)...................................................... 59,000Lease payable (difference)............................................... 141,000

Cash (annual lease payment).......................................... 200,000


Problem 15-21

December 31, 2016Depreciation expense ($953,022 ÷ 10 years)......................... 95,302

Accumulated depreciation–leased building................ 95,302

Interest expense ([$953,022 – 141,000] x 10%)...................... 81,202Interest payable ........................................................ 81,202

Requirement 2

Since the fair value of the land ($200,000) is less than 25% of the combined fair value ($1,450,000), it is in effect ignored and the land and building are treated as a single unit. The “single” leased asset is depreciated as if land were not involved.

Present value of lease payments ($200,000 x 6.75902**) = $1,351,804** present value of an annuity due of $1: n=10, i=10%

January 1, 2016Leased property (calculated above)................................... 1,351,804


Lease payable................................................................ 200,000Cash (annual lease payment).......................................... 200,000

December 31, 2016Depreciation expense ($1,351,804 ÷ 10 years)...................... 135,180

Accumulated depreciation–leased property............... 135,180

Interest expense ([$1,351,804 – 200,000] x 10%)................... 115,180Interest payable ........................................................ 115,180

15–136



Requirement 1

Under U.S. GAAP, land and building elements generally are accounted for as a single unit, unless land represents more than 25% of the total fair value of the leased property. This was the case in Requirement 1 so the land and buildings elements are recorded separately. Under IAS No. 17, land and buildings elements are considered separately unless the land element is not material. So, IFRS would produce the same results in Requirement 1:

Since the fair value of the land ($400,000) is more than 25% of the combined fair value ($1,450,000), both the lessee and the lessor treat the land and building as two separate leases. The land lease is an operating lease, and the building lease is, in this case, a capital lease. Since land could be rented without the building for $59,000, the portion of the annual lease payment attributable to the building is $200,000 – 59,000 = $141,000.

Present value of lease payments ($141,000 x 6.75902**) = 953,022** present value of an annuity due of $1: n=10, i=10%

January 1, 2016Leased building (calculated above).................................... 953,022




December 31, 2016Depreciation expense ($953,022 ÷ 10 years)......................... 95,302


Interest expense ([$953,022 – 141,000] x 10%)...................... 81,202Interest payable ........................................................ 81,202


Problem 15-22

Requirement 2

Under U.S. GAAP, land and building elements generally are accounted for as a single unit, unless land represents more than 25% of the total fair value of the leased property. In Requirement 2, the land and buildings are accounted for as a single unit because the fair value of the land ($200,000) is less than 25% of the combined fair value ($1,450,000). Under IAS No. 17, land and buildings elements are recorded separately unless the land element is not material. So, unless the $200,000 is not considered material, IFRS would produce the following:

Under IFRS, both the lessee and the lessor treat the land and building as two separate leases. The land lease is an operating lease, and the building lease is, in this case, a capital lease. Since land could be rented without the building for $30,000, the portion of the annual lease attributable to the building is $200,000 – 30,000 = $170,000.

Present value of lease payments ($170,000 x 6.75902**) 1,149,033** present value of an annuity due of $1: n=10, i=10%

January 1, 2016Leased property (calculated above)................................... 1,149,033

Lease payable (calculated above).................................. 1, 149,033



December 31, 2016Depreciation expense ($1,149,033 ÷ 10 years)................... 114,903


Interest expense ([$1,149,033 – 170,000] x 10%)................ 97,903Interest payable ........................................................ 97,903

15–138



Requirement 1 LesseeJanuary 1, 2016Right-of-use equipment 1,000,000

Lease payable ($279,556 x 3.5771) 1,000,000 present value of an annuity due of $1: n=4, i=8%

Lease payable 279,556Cash (lease payment) 279,556

December 31, 2016Interest expense ([$1,000,000 – 279,556] x 8%) 57,636Lease payable (difference) 221,920

Cash (lease payment) 279,556

Amortization expense ($1,000,000 ÷ 4 years) 250,000Right-of-use equipment 250,000

Requirement 2 Lessor January 1, 2016Lease receivable ($279,556 x 3.5771) 1,000,000 Equipment inventory (book value) 800,000

Profit (to balance)* 200,000 present value of an annuity due of $1: n=4, i=8%* A company might choose to separate this profit into its two components: Sales revenue ($1,000,000)

and cost of goods sold ($800,000), which is the gross method demonstrated for “sales-type” leases in the main chapter.

Cash (lease payment) 279,556 Lease receivable 279,556

December 31, 2016Cash (lease payment) 279,556 Lease receivable (difference) 221,920

Interest revenue ([$1,000,000 – 279,556] x 8%) 57,636


SUPPLEMENT PROBLEMSProblem 15-23

Problem 15-24

1. Balance Sheet: Lease Payable

Initial balance ($25,000 x 25.10278) $627,570 Quarter 1 reduction (9,311) Quarter 2 reduction (9,544) Quarter 3 reduction (9,782) Quarter 4 reduction (10,027 ) End-of-year balance $588,906

present value of an ordinary annuity of $1: n=40, i=2.5%

Right-of-Use Asset Initial balance $627,570 Quarter 1 amortization (9,311) Quarter 2 amortization (9,544) Quarter 3 amortization (9,782) Quarter 4 amortization (10,027 ) End-of-year balance $588,906

2. Income Statement:

Interest Amortization Total Lease Expense Expense Expense

Quarter 1 $15,689 $ 9,311 $25,000Quarter 2 15,456 9,544 25,000Quarter 3 15,218 9,782 25,000Quarter 4 14,973 10,027 25,000 Total $61,336 $38,664 $100,000

Note that the total lease expense for the four quarters ($100,000) is equal to the $100,000 total lease payments.

15–140


Journal entries (not required, but provide the calculations of numbers reported above):Beginning of leaseRight-of-use asset ($25,000 x 25.10278).................. 627,570

Lease payable.................................................... 627,570

present value of an ordinary annuity of $1: n=40, i=2.5%

End of quarter 1Interest expense (2.5% x $627,570)................................ 15,689Lease payable (difference)....................................... 9,311

Cash (lease payment)............................................. 25,000

Amortization expense ($25,000 – 15,689)................ 9,311Right-of-use equipment.................................. 9,311


End of quarter 2Interest expense (2.5% x [$627,570 – 9,311])................ 15,456Lease payable (difference)....................................... 9,544



End of quarter 3Interest expense (2.5% x [$627,570 – 9,311 – 9,544]).... 15,218Lease payable (difference)....................................... 9,782



End of quarter 4




Interest expense (2.5% x [$627,570 – 9,311 – 9,544 – 9,782]) 14,973Lease payable (difference)....................................... 10,027




$562,907 x 5.32948 = $3,000,000(rounded)

present value of an annuity due of $1: n=6, i=5%\

Because the present value of the lease payments is equal to the ovens’ fair value, we can assume the risks and rewards are transferred to the lessee, so it’s a Type A lease.

2. Lease Payable at December 31, 2016Initial balance, June 30, 2016.................................. $3,000,000 June 30, 2016 reduction....................................... (562,907)* Dec. 31, 2016 reduction....................................... (441,052 ) **Ending balance, December 31, 2016....................... $1,996,041

Right-of-Use Asset at December 31, 2016Initial balance, June 30, 2016.................................. $3,000,000 Amortization at Dec. 31, 2016............................ (500,000 ) **Ending balance, December 31, 2016....................... $2,500,000

3. Expenses for year ended December 31, 2016June 30, 2016 interest expense................................ $ 0Dec. 31, 2016 interest expense................................ 121,855** Interest expense for 2016.................................... $121,855

Amortization expense for 2016............................... 500,000 Total expenses...................................................... $621,855

15–142

Problem 15-25


Calculations:

June 30, 2016*Right-of-use asset (present value: calculated in req. 1).......... 3,000,000

Lease payable (present value: calculated in req. 1)............ 3,000,000


December 31, 2016**Interest expense (5% x [$3 million – 562,907])................... 121,855Lease payable (difference)............................................... 441,052


Amortization expense ($3 million ÷ 3 years x ½ year)........... 500,000Right-of-use asset...................................................... 500,000

4. Expenses for year ended December 31, 2016June 30, 2016 interest............................................. $ 0Dec. 31, 2016 interest............................................. 121,855** Interest for 2016.................................................. $121,855

June 30, 2016 amortization..................................... 0Dec. 31, 2016 amortization..................................... 441,052** Total lease expense............................................... $562,907

Calculations:June 30, 2016*Right-of-use asset (present value: calculated in req. 1).......... 3,000,000

Lease payable (present value: calculated in req. 1)............ 3,000,000





December 31, 2016**Interest expense (5% x [$3 million – 562,907])................... 121,855Lease payable (difference)............................................... 441,052


Amortization expense ($562,907 – 121,855)...................... 441,052Right-of-use asset...................................................... 441,052

In a Type B lease, the lessee records interest the normal way (at the effective interest rate) and then “plugs” the right-of-use asset amortization at the amount needed for interest plus amortization to equal the straight-line lease payment. The lessee records that amount as a single lease expense in the income statement.

Real World Case 15-1Requirement 1

Note 11: “Financing Arrangements and Lease Obligations” indicates that the present value of net lease payments for capital lease obligations was $518,484,000 at February 28, 2014.

Requirement 2

Note 11 Financing Arrangements and Lease Obligations (in part)

Operating and Capital Leases

(in thousands) Operating Capital Leases Leases 2014 $ 325,830 $ 115,340 2015 334,756 120,018

15–144

CASES

Full file at http://testbankeasy.eu/Solution-Manual-for-Intermediate-Accounting,-8th-Edition---Spicelan2016 301,162 107,652 2017 264,995 98,141 2018 210,121 80,262 Thereafter 491,633 204,548 Total minimum renal commitments $ 1,928,497 725,961 Less: amount representing interest (207,477)Present value of minimum lease payments 518,484 Less: current portion (66,887) Long-term obligations $ 451,597

If the operating leases were capitalized, the capital lease liability would increase by approximately a multiple of about 2.7. Note 11 above indicates that future lease payments under operating leases are about 2.7 times higher than for capital leases ($1,928,497 / 725,961). Assuming comparable discount rates and timing of payments, the present value of future lease payments for operating leases would be about: $518,484,000 x 2.7 = $1,399,906,800. Of course, we could also make some reasonable assumptions about discount rates and the timing of payments and estimate the present value of all future payments to be made on the operating leases as we did in the “Decision-Makers’ Perspective” section at the end of the chapter. Results should be comparable. In either case, we have a rough estimate.

Requirement 3

In general, debt increases risk. Debt places owners in a subordinate position relative to creditors because the claims of creditors must be satisfied first in case of liquidation. Also, debt requires payment, usually on specific dates, and failure to pay interest and principal may result in default and perhaps even bankruptcy. The debt-to-equity ratio, total liabilities/shareholders’ equity, frequently is calculated to measure the degree of risk. Other things being equal, the higher the ratio, the higher the risk. Using numbers from the balance sheet, we see that the debt to equity ratio for PetSmart is:

$1,428,186,000 ÷ $1,093,782,000 = 1.3

If debt is increased by $1,399,906,800 from capitalizing operating leases, the debt to equity ratio doubles to 2.6:


Case 15-1 (concluded)

($1,428,186,000 + 1,399,906,800) ÷ $1,093,782,000 = 2.6

As shown in the chapter, adding the assets from capitalizing operating leases also causes the return on assets to decline. Analysts and management should be alert to the off-balance-sheet effect of operating leases. Remember, though, debt also can be an advantage. Debt can be used to enhance the return to shareholders. If a company earns a return on borrowed funds in excess of the cost of borrowing the funds, shareholders are provided with a total return greater than what could have been earned with equity funds alone. This desirable situation is called “favorable financial leverage.”

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Full file at http://testbankeasy.eu/Solution-Manual-for-Intermediate-Accounting,-8th-Edition---SpicelanResearch Case 15-2

Requirement 1 After the first full year under the warehouse lease, the balance in Dowell’s lease payable is $30,816,422. This is the balance after reductions from the first five quarterly lease payments as shown in this amortization schedule. (The first payment was at December 31 of the previous year, the inception of the lease.)

Lease Amortization Schedule

Effective Decrease OutstandingPayments Interest in Balance Balance

2% x Outstanding Balance40,000,000

2,398,303 2,398,303 37,601,6972,398,303 .02 (37,601,697) = 752,034 1,646,269 35,955,4282,398,303 .02 (35,955,428) = 719,109 1,679,194 34,276,2342,398,303 .02 (34,276,234) = 685,525 1,712,778 32,563,4562,398,303 .02 (32,563,456) = 651,269 1,747,034 30,816,4222,398,303 .02 (30,816,422) = 616,328 1,781,975 29,034,4482,398,303 .02 (29,034,448) = 580,689 1,817,614 27,216,8352,398,303 .02 (27,216,835) = 544,337 1,853,966 25,362,8692,398,303 .02 (25,362,869) = 507,257 1,891,046 23,471,8232,398,303 .02 (23,471,823) = 469,436 1,928,867 21,542,9572,398,303 .02 (21,542,957) = 430,859 1,967,444 19,575,5142,398,303 .02 (19,575,514) = 391,510 2,006,793 17,568,7222,398,303 .02 (17,568,722) = 351,374 2,046,929 15,521,7942,398,303 .02 (15,521,794) = 310,436 2,087,867 13,433,9272,398,303 .02 (13,433,927) = 268,679 2,129,624 11,304,3032,398,303 .02 (11,304,303) = 226,086 2,172,217 9,132,0862,398,303 .02 (9,132,086) = 182,642 2,215,661 6,916,4252,398,303 .02 (6,916,425) = 138,328 2,259,975 4,656,4502,398,303 .02 (4,656,450) = 93,129 2,305,174 2,351,2762,398,303 .02 (2,351,276) = 47,027* 2,351,276 0

* rounded


Requirement 2

After the first full year under the warehouse lease, the book value (after accumulated depreciation) of Dowell’s leased warehouses is 32,000,000:

$40,000,000 Leased warehouses, PV of lease payments÷ 5 years Life of lease$ 8,000,000 Accumulated depreciation after one year

$40,000,000 Leased warehouses, PV of lease payments (8,000,000 ) Accumulated depreciation after one year$32,000,000 Book value after one year

Requirement 3

The specific citation that specifies the guidelines for derecognition of capital leases is FASB ASC 840–30–40: “Leases–Capital Leases–Derecognition.” Accounting for lessees is described in paragraphs 40–1 and 2; “Lease Modifications.”

(a) if the proposal to sublease will qualify as a termination of a capital lease:

840–10–40–2: "Leases–Overall–Derecognition–Lessees"

If the nature of a sublease is such that the original lessee is relieved of the primary obligation under the original lease, the transaction should be considered a termination of the original lease agreement.

(b) the appropriate accounting treatment for the sublease:

Because Dowell’s proposed sublease is a termination of a capital lease before the expiration of the lease term, it falls under Par. 40–1:

40–1 A termination of a capital lease before the expiration of the lease term is accounted for by the lessee by removing the asset and obligation, with gain or loss recognized for the difference.

Requirement 4

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Case 15-2 (continued)


Full file at http://testbankeasy.eu/Solution-Manual-for-Intermediate-Accounting,-8th-Edition---SpicelanIn accordance with FASB ASC 840–30–40–1, the asset and obligation representing the original lease would be removed from the accounts and a loss would be recognized for the difference. The journal entry Dowell would record in connection with the sublease is:

Lease payable (balance after 4 quarters; from req. 1). . 30,816,422Loss on sublease (to balance)................................. 1,183,578Accumulated depreciation (balance: from req. 2)..... 8,000,000

Leased warehouses (balance: PV of lease payments) 40,000,000

First, this case has no single right answer. The process of developing the proposed solutions

will likely be more beneficial than the solutions themselves. Students should benefit from participating in the process, interacting first with other group members, then with the class as a whole.

It is important that each student actively participate in the process. Domination by one or two individuals should be discouraged. Discussion likely will include the following:

a. Possible advantages of leasing include: 1. Leasing can preserve the ability to borrow under lines of credit. 2. Leasing can provide an interest rate lower than the incremental borrowing

rate.3. Leasing may avoid violating restrictive loan agreements that prohibit the

issuance of additional debt securities.4. Leasing can lessen the risk of obsolescence.5. Leasing allows 100% financing at fixed interest rates as compared with 70%

to 90% financing when assets are purchased.

b. The lessee views a noncancelable lease as a capital lease if it meets at least one of the following criteria.1. The lease transfers ownership of the property to the lessee at the end of the

lease term.2. The lease contains a bargain purchase option.3. The lease term is equal to 75% 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% of the fair value of the leased property.


Communication Case 15-3

1. and 3. are not met. 2. and 4. are met – if the purchase option is viewed as a bargain purchase option. Is $290,000 enough less than $300,000 that exercise of the option is expected to occur? If so:

2. The right to purchase the vans at the end of the lease term for $290,000, when the estimated fair value is $300,000, is a bargain purchase option.

4. The present value of the minimum lease payments, not including the executory costs, is greater than 90% of the fair value of the vans, calculated as follows:

Present value of minimum lease payments, assuming a BPO:

Lease payments ($300,000 x 3.48685) $1,046,055 Bargain purchase price ($290,000 x 0.68301) 198,073 Total $1,244,128

In this case, it is a capital lease.

Otherwise:

Present value of minimum lease payments, assuming the purchase option is not a BPO:

Lease payments ($300,000 x 3.48685) $1,046,055

Fair value of vans $1,240,000 x 90 %

90% of the fair value of the vans $1,116,000

In this case, it is an operating lease to the lessee.Either way, it is a capital lease to the lessor:

Present value of minimum lease payments, assuming a BPO: Lease payments ($300,000 x 3.48685) $1,046,055 Bargain purchase price ($290,000 x 0.68301) 198,073 Total $1,244,128

Present value of minimum lease payments, assuming the purchase option is not a BPO:

Lease payments ($300,000 x 3.48685) $1,046,055

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Case 15-3 (continued)


Residual value ($300,000 x 0.68301) 204,903 Total $1,250,958

Since Interstate’s cost, $1,050,000, was less than its “selling price,” this is a sales-type lease to Interstate.

c. VIP would record the following at December 31, 2016:Interest expense ([$1,100,000 – 300,000] x 10%)................... 80,000Lease payable................................................................ 220,000

Cash.......................................................................... 300,000

Operating expenses....................................................... 1,000Cash.......................................................................... 1,000

If a BPO is assumed, VIP would have the vans for 7 years:

Depreciation expense ([$1,100,000 – 50,000] ÷ 7 yrs.) 150,000Accumulated depreciation ........................................ 150,000

If a BPO is not assumed, VIP would have the vans for 4 years:

Depreciation expense ([$1,100,000 – 300,000] ÷ 4 yrs.) 200,000Accumulated depreciation ........................................ 200,000



Ethics Case 15-4Discussion should include these elements:

Leasehold improvement depreciation periodThere may be some degree of latitude associated with uncertainty concerning

the life of the leasehold improvements. However, trade publications indicate 25 years probably is out of range. The suggestion to use 25 years clearly is motivated by the desire to “window dress” performance.

Ethical Dilemma:

How does a doubtful justification for the estimated life of leasehold improvements compare with the perceived need to increase reported profits?

Who is affected?PersonKeeneOther managersShareholdersPotential shareholdersEmployeesCreditorsThe company’s auditors

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Full file at http://testbankeasy.eu/Solution-Manual-for-Intermediate-Accounting,-8th-Edition---SpicelanReal World Case 15-5Requirement 1

Leasing can allow a firm to conserve assets, to avoid some risks of owning assets, and obtain favorable tax benefits. Also, leasing sometimes is used as a means of “off-balance-sheet financing.” When funds are borrowed to purchase an asset, the liability has a detrimental effect on the company’s debt-equity ratio and other mechanical indicators of riskiness. Also, the purchased asset increases total assets and thus reduces calculations of the rate of return on assets. In spite of research that indicates the market is not fooled, managers continue to avoid reporting of assets and liabilities by leasing rather than buying and by constructing lease agreements in such a way that capitalizing the assets and liabilities is not required. Whether or not there is any real effect on security prices, off-balance-sheet financing can help a firm avoid exceeding contractual limits on designated financial ratios (like the debt to equity ratio, for instance). In fact, in its annual report, Wal-Mart indicates that it has several restrictive covenants, one of which relates to the debt to equity ratio.

Requirement 2 When capital leases are first recorded, both assets and liabilities increase by the

present value of minimum lease payments. In later years, though, the amounts differ. Leased assets are reduced by depreciation. Lease liabilities are reduced by the principal portion of lease payments.

Requirement 3 ($ in millions)

Interest expense (difference)........................ 273Lease payable (2013 current obligation; paid in 2014: given) 327

Cash (lease payment: given)................... 600

Requirement 4

$ 273 2014 interest (from requirement 3)÷ 3,350 Beginning balance in lease payable–given: $327 + 3,023

8.2%

Approximate average interest rate = 8.2%


Real World Case 15-6Requirement 1

In a sale-leaseback transaction the owner of an asset sells the asset and immediately leases it back from the new owner. We view the sale and simultaneous leaseback of the asset as a single borrowing transaction. On the surface there appear to be two separate transactions, but the substance of the agreement indicates otherwise. The seller-lessee (FedEx in our case) still retains the use of the asset owned prior to the sale-leaseback, but in the process acquires (a) cash from the sale and (b) an obligation to make lease payments over the term of the lease. In substance, the seller-lessee has borrowed cash to be repaid over the lease term (along with interest). So, from this perspective of “substance over form,” we do not immediately recognize any gains that result from sale-leaseback transactions, but defer the gains to be recognized over the term of the lease. There typically is interdependency between the lease terms and the price at which the asset is sold. Viewing the sale and the leaseback as a single transaction is consistent with the way we recognize revenue.

Requirement 2 When amortizing the deferred gain over the lease term, if the lease meets the

criteria to be viewed as a capital lease, we reduce depreciation expense each period by the amortized portion of the gain.

If the leaseback portion of a sale-leaseback transaction is classified as an operating lease, the gain still is deferred, but is recognized as a reduction of rent expense rather than depreciation. Because FedEx amortizes its deferred gains “ratably over the life of the lease as a reduction of rent expense” it apparently considers the leases to be operating leases.

Suggested Grading Concepts and Grading Scheme:

Content (80%) 30 Sale portion of the sale-leaseback (10 each).

Record cash for the sale price. Decrease equipment at its undepreciated cost. Establish a deferred gain for the excess of the sale

price of the equipment over its undepreciated cost. 15 Gain on the sale portion (5 each; maximum 15).

Amortized over the lease term. As a reduction of depreciation expense.

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Communication Case 15-7


Results in essentially the same depreciation and interest as if the asset were not sold and leased back, but

a note is issued for cash instead. Because the sale and the leaseback are two components of a single transaction rather than two

independent transactions. Consistent with the realization principle.

15 Leaseback portion of the sale-leaseback transaction (5 each; maximum 15). Both an asset. And a liability. At the present value of minimum lease payments. Excluding any executory costs. Asset amount cannot exceed fair value.

20 Conceptual basis (10 each). Economic effect of a long-term capital lease on the lessee is similar to that of an installment purchase. Transfers substantially all of the benefits and risks

incident to the ownership of property to the lessee. 80 pointsWriting (20%) 5 Terminology and tone appropriate to the audience (CFO). 6 Organization permits ease of understanding.

Introduction that states purpose. Paragraphs separate main points.

9 English Word selection. Spelling. Grammar.

20 points

Trueblood Case 15-8A solution and extensive discussion materials accompany each case in the

Deloitte & Touche Trueblood Case Study Series. These are available to instructors at: www.deloitte.com/ us/truebloodcases.


IFRS Case 15-9Requirement 1

The desire to obtain “off-balance-sheet financing” sometimes is a leasing stimulus. When funds are borrowed to purchase an asset, the liability has a detrimental effect on the company’s debt-equity ratio and other quantifiable indicators of riskiness. Similarly, the purchased asset increases total assets and correspondingly lowers calculations of the rate of return on assets. As a result, managers often try to avoid reporting assets and liabilities by leasing rather than buying and by constructing lease agreements in such a way that capitalizing the assets and liabilities is not required.

Requirement 2

Whether or not there is any real effect on security prices, sometimes off-balance-sheet financing helps a firm avoid exceeding contractual limits on designated financial ratios (like the debt to equity ratio, for instance). For these reasons, SCI would prefer an operating lease. SCI should not specify a bargain purchase option or the transfer of ownership to the lessee. SCI could structure the lease so that the lease term is less than 75% of its useful life of the leased asset and the present value of lease payments is less than 90% of the asset’s fair value.

Requirement 3

It would be more difficult for SCI to obtain “off-balance-sheet financing” through an operating lease under IFRS, because IAS No. 17 stresses substance over form. IFRS does not provide a specific percentage for determining what constitutes a “major portion” of the asset’s economic life or “substantially all” of the leased asset’s fair value. IFRS also provides a fifth indicator of a lease that normally leads to a finance lease as well as three more indicators that might lead to a finance lease. Professional judgment rather than specific rules determine whether the risks and rewards of ownership have been transferred to the lessee.

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Full file at http://testbankeasy.eu/Solution-Manual-for-Intermediate-Accounting,-8th-Edition---SpicelanAir France/KLM Case

Requirement 1

In general – yes. More specifically – no.

Both sets of standards attempt to identify leases under which substantially all the risks and rewards of ownership are transferred to the lessee and treat the assets as if they had been purchased outright. However, to distinguish between a capital lease and an operating lease, U.S. GAAP uses four specific classification criteria, whereas IFRS uses a variety of “indicators” of a capital (finance) lease. In this regard, IFRS is considered to be more principles-based while U.S. GAAP is more rules-based.

Requirement 2

At December 31, 2013, AF’s operating lease commitments for aircraft totaled €5,687 million. Its capital lease commitments for aircraft had a present value that totaled €3,893 million. While we don’t know the present value of the operating leases, it’s unlikely it would be less than €3,893. Under both U.S. GAAP and IFRS, lessees report operating and finance lease commitments for the upcoming five years. However, under U.S. GAAP, lessees report commitments in each of the next five years and then in total for beyond five years. This is not required by IFRS under which most companies report commitments in the upcoming year, years 2-5, and five years or more. AF, given this latitude, chose to report future payments in the way used by U.S. GAAP companies.


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Chapter 15 Leasestestbankeasy.eu/sample/Solution Manual for Intermediate... · Web view2016. 10. 29. · Chapter 15 Leases . QUESTIONS FOR REVIEW OF KEY TOPICS. Question 15-1. Regardless