Accounting For Leases ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Questions Brief Exercises Exercises Problems Concepts For Analysis

Copyright © 2011 John Wiley & Sons, Inc. Kieso Intermediate: IFRS Edition, Solutions Manual 21-1
CHAPTER 21
Accounting for Leases
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics Questions
Brief
Exercises Exercises Problems
Concepts
for Analysis
*1. Rationale for leasing. 1, 2, 4 1, 2
*2. Lessees; classification
of leases; accounting by
lessees.
3, 5, 7, 8,
14, 20, 22
1, 2, 3,
4, 5
1, 2, 3,
5, 7, 8,
11, 12,
13, 14
1, 2, 3, 4,
6, 7, 8, 9,
11, 12, 14,
15, 16
1, 2, 3,
4, 5, 6
*3. Disclosure of leases. 19, 21 4, 5, 7, 8 2, 5
*4. Lessors; classification
of leases; accounting by
lessors.
6, 9,
10, 11,
12, 13
6, 7,
8, 11
4, 5, 6, 7,
9, 10, 12,
13, 14
1, 2, 3, 5,
10, 13,
14, 16
2, 4
*5. Residual values; bargain-
purchase options; initial
direct costs.
15, 16,
17, 18
9, 10 4, 8,
9, 10
6, 7, 10,
11, 13, 14,
15, 16
5, 6
*6. Sale-leaseback. 23 12 15, 16 7, 8
*This material is dealt with in an Appendix to the chapter.

21-2 Copyright © 2011 John Wiley & Sons, Inc. Kieso Intermediate: IFRS Edition, Solutions Manual
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Brief
Exercises Exercises Problems
1. Explain the nature, economic substance, and
advantages of lease transactions.
2. Describe the accounting criteria and procedures
for capitalizing leases by the lessee.
1, 2, 3, 4 1, 2, 3,
5, 11
1, 3, 4, 6, 7,
8, 9, 11, 12,
14, 15, 16
3. Contrast the operating and capitalization
methods of recording leases.
5 5, 12,
13, 14
2, 15
4. Identify the classifications of leases for the lessor. 6, 7, 8 12, 13, 14 2, 10, 13, 16
5. Describe the lessor s accounting for direct-
financing leases.
6, 7 4, 10 5
6. Identify special features of lease arrangements
that cause unique accounting problems.
9, 10 8, 9 4, 9, 11, 12
7. Describe the effect of residual values, guaranteed
and unguaranteed, on lease accounting.
9, 10 3, 8 6, 10, 11, 13,
14, 15, 16
8. Describe the lessor s accounting for sales-type
leases.
11 6, 7 1, 3, 10, 13
9. List the disclosure requirements for leases. 3, 4, 5, 7, 8
*10. Understand and apply lease accounting concepts
to various lease arrangements.
*11. Describe the lessee s accounting for sale-
leaseback transactions.
12 15, 16

ASSIGNMENT CHARACTERISTICS TABLE
Item Description
Level of
Difficulty
Time
(minutes)
E21-1 Lessee entries, finance lease with unguaranteed
residual value.
Moderate 15 20
E21-2 Lessee computations and entries, finance lease
with guaranteed residual value.
Moderate 20 25
E21-3 Lessee entries, finance lease with executory costs
and unguaranteed residual value.
Moderate 20 30
E21-4 Lessor entries, direct-financing lease with option to purchase. Moderate 20 25
E21-5 Type of lease, amortization schedule. Simple 15 20
E21-6 Lessor entries, sales-type lease. Moderate 15 20
E21-7 Lessee-lessor entries, sales-type lease. Moderate 20 25
E21-8 Lessee entries with bargain-purchase option. Moderate 20 30
E21-9 Lessor entries with bargain-purchase option. Moderate 20 30
E21-10 Computation of rental, journal entries for lessor. Moderate 15 25
E21-11 Amortization schedule and journal entries for lessee. Moderate 20 30
E21-12 Accounting for an operating lease. Simple 10 20
E21-13 Accounting for an operating lease. Simple 15 20
E21-14 Operating lease for lessee and lessor. Simple 15 20
*E21-15 Sale-leaseback. Moderate 20 30
*E21-16 Lessee-lessor, sale-leaseback. Moderate 20 30
P21-1 Lessee-lessor entries-sales-type lease. Simple 20 25
P21-2 Lessee-lessor entries, operating lease. Simple 20 30
P21-3 Lessee-lessor entries, financial statement presentation;
sales-type lease.
Moderate 35 45
P21-4 Statement of financial position and income statement
disclosure lessee.
Moderate 30 40
P21-5 Statement of financial position and income statement
disclosure lessor.
Moderate 30 40
P21-6 Lessee entries with residual value. Moderate 25 35
P21-7 Lessee entries and statement of financial position
presentation, finance lease.
Moderate 25 30
P21-8 Lessee entries and statement of financial position
presentation, finance lease.
Moderate 20 30
P21-9 Lessee entries, finance lease with monthly payments. Moderate 20 30
P21-10 Lessor computations and entries, sales-type lease with
unguaranteed residual value.
Complex 30 40
P21-11 Lessee computations and entries, finance lease with
unguaranteed residual value.
Complex 30 40
P21-12 Basic lessee accounting with difficult PV calculation. Moderate 40 50
P21-13 Lessor computations and entries, sales-type lease with
guaranteed residual value.
Complex 30 40

ASSIGNMENT CHARACTERISTICS TABLE (Continued)
Item Description
Level of
Difficulty
Time
(minutes)
P21-14 Lessee computations and entries, finance lease with
guaranteed residual value.
Complex 30 40
P21-15 Operating lease vs. finance lease. Moderate 30 40
P21-16 Lessee-lessor accounting for residual values. Complex 30 40
CA21-1 Lessee accounting and reporting. Moderate 15 25
CA21-2 Lessor and lessee accounting and disclosure. Moderate 25 35
CA21-3 Lessee capitalization criteria. Moderate 20 30
CA21-4 Comparison of different types of accounting by lessee
and lessor.
Moderate 15 25
CA21-5 Lessee capitalization of bargain-purchase option. Moderate 30 35
CA21-6 Lease capitalization, bargain-purchase option Moderate 20 25
*CA21-7 Sale-leaseback. Moderate 15 25
*CA21-8 Sale-leaseback. Moderate 20 25

ANSWERS TO QUESTIONS
**1. The major lessor groups are banks, captive leasing companies, and independents. Captive leasing
companies have the point of sale advantage in finding leasing customers; that is, as soon as a
parent receives a possible order, a lease financing arrangement can be developed by its leasing
subsidiary. Furthermore, the captive lessor has the product knowledge which gives it an
advantage when financing the parents product. The current trend is for captives to focus on the
company s products rather than to do general lease financings.
**2. (a) Possible advantages of leasing:
1. Leasing permits the write-off of the full cost of the assets (including any land and residual
value), thus providing a possible tax advantage.
2. Leasing may be more flexible in that the lease agreement may contain less restrictive
provisions than the bond indenture.
3. Leasing permits 100% financing of assets.
4. Leasing may permit more rapid changes in equipment, reduce the risk of obsolescence,
and pass the risk in residual value to the lessor or a third party.
5. Potential of off-balance-sheet financing with certain types of leases.
Assuming that funds are readily available through debt financing, there may not be great
advantages (in addition to the above-mentioned) to signing a non-cancelable, long-term
lease. One of the usual advantages of leasing is its availability when other debt financing
is unavailable.
(b) Possible disadvantages of leasing:
1. In an ever-increasing inflationary economy, retaining title to assets may be desirable as
a hedge against inflation.
2. Interest rates for leasing often are higher and a profit factor may be included in addition.
3. In some cases, owning the asset provides unique tax advantages, such as when bonus
depreciation is permitted.
(c) Since a long-term non-cancelable lease which is used as a financing device generally
results in the capitalization of the leased assets and recognition of the lease commitment in
the statement of financial position, the comparative effect is not very different from purchase
and ownership. Assets leased under such terms would be capitalized at the present value of
the future lease payments; this value is probably somewhat equivalent to the purchase price
of the assets. Bonds sold at par would be nearly equivalent to the present value of the future
lease payments; in neither case would interest be capitalized. The amounts presented in the
statement of financial position would be quite comparable as would the general
classifications; the specific labels (leased assets and lease liability) would be different.
**3. Lessees have available two lease accounting methods: (a) the operating method and (b) the
finance-lease method. Under the operating method, the leased asset remains the property of the
lessor with the payment of a lease rental recognized as rental expense. Generally the lessor pays
the insurance, taxes, and maintenance costs related to the leased asset. Under the finance-lease
method, the lessee treats the lease transaction as if an asset were being purchased on credit;
therefore, the lessee: (1) sets up an asset and a related liability and (2) recognizes depreciation of
the asset, reduction of the liability, and interest expense.

Questions Chapter 21 (Continued)
**4. Ballard Company s rental of warehousing space on a short-term and sporadic basis is seldom
construed as the acquisition of an asset or even a financing arrangement. The contract consists
mainly of services which are to be performed proportionately by the lessor and the lessee the
rent to be paid by the lessee is offset by the service to be performed by the lessor. While a case
can be made for the existence of an acquisition of some property rights, be they ever so trifling,
the accounting treatment would be to record only the periodic rental payments as they are made
and to allocate rent expense to the periods in which the benefits are received. No asset would be
capitalized in this case, and an liability for lease payments would be recorded only to the extent
that services received from the lessor exceeded the rentals paid; that is, the rent payment is
overdue. This lease should be reported as an operating lease.
**5. Minimum rental payments are the periodic payments made by the lessee and received by the
lessor. These payments may include executory costs (such as maintenance, taxes, and insurance.)
Minimum lease payments are payments required or expected to be made by the lessee. They
include minimum rental payments (less executory costs), a bargain purchase option, a guaranteed
residual value, and a penalty for failure to renew the lease. The present value of the minimum
lease payments is capitalized by the lessee.
**6. The distinction between a direct-financing lease and a sales-type lease is the presence or absence
of a manufacturer s or dealer s profit. A sales-type lease involves a manufacturer s or dealer s
profit, and a direct-financing lease does not. The profit is the difference between the fair value of
the leased property at the inception of the lease and the lessor s cost or carrying value.
**7. Under the operating method, a rent expense (and a compensating liability) accrues day by day to
the lessee as the property is used. The lessee assigns rent to the periods benefiting from the use
of the asset and ignores in the accounting any commitments to make future payments. Appropriate
accruals are made if the accounting period ends between cash payment dates.
**8. Under the finance-lease method, the lessee treats the lease transactions as if the asset were
being purchased on an installment basis: a financial transaction in which an asset is acquired and
a liability is created. The asset and the liability are stated in the lessee s statement of financial
position at the lower of: (1) the present value of the minimum lease payments (excluding
executory costs) during the lease term or (2) the fair value of the leased asset at the inception of
the lease. The present value of the lease payments is computed using the lessee s incremental
borrowing rate unless the implicit rate used by the lessor is lower and the lessee has knowledge
of it. The effective-interest method is used to allocate each lease payment between a reduction of
the lease liability and interest expense.
If the lease transfers ownership or contains a bargain-purchase option, the asset is depreciated
in a manner consistent with the lessee s normal depreciation policy on assets owned, using the
economic life of the asset and allowing for salvage value. If the lease does not transfer ownership
or contain a bargain-purchase option, the leased asset is amortized over the lease term.
**9. From the standpoint of the lessor, leases may be classified for accounting purposes are classified as:
(a) operating leases, (b) direct-financing leases, and (c) sales-type leases.
From the standpoint of lessors, leases are classified as finance leases if they meet one or more
of the following four criteria:
1. The lease transfers ownership of the property to the lessee,
2. The lease contains a bargain-purchase option,
3. The lease term is for the major part of the economic life of the asset,
4. The present value of the minimum lease payments amounts to substantially all of the fair
value of the leased asset.

Finance leases are classified as direct-financing leases or sales-type leases. All other leases are
classified as operating leases. The distinction for the lessor between a direct-financing lease and
a sales-type lease is the presence or absence of a manufacturer s or dealer s profit or loss.
*10. If the lease transaction satisfies the necessary criteria to be classified as a direct-financing lease,
the lessor records a lease receivable for the leased asset. The lease receivable is the present
value of the minimum lease payments. Minimum lease payments include the rental payments
(excluding executory costs), bargain-purchase option (if any), guaranteed residual value (if any)
and penalty forfeiture to renew (if any). In addition, the present value of the unguaranteed residual
value (if any) must also be included.
*11. Under the operating method, each rental receipt of the lessor is recorded as rental revenue on
the use of an item carried as a fixed asset. The fixed asset is depreciated in the normal manner,
with the depreciation expense is recognized in the same period as the rental revenue. The amount
of revenue recognized in each accounting period is equivalent to the amount of rent receivable
according to the provisions of the lease. In addition to the depreciation charge, maintenance costs
and the cost of any other services rendered under the provisions of the lease that pertain to the
current accounting period are charged against the recognized revenue.
*12. Walker Company can use the sales-type lease accounting method if at the inception of the lease a
manufacturer s or dealer s profit (or loss) exists and the lease meets one or more of the following
four criteria:
(1) The lease transfers ownership of the property to the lessee,
(2) The lease contains a bargain-purchase option,
(3) The lease term is for the major part of the economic life of the asset,
(4) The present value of the minimum lease payments amounts to substantially all of the fair
value of the leased asset.
*13. Metheny Corporation should recognize the difference between the fair value (normal sales price)
of the leased property at the inception of the lease and its cost or carrying amount (book value) as
gross profit in the period the sales-type lease begins and the assets are transferred to the lessee.
The balance of the transaction is treated as a direct-financing lease (i.e., interest revenue is earned
over the lease term).
*14. The lease agreement between Alice Foyle, M.D. and Brownback Realty, Inc. appears to be in
substance a purchase of property. Because the lease has a bargain-purchase option which
transfers ownership of the property to the lessee, the lease is a finance lease. Additional evidence
of the finance lease character is that the lessor recovers all costs plus a reasonable rate of return
on investment. As a finance lease, the property and the related liability should be recorded at the
discounted amount of the future lease payments with that amount being allocated between the
land and the building in proportion to their fair values at the inception of the lease. The building
should be depreciated over its estimated useful life.
*15. (a) (1) The lessee s accounting for a lease with an unguaranteed residual value is the same as
the accounting for a lease with no residual value in terms of the computation of the minimum
lease payments and the capitalized value of the leased asset and the lease obligation.
That is, unguaranteed residual values are not included in the lessee s minimum lease
payments.

(2) A guaranteed residual value affects the lessee s computation of the minimum lease
payments and the capitalized amount of the leased asset and the lease liability.
The capitalized value is affected initially by the presence of a guaranteed residual value
since the present value of the lease obligation is now made up of two components the
periodic lease payments and the guaranteed residual value. The amortization of
the lease liability will result in a lease liability balance at the end of the lease period which
is equal to the guaranteed residual value. Upon termination of the lease, the lessee may
recognize a gain or loss depending on the relationship between the actual residual value
and the amount guaranteed.
(b) (1) & (2) The amount to be recovered by the lessor is the same whether the residual value
is guaranteed or unguaranteed. Therefore, the amount of the periodic lease
payments as set by the lessor is the same whether the residual value is guaranteed
or unguaranteed.
*16. If the estimate of the residual value declines, the lessor must recognize a loss to the extent of the
decline in the period of the decline. Taken literally, the accounting for the entire transaction must
be revised by the lessor using the changed estimate. The lease receivable is reduced by the
amount of the decline in the estimated residual value. Upward adjustments of the estimated
residual value are not made.
*17. If a bargain-purchase option exists, the lessee must increase the present value of the minimum
lease payments by the present value of the option price. A bargain-purchase option also affects
the depreciable life of the leased asset since the lessee must depreciate the asset over its
economic life rather than the term of the lease. If the lessee fails to exercise the option, the
lessee will recognize a loss to the extent of the net book value of the leased asset in the period
that the option expired.
*18. Initial direct costs are the incremental costs incurred by the lessor that are directly associated with
negotiating, consummating and initially processing leasing transactions. For operating leases, the
lessor should defer initial direct costs and allocate them over the lease term in proportion to the
recognition of rental revenue. In a sales-type lease transaction, the lessor expenses the initial direct
costs in the year of incurrence (i.e., the year in which profit on the sale is recognized). In a direct-
financing lease, initial direct costs should be added to the net investment in the lease and
amortized over the life of the lease as a yield adjustment.
*19. Lessees and lessors should disclose the future minimum rental payments required as of the
date of the latest statement of financial position presented, in the aggregate, and for the next
year, for years 2-5, and thereafter.
20. Both U.S. GAAP and IFRS share the same objective of recording leases by lessees and lessors
according to their economic substance that is, according to the definitions of assets and liabilities.
U.S. GAAP for leases is much more rule-based with specific bright-line criteria to determine if a
lease arrangement transfers the risks and rewards of ownership; IFRS is more general in its
provisions.

21. One example of the less detailed guidance in lease accounting under IFRS involves disclosure
policy. Under U.S. GAAP, extensive disclosure of future noncancelable lease payments is required
for the next five years and the years thereafter. Under IFRS, not as much detail is required, as
shown in the sample disclosure below.
IFRS Sample Lease Note Disclosure
The Group s obligations under finance leases are secured by the lessors title to the leased assets.
Finance lease liabilities (euros, 000,000)
Minimum lease payments, 31/12/11
No later than 1 year................................................................................ € 58
Later than 1 year and not later than 5 years ........................................... 44
Later than 5 years ..................................................................................
€102
Thus, with no detail on the year-by-year breakout of payments due in years 1 through 5, it is
more difficult to estimate the impact of the off-balance sheet liabilities for IFRS companies.
22. Lease accounting is one of the areas identified in the IASB/FASB Memorandum of
Understanding and also a topic recommended by the SEC in its off-balance-sheet study for
standard-setting attention. The joint project will initially primarily focus on lessee accounting. One
of the first areas to be studied is, What are the assets and liabilities to be recognized related to a
lease contract? The current exposure draft calls for all leases to be recorded as capital leases
based on a right of use model. Thus, the operating lease classification will be eliminated.
*23. The term sale-leaseback describes a transaction in which the owner of property sells such
property to another and immediately leases it back from the new owner. The property is sold
generally at a price equal to or less than current fair value and leased back for a term
approximating the property s useful life for lease payments sufficient to repay the buyer for the
cash invested plus a reasonable return on the buyer s investment. The purpose of the transaction
is to raise money with certain property given as security. For accounting purposes the sale-
leaseback should be accounted for by the lessee as a finance lease if the criteria are satisfied
and by the lessor as a purchase and a direct-financing lease if the criteria are satisfied. Any
income or loss experienced by the seller-lessee from the sale of the assets that are leased back
should be deferred and amortized over the lease term (or the economic life if either criteria (1) a
bargain purchase option or (2) a transfer of ownership occurs at the end of the lease is satisfied)
in proportion to the amortization of the leased assets. Losses should be recognized immediately.

SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 21-1
The lease does not meet the transfer of ownership test, the bargain-purchase
test, or the economic life test [(5 years ÷ 8 years) < 75%]. However, it does
pass the recovery of investment test. The present value of the minimum lease
payments (¥3,100,000 X 4.16986 = ¥12,926,566) is greater than 90% of the
FV of the asset (90% X ¥13,800,000 = ¥12,420,000). Therefore, Mizuno should
classify the lease as a capital lease.
BRIEF EXERCISE 21-2
Leased Equipment Under Finance Leases .................. 150,000*
Lease Liability........................................................ 150,000
Lease Liability................................................................ 43,019
Cash........................................................................ 43,019
*$43,019 X 3.48685 (PVADi = 10, n = 4)
BRIEF EXERCISE 21-3
Interest Expense............................................................ 29,530
Interest Payable [($300,000 $53,920) X 12%]..... 29,530
Depreciation Expense ................................................... 37,500
Accumulated Depreciation ($300,000 X 1/8) ........ 37,500
BRIEF EXERCISE 21-4
Interest Payable [($300,000 $53,920) X 12%] ............ 29,530
Lease Liability................................................................ 24,390
Cash........................................................................ 53,920
BRIEF EXERCISE 21-5
Rent Expense................................................................. 35,000
Cash........................................................................ 35,000

BRIEF EXERCISE 21-6
Lease Receivable (4.99271 X $30,044) .......................... 150,000
Equipment............................................................... 150,000
Cash ................................................................................ 30,044
Lease Receivable.................................................... 30,044
BRIEF EXERCISE 21-7
Interest Receivable......................................................... 9,596
Interest Revenue [($150,000 $30,044) X 8%] ...... 9,596
BRIEF EXERCISE 21-8
Cash ................................................................................ 15,000
Rent Revenue.......................................................... 15,000
Depreciation Expense.................................................... 10,000
Accumulated Depreciation (€80,000 X 1/8) ........... 10,000
BRIEF EXERCISE 21-9
Leased Machinery Under Finance Leases.................... 202,921*
Lease Liability......................................................... 202,921
*PV of rentals $40,000 X 4.79079 $191,632
[PV of guar. RV $20,000 X .56447 11,289
$202,921
Lease Liability ................................................................ 40,000
Cash......................................................................... 40,000
BRIEF EXERCISE 21-10
Lease Receivable ........................................................... 202,921
Machinery................................................................ 202,921
Cash ................................................................................ 40,000

BRIEF EXERCISE 21-11
Lease Receivable (£40,800 X 4.03735) ......................... 164,724
Sales ....................................................................... 164,724
Cost of Goods Sold....................................................... 110,000
Inventory ................................................................ 110,000
Cash ............................................................................... 40,800
Lease Receivable................................................... 40,800
*BRIEF EXERCISE 21-12
Cash ............................................................................... 33,000
Truck....................................................................... 28,000
Unearned Profit on Sale-Leaseback..................... 5,000
Leased Truck Under Finance Leases........................... 33,000*
Lease Liability........................................................ 33,000
*(€8,705 X 3.79079; €1 difference due to rounding.)
Accumulated Depreciation (€33,000 X 1/5)........... 6,600
Unearned Profit on Sale-Leaseback............................. 1,000
Depreciation Expense (€5,000 X 1/5) .................... 1,000
Interest Expense (€33,000 X 10%) ................................ 3,300
Lease Liability................................................................ 5,405
Cash........................................................................ 8,705

SOLUTIONS TO EXERCISES
EXERCISE 21-1 (15 20 minutes)
(a) This is a finance lease to Adams since the lease term (5 years) is greater
than 75% of the economic life (6 years) of the leased asset. The lease
term is a major part [831
/3% (5 ÷ 6)] of the asset s economic life.
(b) Computation of present value of minimum lease payments:
$9,968 X 4.16986* = $41,565
*Present value of an annuity due of 1 for 5 periods at 10%.
(c) 1/1/11 Leased Machine Under Finance
Leases ................................................. 41,565
Lease Liability ................................. 41,565
Lease Liability......................................... 9,968
Cash ................................................. 9,968
12/31/11 Depreciation Expense ............................ 8,313
Accumulated Depreciation
Capital Leases............................. 8,313
($41,565 ÷ 5 = $8,313)
Interest Expense..................................... 3,160
Interest Payable............................... 3,160
[($41,565 $9,968) X .10]
1/1/12 Lease Liability......................................... 6,808
Interest Payable ...................................... 3,160
Cash ................................................. 9,968

(a) To Brecker, the lessee, this lease is a finance lease because the terms
satisfy the following criteria:
1. The lease term is greater than 75% of the economic life of the leased
asset; that is, the lease term is 831
/3 % (50/60) of the economic life.
2. The present value of the minimum lease payments is greater than
90% of the fair value of the leased asset; that is, the present value
of €10,515 (see below) amounts to substantially all (96%) of the fair
value of the leased asset:
(b) The minimum lease payments in the case of a guaranteed residual
value by the lessee include the guaranteed residual value. The present
value therefore is:
Monthly payment of €250 for 50 months ........... € 9,800
Residual value of €1,180..................................... 715
Present value of minimum lease payments ...... €10,515
(c) Leased Property Under Finance Leases .................. 10,515
Lease Liability ..................................................... 10,515
(d) Depreciation Expense ............................................... 186.70
Accumulated Depreciation Finance
Leases.............................................................. 186.70
[(€10,515 €1,180) ÷ 50 months = €186.70]
(e) Lease Liability............................................................ 144.85
Interest Expense (1% X €10,515)............................... 105.15
Cash..................................................................... 250.00
Capitalized amount of the lease:
Yearly payment ......................................................... $90,000.00
Executory costs ........................................................ (3,088.14)
Minimum annual lease payment .............................. $86,911.86

EXERCISE 21-3 (Continued)
Present value of minimum lease payments
$86,911.86 X 6.32825 = $550,000.00
1/1/11 Leased Building Under Finance
Leases ........................................... 550,000.00
Lease Liability ........................... 550,000.00
1/1/11 Executory Costs Property Taxes..... 3,088.14
Lease Liability................................... 86,911.86
Cash........................................... 90,000.00
12/31/11 Depreciation Expense ...................... 55,000.00
Finance Leases ..................... 55,000.00
($550,000 ÷ 10)
12/31/11 Interest Expense
(See Schedule 1)........................... 55,570.58
Interest Payable ........................ 55,570.58
1/1/12 Executory Costs Property Taxes...... 3,088.14
Interest Payable................................ 55,570.58
Lease Liability................................... 31,341.28
Cash........................................... 90,000.00
12/31/12 Depreciation Expense ...................... 55,000.00
Finance Leases ..................... 55,000.00
12/31/12 Interest Expense............................... 51,809.62
Interest Payable ........................ 51,809.62

Schedule 1 STORA ENSO CORP.
Lease Amortization Schedule
(Lessee)
Date
Annual
Payment Less
Executory
Costs
Interest (12%)
on Liability
Reduction
of Lease
Liability Lease Liability
1/1/11 $550,000.00
1/1/11 $86,911.86 $ 0 $86,911.86 463,088.14
1/1/12 86,911.86 55,570.58 31,341.28 431,746.86
1/1/13 86,911.86 51,809.62 35,102.24 396,644.62
Computation of annual payments
Cost (fair value) of leased asset to lessor ................................ £240,000.00
Less: Present value of residual value
(residual value in this case)
£16,000 X .82645
(Present value of 1 at 10% for 2 periods) ...................... 13,223.20
Amount to be recovered through lease payments................... £226,776.80
Two periodic lease payments £226,776.80 ÷ 1.73554* ............. £130,666.42
*Present value of an ordinary annuity of 1 for 2 periods at 10%
KRAUSS LEASING COMPANY (Lessor)
Date
Annual Payment
Less Executory
Costs
Interest
on Lease
Receivable
Recovery
of Lease
Receivable
Lease
Receivable
1/1/11 £240,000.00
12/31/11 £130,666.42 *£24,000.00 £106,666.42 133,333.58
12/31/12 130,666.42 * 13,332.84* 117,333.58 16,000.00
*£37,332.84
*Difference of £.52 due to rounding.

(a) 1/1/11 Lease Receivable...................... 240,000.00
Equipment.......................... 240,000.00
12/31/11 Cash (£130,666.42 + £7,000) ..... 137,666.42
Executory Costs
Payable........................... 7,000.00
Lease Receivable .............. 106,666.42
Interest Revenue ............... 24,000.00
12/31/12 Cash........................................... 137,666.42
Executory Costs
Payable........................... 7,000.00
(b) 12/31/12 Cash........................................... 16,000.00
(a) Because the lease term is longer than 75% of the economic life of the
asset and the present value of the minimum lease payments is more
than 90% of the fair value of the asset, it is a finance lease to the
lessee. The lease is a direct-financing lease to the lessor since the
machine s cost and fair value are the same.
The lessee should adopt the finance lease method and record the
leased asset and lease liability at the present value of the minimum
lease payments using the lessor s implicit rate unless it is impracticable
to determine. Otherwise, use the lessee s incremental borrowing rate.
The lessee s depreciation depends on whether ownership transfers to
the lessee or if there is a bargain purchase option. If one of these
conditions is fulfilled, amortization would be over the economic life of
the asset. Otherwise, it would be depreciated over the lease term.
Because both the economic life of the asset and the lease term are three
years, the leased asset should be depreciated over this period.

The lessor should adopt the direct-financing lease method and replace
the asset cost of $75,000 with Lease Receivable of $75,000. (See
schedule below.) Interest would be recognized annually at a constant
rate relative to the unrecovered net investment.
Cost (fair value of leased asset) ............................................. $75,000
Amount to be recovered by lessor through lease
payments.............................................................................. $75,000
Three annual lease payments: $75,000 ÷ 2.53130* ............... $29,629
*Present value of an ordinary annuity of 1 for 3 periods at 9%.
(b) Schedule of Interest and Amortization
Rent Receipt/
Payment
Interest
Revenue/
Expense
Reduction of
Principal
Receivable/
Liability
1/1/11 $75,000
12/31/11 $29,629 *$6,750* $22,879 52,121
12/31/12 29,629 4,691 24,938 27,183
12/31/13 29,629 2,446 27,183 0
*$75,000 X .09 = $6,750
(a) ¥38,514,000 X 5.7122* = ¥220,000,000
(b) 1/1/11 Lease Receivable ........................ 220,000,000
Cost of Goods Sold..................... 170,000,000
Sales..................................... 220,000,000
Inventory .............................. 170,000,000
1/1/11 Cash ............................................. 38,514,000
Lease Receivable................. 38,514,000

12/31/11 Interest Receivable ............................ 19,963,000
Interest Revenue
[(¥220,000,000
¥38,514,000) X .11
rounded].................................. 19,963,000
(a) This is a finance lease to Immelman since the lease term is 75% (6 ÷ 8) of
the asset s economic life. In addition, the present value of the minimum
lease payments is more than 90% of the fair value of the asset.
This is also a finance lease to Palmer since the lease term is 75% of the
asset s economic life. Because the fair value of the equipment
($200,000) exceeds the lessor s cost ($150,000), the lease is a sales-
type lease.
(b) Computation of annual rental payment:
$200,000 ($10,000 X .53464)*
4.69590**
= $41,452
**Present value of $1 at 11% for 6 periods.
**Present value of an annuity due at 11% for 6 periods.
(c) 1/1/11 Leased Equipment Under Finance
Leases............................................... 190,877
Lease Liability
($41,452 X 4.60478)***............... 190,877
Lease Liability ...................................... 41,452
Cash .............................................. 41,452
***Present value of an annuity due at 12% for 6 periods.
12/31/11 Depreciation Expense.......................... 31,813
($190,877 ÷ 6 years).................. 31,813
Interest Expense .................................. 17,931
Interest Payable
($190,877 $41,452) X .12........ 17,931

(d) 1/1/11 Lease Receivable ............................. 200,000*
Cost of Goods Sold.......................... 144,654**
Sales.......................................... 194,654***
Inventory ................................... 150,000
* *($41,452 X 4.6959) + ($10,000 X .53464)
**$150,000 ($10,000 X .53464)
***$41,452 X 4.6959
Cash .................................................. 41,452
Lease Receivable...................... 41,452
12/31/11 Interest Receivable .......................... 17,440
Interest Revenue
[($200,000 $41,452) X .11]... 17,440
(a) The lease agreement has a bargain-purchase option and thus meets
the criteria to be classified as a finance lease from the viewpoint of the
lessee. Also, the present value of the minimum lease payments exceeds
90% of the fair value of the asset.
(b) The lease agreement has a bargain-purchase option. The lease, there-
fore, qualifies as a finance-type lease from the viewpoint of the lessor.
Due to the fact that the initial amount of lease receivable (net
investment) (which in this case equals the present value of the
minimum lease payments, €81,000) exceeds the lessor s cost (€65,000),
the lease is a sales-type lease.
(c) Computation of lease liability:
€18,829.49 Annual rental payment
X 4.16986 PV of annuity due of 1 for n = 5, i = 10%
€78,516.34 PV of periodic rental payments

€ 4,000.00 Bargain-purchase option
X .62092 PV of 1 for n = 5, i = 10%
€ 2,483.68 PV of bargain-purchase option
+ 2,483.68 PV of bargain-purchase option
€81,000.00* Lease liability
*rounded
GILL COMPANY (Lessee)
Date
Annual Lease
Payment Plus
BPO
Interest
(10%) on
Liability
Reduction
of Lease
Liability
Lease
Liability
5/1/10 €81,000.00
5/1/10 €18,829.49 €18,829.49 62,170.51
5/1/11 18,829.49 *€ 6,217.05 12,612.44 49,558.07
5/1/12 18,829.49 4,955.81 13,873.68 35,684.39
5/1/13 18,829.49 3,568.44 15,261.05 20,423.34
5/1/14 18,829.49 2,042.33 16,787.16 3,636.18
4/30/15 4,000.00 * 363.82* 3,636.18 0
€98,147.45 €17,147.45 €81,000.00
*Rounding error is 20 cents.
(d) 5/1/10 Leased Equipment Under
Finance Leases ............................... 81,000.00
Lease Liability.............................. 81,000.00
Lease Liability ..................................... 18,829.49
Cash ............................................. 18,829.49
12/31/10 Interest Expense ................................. 4,144.70
Interest Payable
(€6,217.05 X 8/12 = €4,144.70) .... 4,144.70

Depreciation Expense..................... 5,400
Finance Leases.................... 5,400
(€81,000.00 ÷ 10 =
(€8,100.00; €8,100.00 X
(8/12 = €5,400)
1/1/11 Interest Payable............................... 4,144.70
Interest Expense...................... 4,144.70
5/1/11 Interest Expense ............................. 6,217.05
Lease Liability ................................. 12,612.44
Cash ......................................... 18,829.49
Interest Payable....................... 3,303.87
(€4,955.81 X 8/12 =
(€3,303.87)
12/31/11 Depreciation Expense..................... 8,100.00
Finance Leases.................... 8,100.00
(€81,000.00 ÷ 10 years =
(€8,100.00)
(Note to instructor: Because a bargain-purchase option was involved,
the leased asset is depreciated over its economic life rather than over
the lease term.)
Note: The lease agreement has a bargain-purchase option. The lease,
therefore, qualifies as a finance lease from the viewpoint of the lessor.
Due to the fact that the amount of the sale (which in this case equals the
present value of the minimum lease payments, €81,000) exceeds the lessor s
cost (€65,000), the lease is a sales-type lease.

The minimum lease payments associated with this lease are the periodic
annual rents plus the bargain-purchase option. There is no residual value
relevant to the lessor s accounting in this lease.
(a) The lease receivable is computed as follows:
€18,829.49 Annual rental payment
X 4.16986 PV of annuity due of 1 for n = 5, i = 10%
€ 4,000.00 Bargain purchase option
X .62092 PV of 1 for n = 5, i = 10%
€ 2,483.68 PV of bargain-purchase option
+ 2,483.68 PV of bargain-purchase option
€81,000.00* Lease receivable at inception
*Rounded
(b) LENNOX LEASING COMPANY (Lessor)
Date
Annual Lease
Payment Plus
BPO
Interest (10%)
on Lease
Receivable
Recovery
of Lease
Receivable
Lease
Receivable
5/1/10 €81,000.00
5/1/10 €18,829.49 €18,829.49 62,170.51
5/1/11 18,829.49 € 6,217.05 12,612.44 49,558.07
5/1/12 18,829.49 4,955.81 13,873.68 35,684.39
5/1/13 18,829.49 3,568.44 15,261.05 20,423.34
5/1/14 18,829.49 2,042.33 16,787.16 3,636.18
4/30/15 4,000.00 363.82* 3,636.18 0
€98,147.45 *€17,147.45 €81,000.00

(c) 5/1/10 Lease Receivable ...................... 81,000.00
Cost of Goods Sold................... 65,000.00
Sales................................... 81,000.00
Inventory ............................ 65,000.00
Cash ........................................... 18,829.49
Lease Receivable............... 18,829.49
12/31/10 Interest Receivable ................... 4,144.70
Interest Revenue................ 4,144.70
(€6,217.05 X 8/12 =
€4,144.70)
5/1/11 Cash ........................................... 18,829.49
Interest Receivable............ 4,144.70
(€6,217.05 €4,144.70)
(€4,955.81 X 8/12 =
(€3,303.87)
5/1/12 Cash ........................................... 18,829.49
Interest Receivable............ 3,303.87
(€4,955.81 €3,303.87)
(€3,568.44 X 8/12 =
(€2,378.96)

(a) Fair value of leased asset to lessor................................. £343,000.00
Less: Present value of unguaranteed
residual value £61,071 X .56447
(present value of 1 at 10% for 6 periods) ............. 34,472.75
Amount to be recovered through lease payments......... £308,527.25
Six periodic lease payments £308,527.25 ÷ 4.79079* ..... £ 64,400.00**
*Present value of annuity due of 1 for 6 periods at 10%.
**Rounded to the nearest pound.
(b) FIEVAL LEASING COMPANY (Lessor)
Date
Annual
Lease
Payment
Plus URV
Interest (10%)
on Lease
Receivable
Recovery
of Lease
Receivable
Lease
Receivable
1/1/10 £343,000
1/1/10 £ 64,400 £ 64,400 278,600
1/1/11 64,400 £ 27,860 36,540 242,060
1/1/12 64,400 24,206 40,194 201,866
1/1/13 64,400 20,187 44,213 157,653
1/1/14 64,400 15,765 48,635 109,018
1/1/15 64,400 10,902 53,498 55,520
12/31/15 61,071 5,551 55,520 0
£447,471 £104,471 £343,000
(c) 1/1/10 Lease Receivable................................. 343,000
Equipment..................................... 343,000
1/1/10 Cash...................................................... 64,400
Lease Receivable ......................... 64,400
12/31/10 Interest Receivable .............................. 27,860
Interest Revenue .......................... 27,860
1/1/11 Cash...................................................... 64,400
Lease Receivable ......................... 36,540
Interest Receivable....................... 27,860
Interest Revenue .......................... 24,206

Note: This lease is a finance lease to the lessee because the lease term
(five years) exceeds 75% of the remaining economic life of the asset (five years).
Also, the present value of the minimum lease payments exceeds 90% of the
fair value of the asset.
$20,541.11 Annual rental payment
X 4.16986 PV of an annuity due of 1 for n = 5, i = 10%
$85,653.55 PV of minimum lease payments
(a) AZURE COMPANY (Lessee)
Date
Annual Lease
Payment
Interest (10%)
on Liability
Reduction
of Lease
Liability
Lease
Liability
1/1/10 $85,653.55
1/1/10 $ 20,541.11 $20,541.11 65,112.44
1/1/11 20,541.11 *$ 6,511.24 14,029.87 51,082.57
1/1/12 20,541.11 5,108.26 15,432.85 35,649.72
1/1/13 20,541.11 3,564.97 16,976.14 18,673.58
1/1/14 20,541.11 * 1,867.53* 18,673.58 0
$102,705.55 *$17,052.00 $85,653.55
(b) 1/1/10 Leased Equipment Under
Finance Leases ....................... 85,653.55
Lease Liability...................... 85,653.55
1/1/10 Lease Liability ............................. 20,541.11
Cash ..................................... 20,541.11
During 2010
Insurance Expense ..................... 900.00
Cash ..................................... 900.00
Property Tax Expense................. 1,600.00
Cash ..................................... 1,600.00

Depreciation Expense..................... 17,130.71
Finance Leases.................... 17,130.71
($85,653.55 ÷ 5 = $17,130.71)
1/1/11 Interest Payable .............................. 6,511.24
Interest Expense...................... 6,511.24
Interest Expense ............................. 6,511.24
Lease Liability ................................. 14,029.87
Cash ......................................... 20,541.11
During 2011
Insurance Expense ......................... 900.00
Cash ......................................... 900.00
Property Tax Expense .................... 1,600.00
Cash ......................................... 1,600.00
Depreciation Expense..................... 17,130.71
Finance Leases.................... 17,130.71
Note to instructor:
1. The lessor sets the annual rental payment as follows:
Fair value of leased asset to lessor................................. $90,000.00
Less: Present value of unguaranteed
residual value $7,000 X .62092
(present value of 1 at 10% for 5 periods) ............. 4,346.44
Amount to be recovered through lease payments ......... $85,653.56
Five periodic lease payments
$85,653.56 ÷ 4.16986*.................................................... $20,541.11
*Present value of annuity due of 1 for 5 periods at 10%.

2. The unguaranteed residual value is not subtracted when depreciating
the leased asset.
(a) Entries for Secada are as follows:
1/1/11 Building............................................. 3,600,000
Cash .............................................. 3,600,000
12/31/11 Cash .................................................. 220,000
Rental Revenue......................... 220,000
Depreciation Expense...................... 72,000
Building (€3,600,000 ÷ 50) ..... 72,000
Property Tax Expense...................... 85,000
Insurance Expense .......................... 10,000
Cash .......................................... 95,000
(b) Entries for Ryker are as follows:
12/31/11 Rent Expense ................................... 220,000
Cash .......................................... 220,000
(c) The real estate broker s fee should be capitalized and amortized equally
over the 10-year period. As a result, real estate fee expense of $3,000
(€30,000 ÷ 10) should be reported in each period.
(a) Annual rental revenue ........................................................ $180,000
Less: Maintenance and other executory costs................ 25,000
Depreciation ($900,000 ÷ 8)..................................... 112,500
Income before income tax.................................................. $ 42,500

(b) Rent expense ...................................................................... $180,000
Note: Both the rent security deposit and the last month s rent prepayment
should be reported as a non-current asset.
(a) SAGE COMPANY
Rent Expense
For the Year Ended December 31, 2011
Monthly rental ..................................................................... $ 15,600
Lease period in 2011 (March December)........................... X 10 months
$ 156,000
(b) HOOKE INC.
Income or Loss from Lease before Taxes
For the Year Ended December 31, 2011
Rental revenue ($15,600 X 10 months).......... $156,000
Less expense
Depreciation............................................. $100,000**
Commission ............................................. 6,250** 106,250
Income from lease before taxes .................... $ 49,750
**$1,200,000 cost ÷ 10 years = $120,000/year
$120,000 X 10/12 = $100,000
**(Note to instructor: Under principles of accrual accounting, the com-
mission should be amortized over the life of the lease: $30,000 ÷
4 years = $7,500 X 10/12 = $6,250.)

*EXERCISE 21-15 (20 30 minutes)
Peking Duck Co. (Lessee)*
1/1/11 Cash.................................................... 510,000.00
Computer.................................... 450,000.00
Unearned Profit on Sale
Leaseback............................... 60,000.00
Leased Computer Under Finance
Leases ............................................ 510,000.00
Lease Liability
(¥83,000.11 X 6.14457)............ 510,000.00
Throughout 2011
Executory Costs ................................ 9,000.00
Accounts Payable or Cash ........ 9,000.00
12/31/11 Unearned Profit on Sale
Leaseback ...................................... 6,000.00
Depreciation Expense**
(¥60,000 ÷ 10).......................... 6,000.00
12/31/11 Depreciation Expense ....................... 51,000.00
(¥510,000 ÷ 10)........................ 51,000.00
Interest Expense................................ 51,000.00
Lease Liability.................................... 32,000.11
Cash ............................................ 83,000.11
**The lease should be treated as a finance lease because the present value
of minimum lease payments equals the fair value of the computer. Also,
the lease term is greater than 75% of the economic life of the asset, and
title transfers at the end of the lease.
**The credit could also be to a revenue account.
Note to instructor:
1. The present value of an ordinary annuity at 10% for 10 periods should
be used to capitalize the asset. In this case, Peking Duck Co. would use
the implicit rate of the lessor because it is known to Peking Duck Co.

*EXERCISE 21-15 (Continued)
2. The unearned profit on the sale-leaseback should be amortized on the
same basis that the asset is being depreciated.
Partial Lease Amortization Schedule
Date
Annual
Lease
Payment Interest (10%) Amortization Balance
1/1/11 ¥510,000.00
12/31/11 ¥83,000.11 ¥51,000.00 ¥32,000.11 477,999.89
Liquidity Finance Co. (Lessor)*
1/1/11 Computer................................... 510,000.00
Cash ................................... 510,000.00
Lease Receivable...................... 510,000.00
Computer........................... 510,000.00
12/31/11 Cash........................................... 83,000.11
*Lease should be treated as a direct-financing lease because the present
value of the minimum lease payments equals the fair value of the
computer, and the cost to the lessor equals the fair value of the asset
at the inception of the lease.
*EXERCISE 21-16 (20 30 minutes)
(a) Sale-leaseback arrangements are treated as though two transactions
were a single financing transaction if the lease qualifies as a finance
lease. Any gain or loss on the sale is deferred and amortized over the
lease term (if possession reverts to the lessor) or the economic life (if
ownership transfers to the lessee). In this case, the lease qualifies as a
finance lease because the lease term (10 years) is 83% of the remaining
economic life of the leased property (12 years). Therefore, at 12/31/11,
all of the gain of $160,000 ($560,000 $400,000) would be deferred and
amortized over 10 years. Since the sale took place on 12/31/11, there
is no amortization for 2011.

*EXERCISE 21-16 (Continued)
(b) A sale-leaseback is usually treated as a single financing transaction
in which any profit on the sale is deferred and amortized by the seller.
In this situation the seller-lessee accounts for the lease as an operating
lease with the sale and the leaseback accounted for as separate
transactions. Therefore, the full gain ($480,000 $420,000, or $60,000)
is recognized.
(c) The profit on the sale of $99,000 should be deferred and amortized
over the lease term. Since the leased asset is being depreciated using
the sum-of-the-years depreciation method, the deferred gain should
also be reported in the same manner. Therefore, in the first year, $18,000
(10/55 X $99,000) of the gain would be recognized.
(d) In this case, Durocher would report a loss of $87,300 ($300,000
$212,700) for the difference between the book value and lower fair value.
The profession requires that when the fair value of the asset is less
than the book value (carrying amount), a loss must be recognized
immediately. In addition, rent expense of $72,000 should be reported.

TIME AND PURPOSE OF PROBLEMS
Problem 21-1 (Time 20 25 minutes)
Purpose to develop an understanding of the accounting principles used in a sales-type lease for both
the lessee and the lessor. The student is required to discuss the nature of the lease and make journal
entries for both the lessee and the lessor.
Purpose to develop an understanding of the accounting treatment for operating leases. The student is
required to identify the type of lease involved, explain the respective reasons for their classification, and
discuss the accounting treatment that should be applied for both the lessee and lessor. The student is
also asked to prepare the journal entries to reflect the first year of this lease contract for both the lessee
and lessor and to discuss the disclosures required of the lessee and lessor.
Purpose to develop an understanding of the accounting procedures involved in a sales-type leasing
arrangement. The student is required to discuss the nature of this lease transaction from the viewpoint
of both the lessee and lessor. The student is also requested to prepare the journal entries to record the
lease for both the lessee and lessor plus illustrate the items and amounts that would be reported on the
statement of financial position at the end of the first year for the lessee and the lessor.
Purpose to provide an understanding of how lease information is reported on the statement of
financial position and income statement for three different years in regard to the lessee. In addition, the
year-end month is changed in order to help provide an understanding of the complications involved with
partial periods.
Purpose to provide an understanding of how lease information is reported on the statement of
financial position and income statement for three different years in regard to the lessor. In addition, the
year-end month is changed in order to help provide an understanding of the complications involved with
partial periods.
Purpose to provide an understanding of the journal entries to be recorded by the lessee given a
guaranteed residual value. Journal entries for two periods are required.
Purpose to develop an understanding of the accounting for a finance lease by the lessee in an annuity
due arrangement. The student is required to prepare the lease amortization schedule for the entire term
of the lease and all the necessary journal entries for the lease through the first two lease payments.
The student is also asked to indicate the amounts that would be reported on the lessee s statement of
financial position.
Purpose to develop an understanding of the accounting by the lessee for a finance lease. The student
is required to explain the relationship between the capitalized amount of leased equipment and the
leasing arrangement. The student is asked to prepare the lessee s journal entries at the date of
inception, for depreciation of the leased asset, and for the first lease payment, as well as to indicate the
amounts that should be reported on the lessee s statement of financial position.

Time and Purpose of Problems (Continued)
Purpose to develop an understanding of the accounting for a finance lease by a lessee in an annuity
due arrangement. The student is required to prepare all the journal entries, with supportive
computations, which the lessee would have made to record the lease for the first period of the lease.
Purpose to develop an understanding of the accounting treatment accorded a sales-type lease involving
an unguaranteed residual value. The student is required to discuss the nature of the lease with regard
to the lessor and to compute the lease receivable, the sales price, and the cost of sales. The student is
also required to construct a 10-year lease amortization schedule for the leasing arrangement, and to
prepare the lessor s journal entries for the first year of the lease contract.
Purpose to develop an understanding of a finance lease with an unguaranteed residual value. The
student explains why it is a finance lease and computes the amount of the initial obligation. The student
prepares a 10-year amortization schedule and all of the lessee s journal entries for the first year.
Purpose to develop an understanding of the accounting for finance leases where the lease payments
for the first half of the lease term differ from those for the latter half. The student is required to compute
for the lessee the discounted present value of the leased property and the related obligation at the
lease s inception date. The student is also asked to prepare journal entries for the lessee.
Purpose to develop an understanding of a sales-type lease with a guaranteed residual value. The
student discusses the classification of the lease and computes the lease receivable at inception of
lease, sales price, and cost of sales. The student prepares a 10-year amortization schedule and all of
the lessor s journal entries for the first year.
Purpose to develop an understanding of a finance lease with a guaranteed residual value. The
student explains why it is a finance lease and computes the amount of the initial obligation. The student
prepares a 10-year amortization schedule and all of the lessee s journal entries for the first year.
Purpose to develop a memo to your audit supervisor to discuss: (a) why you inspected the lease
agreement, (b) what you determined about the lease, and (c) how you advised your client to account for
the lease. As part of the discussion you are required to make the journal entry necessary to record the
lease property.
Purpose to develop an understanding of how residual values affect the accounting for the lessee and
the lessor. The student must understand both the accounting for a guaranteed and unguaranteed residual
value and determine how large the residual value must be to have operating lease treatment.

SOLUTIONS TO PROBLEMS
PROBLEM 21-1
(a) This is a finance lease to Jensen since the lease term is greater than
75% of the economic life of the leased asset. The lease term is 78%
(7 ÷ 9) of the asset s economic life.
This is a finance lease to Glaus because the lease term is greater than
75% of the asset s economic life. Since the fair value ($700,000) of the
equipment exceeds the lessor s cost ($525,000), the lease is a sales-
type lease.
(b) Calculation of annual rental payment:
$700,000 ($100,000 X .51316)*
5.35526**
= $121,130
(c) Computation of present value of minimum lease payments:
PV of annual payments: $121,130 X 5.23054** = $633,575
PV of guaranteed residual value: $100,000 X .48166** = 48,166
$681,741
(d) 1/1/10 Leased Machinery Under Finance
Leases............................................... 681,741
Lease Liability............................... 681,741
Lease Liability ...................................... 121,130
Cash .............................................. 121,130

PROBLEM 21-1 (Continued)
12/31/10 Depreciation Expense......................... 83,106
($681,741 $100,000) ÷ 7......... 83,106
Interest Expense ................................. 61,667
Interest Payable
($681,741 $121,130) X .11 ..... 61,667
1/1/11 Lease Liability ..................................... 59,463
Interest Payable................................... 61,667
Cash ............................................. 121,130
12/31/11 Depreciation Expense......................... 83,106
Accumulated Depreciation.......... 83,106
Interest Expense ................................. 55,126
Interest Payable........................... 55,126
[($681,741 $121,130
$59,463) X .11]
(e) 1/1/10 Lease Receivable ................................ 700,000
Cost of Goods Sold............................. 525,000
Sales............................................. 700,000
Inventory ...................................... 525,000
Cash ..................................................... 121,130
Lease Receivable......................... 121,130
12/31/10 Interest Receivable ............................. 57,887
Interest Revenue
[($700,000 $121,130) X .10]... 57,887
1/1/11 Cash ..................................................... 121,130
Lease Receivable......................... 63,243
Interest Receivable...................... 57,887
Interest Revenue........................... 51,563
[($700,000 $121,130
$63,243) X .10]

PROBLEM 21-2
(a) The lease is an operating lease to the lessee and lessor because:
1. it does not transfer ownership,
2. it does not contain a bargain-purchase option,
3. it does not cover the major part (at least 75%) of the estimated
economic life of the crane, and
4. the present value of the lease payments does not amount to
substantially all (at least 90%) of the fair value of the leased crane.
$33,000 Annual Lease Payments X PV of annuity due at 9% for 5 years
$33,000 X 4.23972 = $139,910.76, which is less than $216,000.00 (90% X
$240,000.00).
At least one of the four criteria would have had to be satisfied for the
lease to be classified as other than an operating lease.
(b) Lessee s Entries
Rent Expense............................................................. 33,000
Cash..................................................................... 33,000
Lessor s Entries
Insurance Expense.................................................... 500
Tax Expense............................................................... 2,000
Maintenance Expense ............................................... 650
Cash or Accounts Payable................................. 3,150
Depreciation Expense ............................................... 18,750
Accumulated Depreciation Crane
[($240,000 $15,000) ÷ 12] ............................. 18,750
Cash............................................................................ 33,000
Rental Revenue................................................... 33,000

(c) Abriendo as lessee must disclose in the income statement the $33,000
of rent expense and in the notes the future minimum rental payments
required as of January 1 (in total, $132,000) and for the next year
(2012 $33,000) and years 2 5 ($99,000). Nothing relative to this lease
would appear on the lessee s statement of financial position.
Cancun as lessor must disclose in the statement of financial position or in
the notes the cost of the leased crane ($240,000) and the accumulated
depreciation of $18,750 separately from assets not leased. Additionally,
Cancun must disclose in the notes the minimum future rentals as a
total of $132,000, and for the next year (2012 $33,000) and years 2 5
($99,000).
The income statement for the lessor reports rental revenue and expenses
for insurance, taxes, maintenance, and depreciation expense.

PROBLEM 21-3
(a) The lease should be treated as a finance lease by Labron Industries
requiring the lessee to capitalize the leased asset. The lease qualifies for
finance lease accounting by the lessee because: (1) title to the engines
transfers to the lessee, (2) the lease term is equal to the estimated life
of the asset, and (3) the present value of the minimum lease payments
exceeds 90% of the fair value of the leased engines. The transaction
represents a purchase financed by installment payments over a 10-year
period.
For Ewing Inc. the transaction is a sales-type lease because a manu-
facturer s profit accrues to Ewing. This lease arrangement also represents
the manufacturer s financing the transaction over a period of 10 years.
Present Value of Lease Payments
$413,971 X 7.24689* .................................................. $3,000,000
*Present value of an annuity due at 8% for 10 years, rounded by $2.
Dealer Profit
Sales (present value of lease payments) .................... $3,000,000
Less cost of engines .................................................... 2,600,000
Profit on sale................................................................. $ 400,000
(b) Leased Engines Under Finance Leases.......... 3,000,000
Lease Liability............................................ 3,000,000
(c) Lease Receivable.............................................. 3,000,000
Cost of Goods Sold .......................................... 2,600,000
Sales ........................................................... 3,000,000
Inventory .................................................... 2,600,000
(d) Lessee
Lease Liability................................................... 413,971
Cash............................................................ 413,971
Lessor
Cash................................................................... 413,971
Lease Receivable....................................... 413,971

(e) LABRON INDUSTRIES
Date
Annual
Lease
Receipt/
Payment
Interest on
Receivable/
Liability at 8%
Reduction in
Receivable/
Liability
Lease
Receivable/
Liability
1/1/11 3,000,000
1/1/11 413,971 413,971 2,586,029
1/1/12 413,971 206,882 207,089 2,378,940
1/1/13 413,971 190,315 223,656 2,155,284
Lessee
Interest Expense .............................................. 206,882
Interest Payable ........................................ 206,882
Lessor
Interest Receivable .......................................... 206,882
Interest Revenue ....................................... 206,882
(f) LABRON INDUSTRIES
Statement of Financial Position
December 31, 2011
Property, plant, and equipment: Non-current liabilities:
Lease liability
(See schedule)
$2,378,940**
Leased property
under finance leases $3,000,000 Current liabilities:
Less accumulated
depreciation 300,000* Interest payable 206,882
$2,700,000 Lease liability 207,089***
*$3,000,000 ÷ 10 = $300,000
**No portion of this amount paid within the next year.
***($413,971 $206,882)
Note: The title Obligations under Finance Leases is often used instead of Lease
Liability.

EWING INC.
December 31, 2011
Assets
Noncurrent assets:
Lease receivable ........................................................ $2,378,940*
Current assets:
Interest receivable ..................................................... 206,882
Lease receivable ........................................................ 207,089
*See balance on amortization schedule at 1/1/12.

PROBLEM 21-4
(a) 1. £23,768 Interest expense (See amortization schedule)
£ 5,500 Lease executory expense
£50,064 Depreciation expense (£300,383 ÷ 6 = £50,064)
2. Non-current liabilities:
£198,751 Lease liability
Current liabilities:
£ 38,932 Lease liability
£ 23,768 Interest payable
Property, plant, and equipment:
£300,383 Leased computer under finance lease
(£50,064) Accumulated depreciation
3. £19,875 Interest expense (See amortization schedule)
4. Non-current liabilities:
Current liabilities:
(b) 1. £ 5,942 Interest expense (£23,768 X 3/12 = £5,942)
£ 1,375 Lease executory expense (£5,500 X 3/12 = £1,375)
£12,516 Depreciation expense
(£300,383 ÷ 6 = £50,064;
(£50,064 X 3/12 = £12,516)

2. Current liabilities:
Non-current liabilities:
Current assets:
£ 4,125 Prepaid lease executory costs
(£5,500 X 9/12 = £4,125)
3. £22,795 Interest expense
[(£23,768 £5,942) + (£19,875 X 3/12) =
[£17,826 + £4,969 = £22,795]
4. Current liabilities:
£ 4,969 Interest payable (£19,875 X 3/12 = £4,969)
Non-current liabilities:
(£12,516 + £50,064 = £62,580)
Current assets:
£ 4,125 Prepaid lease executory costs
(£5,500 X 9/12 = £4,125)

PROBLEM 21-5
(a) 1. £23,768 Interest revenue
2. Non-current assets:
£198,751 Lease receivable
Current assets:
£ 62,700 Lease receivable £38,932
Interest receivable £23,768
3. £19,875 Interest revenue
Current assets:
(b) 1. £5,942 Interest revenue (£23,768 X 3/12 = £5,942)
Current assets:
3. £22,795 Interest revenue
[(£23,768 £5,942) + (£19,875 X 3/12) =
[£17,826 + £4,969 = £22,795]
Current assets:
Interest receivable £ 4,969

PROBLEM 21-6
Note: This lease is a capital lease to the lessee because the lease term
(six years) exceeds 75% of the remaining economic life of the asset (six years).
Also, the present value of the minimum lease payments exceeds 90% of the
fair value of the asset.
€ 124,798 Annual rental payment
€ 574,668* PV of periodic rental payments
€ 50,000 Guaranteed residual value
X .50663 PV of 1 for n = 6, i = 12%
€ 25,332 PV of guaranteed residual value
€ 574,668* PV of periodic rental payments
+ 25,332 PV of guaranteed residual value
€ 600,000 PV of minimum lease payments
(a) SHIGEKI COMPANY (Lessee)
Date
Annual
Lease
Payment
Plus GRV
Interest (12%)
on Liability
Reduction
of Lease
Liability
Lease
Liability
1/1/10 €600,000
1/1/10 €124,798 €124,798 475,202
1/1/11 124,798 *€ 57,024 67,774 407,428
1/1/12 124,798 48,891 75,907 331,521
1/1/13 124,798 39,783 85,015 246,506
1/1/14 124,798 29,581 95,217 151,289
1/1/15 124,798 18,155 106,643 44,646
12/31/15 50,000 * 5,354* 44,646 0
€798,788 €198,788 €600,000
*Rounding error is €1.
**Rounding error is €3.

(b) January 1, 2010
Leased Equipment Under Finance Leases .......... 600,000
Lease Liability ................................................. 600,000
Lease Liability........................................................ 124,798
Cash................................................................. 124,798
During 2010
Lease Executory Expense..................................... 5,000
Cash................................................................. 5,000
December 31, 2010
Interest Expense .................................................... 57,024
Interest Payable .............................................. 57,024
Depreciation Expense ........................................... 91,667
Leases ([€600,000 €50,000] ÷ 6)............... 91,667
January 1, 2011
Interest Payable ..................................................... 57,024
Interest Expense ............................................. 57,024
Lease Liability........................................................ 67,774
Cash................................................................. 124,798
During 2011
Lease Executory Expense..................................... 5,000
Cash................................................................. 5,000
December 31, 2011
Leases.......................................................... 91,667

(Note to instructor: The guaranteed residual value was subtracted for
purposes of determining the depreciable base. The reason is that at
the end of the lease term, hopefully, this balance can offset the remaining
lease liability balance. To depreciate the leased asset to zero might lead to
a large gain in the final years if the asset has a value at least equal to its
guaranteed amount.)

PROBLEM 21-7
(a) December 31, 2010
Lease Liability ................................................. 166,794
(To record leased asset and related
liability at the present value of
5 future annual payments of $40,000
discounted at 10%, $40,000 X 4.16986)
Lease Liability........................................................ 40,000
Cash................................................................. 40,000
(To record the first rental payment)
(b) December 31, 2011
Leases.......................................................... 23,828
(To record depreciation of the leased
asset based upon a cost to Ludwick of
$166,794 and a life of 7 years)
Lease Liability........................................................ 27,321
Cash................................................................. 40,000
(To record annual payment on lease
obligation of which $12,679 represents
interest at 10% on the unpaid principal
of $126,794)

LUDWICK STEEL COMPANY (Lessee)
(Annuity Due Basis)
Date
Annual
Lease
Payment
Interest (10%)
on Liability
Reduction
of Lease
Liability
Lease
Liability
12/31/10 $166,794
12/31/10 $40,000 $ 0 $40,000 126,794
12/31/11 40,000 12,679 27,321 99,473
12/31/12 40,000 9,947 30,053 69,420
12/31/13 40,000 6,942 33,058 36,362
12/31/14 40,000 3,638* 36,362 0
*Rounding error of $2
(c) December 31, 2012
Interest Expense........................................................ 9,947
Lease Liability............................................................ 30,053
Cash..................................................................... 40,000
(To record annual payment on lease
liability of which $9,947 represents
interest at 10% on the unpaid principal
of $99,473)
Depreciation Expense ............................................... 23,828
Leases ............................................................. 23,828
(To record annual depreciation on assets
leased)

(d) LUDWICK STEEL COMPANY
December 31, 2012
Property, plant, and equipment: Non-current liabilities:
Lease liability $36,362
Leased equipment
under finance leases $166,794 Current liabilities:
Less: Accumulated
depreciation 47,656 Lease liability 33,058
$119,138

PROBLEM 21-8
(a) The $550,000 is the present value of the five annual lease payments of
$137,899 less the $6,000 attributable to the payment for taxes, insurance,
and maintenance. In other words, it is the present value of five $131,899
payments to be made at the beginning of each year discounted at 10%,
(the implicit or incremental rates since the lessee knows the implicit
rate). The cost of taxes, insurance, and maintenance represents periodic
services to be performed in the future by the lessor and should not be
capitalized. The amount capitalized represents the completed service
element by the lessor company in that it has made the property
available; the taxes, insurance, and maintenance represent the
uncompleted, unrendered services of the lessor.
(b) Leased Equipment Under Finance Leases ........... 550,000
Lease Liability.................................................. 550,000
($131,899 X Annuity Due Factor for
5 years at 10% = $131,899 X 4.16986 =
$550,000)
Taxes, Insurance, and Maintenance Expense ...... 6,000
Lease Liability......................................................... 131,899
Cash.................................................................. 137,899
(c) Depreciation Expense ............................................ 220,000
Leases .......................................................... 220,000
($550,000 X 40% = $220,000)
(d) Interest Expense..................................................... 41,810
Interest Payable ............................................... 41,810
(See amortization schedule)
(e) Taxes, Insurance, and Maintenance Expense ...... 6,000
Interest Payable ...................................................... 41,810
Lease Liability......................................................... 90,089
Cash.................................................................. 137,899

CAGE COMPANY (Lessee)
Date
Annual
Lease
Payment
Interest (10%)
on Liability
Reduction
of Lease
Liability
Lease
Liability
1/1/11 $550,000
1/1/11 $131,899 $131,899 418,101
1/1/12 131,899 $41,810 90,089 328,012
1/1/13 131,899 32,801 99,098 228,914
(f) CAGE COMPANY
December 31, 2011
Assets Liabilities
Property, plant, and equipment: Non-current:
Leased property under
finance leases $550,000 Lease liability $328,012
Less: Accumulated
depreciation 220,000
Current:
Interest payable 41,810
$330,000 Lease liability 90,089*
*See Lease Amortization Schedule in part (e) above.

PROBLEM 21-9
Entries on August 1, 2011:
(1) Leased Equipment Under Finance Leases ...... 2,845,263
Lease Liability............................................. 2,845,263
Explanation and computation: This is a finance lease because the
lease term exceeds 75% of the asset s useful life.
The leased computer and the related liability are recorded at the
present value of the minimum lease payments, excluding the maintenance
charge, as follows: (€40,000 €3,000) X 76.899 = €2,845,263.
(2) Computer Maintenance Expense..................... 3,000
Lease Liability................................................... 37,000
Cash............................................................ 40,000
Explanation: This entry is to record the August 1, 2011, first payment
under the lease agreement. No interest is recognized on August 1
because the agreement began on that date. Cash payment includes
€3,000 of maintenance cost.
Entries on August 31, 2011:
(1) Interest Expense............................................... 28,083
Interest Payable ......................................... 28,083
Explanation and computation: Interest accrued on the unpaid balance
of the lease obligations from August 1 to August 31, 2011, is computed
as follows: (€2,845,263 €37,000) X .01 = €28,083.
(2) Depreciation Expense ...................................... 19,759
Leases .................................................... 19,759
Explanation and computation: Depreciation is recorded for one month of
the use of computer using the lease term: (€2,845,263 X 1/12 X 1/12 =
€19,759).

PROBLEM 21-10
(a) The lease is a sales-type lease because: (1) the lease term exceeds
75% of the asset s estimated economic life, and (2) Moonstruck Company
realized an element of profit aside from the financing charge.
1. Present value of an annuity due of $1 for
10 periods discounted at 10%.................................... 6.75902
Annual lease payment .................................................... X $ 40,000
Present value of the 10 rental payments....................... 270,361
Add present value of estimated residual
value of $20,000 in 10 years at 10%
($20,000 X .38554) ...................................................... 7,711
Lease receivable at inception ........................................ $278,072
2. Sales price is $270,361 (the present value of the 10 annual lease
payments); or, the initial PV of $278,072 minus the PV of the un-
guaranteed residual value of $7,711.
3. Cost of sales is $172,289 (the $180,000 cost of the asset less the
present value of the unguaranteed residual value).

(b) MOONSTRUCK COMPANY (Lessor)
Annuity Due Basis, Unguaranteed Residual Value
Beginning
of Year
Annual Lease
Payment Plus
Residual Value
Interest (10%)
on Lease
Receivable
Lease
Receivable
Recovery
Lease
Receivable
(a) (b) (c) (d)
Initial PV $278,072
1 $ 40,000 $ 40,000 238,072
2 40,000 *$ 23,807 16,193 221,879
3 40,000 22,188 17,812 204,067
4 40,000 20,407 19,593 184,474
5 40,000 18,447 21,553 162,921
6 40,000 16,292 23,708 139,213
7 40,000 13,921 26,079 113,134
8 40,000 11,313 28,687 84,447
9 40,000 8,445 31,555 52,892
10 40,000 5,289 34,711 18,181
End of 10 20,000 * 1,819* 18,181 0
$420,000 *$141,928 $278,072
*Rounding error is $1.00.
(a) Annual lease payment required by lease contract.
(b) Preceding balance of (d) X 10%, except beginning of first year of lease term.
(c) (a) minus (b).
(d) Preceding balance minus (c).
(c) Beginning of the Year
Cost of Goods Sold ................................................ 172,289
Sales ................................................................. 270,361
Computer Inventory......................................... 180,000
(To record the sale and the cost of goods
sold in the lease transaction)
Selling Expense ...................................................... 4,000
Cash.................................................................. 4,000
(To record payment of the initial direct
costs relating to the lease)

Cash........................................................................... 40,000
Lease Receivable ............................................... 40,000
(To record receipt of the first lease
payment)
End of the Year
Interest Receivable ................................................... 23,807
Interest Revenue ................................................ 23,807
(To record interest earned during the
first year of the lease)

PROBLEM 21-11
(a) The lease is a finance lease because: (1) the lease term exceeds 75%
of the asset s economic life and (2) the present value of the minimum
lease payments exceeds 90% of the fair value of the leased asset.
Initial Liability Under Finance Leases:
Minimum lease payments ($40,000) X PV of an
annuity due for 10 periods at 10% (6.75902)................ $270,361
(b) NATIONAL AIRLINES (Lessee)
(Annuity due basis and URV)
Beginning
of Year
Annual Lease
Payment
Interest (10%)
on Lease
Liability
Reduction
of Lease
Liability
Lease
Liability
(a) (b) (c) (d)
Initial PV $270,361
1 $ 40,000 $ 40,000 230,361
2 40,000 $ 23,036 16,964 213,397
3 40,000 21,340 18,660 194,737
4 40,000 19,474 20,526 174,211
5 40,000 17,421 22,579 151,632
6 40,000 15,163 24,837 126,795
7 40,000 12,680 27,320 99,475
8 40,000 9,948 30,052 69,423
9 40,000 6,942 33,058 36,365
10 40,000 3,635* 36,365 0
$400,000 $129,639 $270,361
*Rounding error is $1.
(c) (a) minus (b).

(c) Lessee s journal entries:
Beginning of the Year
Lease Liability ................................................. 270,361
(To record the lease of computer
equipment using finance lease method)
Lease Liability........................................................ 40,000
Cash................................................................. 40,000
(To record the first rental payment)
End of the Year
(To record accrual of annual interest on
lease liability)
Accumulated Depreciation Leased
Equipment ................................................... 27,036
(To record depreciation expense for
first year [$270,361 ÷ 10])

PROBLEM 21-12
(a) GRISHELL SHIPPING COMPANY
Schedule to Compute the Discounted Present Value
of Terminal Facilities and the Related Obligation
January 1, 2010
Present value of first 10 payments:
Immediate payment ...................................... £ 800,000
Present value of an ordinary annuity for
9 years at 6% (£800,000 X 6.801692)........ 5,441,354 £6,241,354
Present value of last 10 payments:
First payment of £320,000............................ 320,000
Present value of an ordinary annuity for
9 years at 6% (£320,000 X 6.801692)........ 2,176,541
Present value of last 10 payments at
January 1, 2020......................................... 2,496,541
Discount to January 1, 2010
(£2,496,541 X .558395) .............................. 1,394,056
Discounted present value of terminal
facilities and related obligation ............... £7,635,410
(Note to instructor: The student can compute the £6,241,354 by using
the present value of an annuity due for 10 periods at 6% (7.80169 X
£800,000 = £6,241,352; £2 rounding difference). For the last ten periods,
the present value of an annuity due for 20 periods less the present value
of an annuity due for 10 periods can be used as follows: ([12.15812
7.80169] X £320,000 = £1,394,058; £2 difference due to rounding.)
(b) (1) January 1, 2012
Interest Payable .................................................. 384,480
Lease Liability..................................................... 415,520
Property Taxes Expense .................................... 125,000
Property Insurance Expense ............................. 23,000
Cash.............................................................. 948,000

Partial Amortization Schedule
(Annuity Due Basis)
Date
Lease
Payment
Executory
Costs
Interest
(6%) on
Lease
Liability
Reduction
of Lease
Liability
Lease
Liability
1/1/10 £7,600,000
1/1/10 £948,000 £148,000 £ 0 £800,000 6,800,000
1/1/11 948,000 148,000 408,000 392,000 6,408,000
1/1/12 948,000 148,000 384,480 415,520 5,992,480
1/1/13 948,000 148,000 359,549 440,451 5,552,029
(2) December 31, 2012
Depreciation Expense Finance Leases.............. 190,000
Leased Assets............................................. 190,000
(To record annual depreciation expense
on leased assets) (£7,600,000 ÷ 40)
Note: The leased asset is depreciated over its economic life because a
bargain purchase is available at the end of the lease term.
(3) December 31, 2012
(To record interest accrual at 6% on
outstanding debt of £5,992,480)

PROBLEM 21-13
(a) The noncancelable lease is a sales-type lease because: (1) the lease
term is for a major part [83% (10 ÷ 12)] of the economic life of the leased
asset, (2) the present value of the minimum lease payments exceeds
90% of the fair value of the leased property, and (3) the lease provides
the lessor with manufacturer s profit in addition to interest revenue.
1. Lease Receivable:
Present value of annual payments of $60,000
made at the beginning of each period for 10 years,
$60,000 X 6.75902 (PV of an annuity due @ 10%)........ $405,541
Present value of guaranteed residual value,
$15,000 X .38554............................................................. 5,783
Present value of minimum lease payments ............. $411,324
2. Sales price is the same as the present value of
minimum lease payments ............................................. $411,324
3. Cost of sales is the cost of manufacturing the
x-ray machine................................................................. $250,000

(b) AMIRANTE INC. (Lessor)
(Annuity due basis, guaranteed residual value)
Beginning
of Year
Annual Lease
Payment Plus
Residual Value
Interest (10%)
on Lease
Receivable
Recovery
of Lease
Receivable
Lease
Receivable
(a) (b) (c) (d)
Initial PV $411,324
1 $ 60,000 $ 60,000 351,324
2 60,000 $ 35,132 24,868 326,456
3 60,000 32,646 27,354 299,102
4 60,000 29,910 30,090 269,012
5 60,000 26,901 33,099 235,913
6 60,000 23,591 36,409 199,504
7 60,000 19,950 40,050 159,454
8 60,000 15,945 44,055 115,399
9 60,000 11,540 48,460 66,939
10 60,000 6,694 53,306 13,633
End of 10 15,000 * 1,367* 13,633 0
$615,000 *$203,676 $411,324
*Rounding error is $4.00.
(c) (a) minus (b).
(c) Lessor s journal entries:
Cost of Goods Sold ............................................... 250,000
Sales ................................................................ 411,324
X-ray Machine Inventory................................. 250,000
Selling Expense ..................................................... 14,000
Cash or Payable .............................................. 14,000
(To record the incurrence of initial direct
costs relating to the lease)

Cash............................................................................ 60,000
Lease Receivable................................................ 60,000
(To record receipt of the first lease
payment)
End of the Year
Interest Receivable.................................................... 35,132
Interest Revenue................................................. 35,132
(To record interest earned during the first
year of the lease)

PROBLEM 21-14
(a) The noncancelable lease is a finance lease because: (1) the lease term is
for a major part [83% (10 ÷ 12)] of the economic life of the leased asset
and (2) the present value of the minimum lease payments exceeds 90%
of the fair value of the leased asset.
Initial Liability Under Finance Lease:
PV of lease payments, $60,000 X 6.75902 ....................... $405,541
PV of guaranteed residual value, $15,000 X .38554 ........ 5,783
Initial liability under finance lease ................................... $411,324
(b) CHAMBERS MEDICAL (Lessee)
(Annuity Due Basis, GRV)
Beginning
of Year
Annual Lease
Payment Plus
GRV
Interest (10%)
on Unpaid
Liability
Reduction
of Lease
Liability
Lease
Liability
(a) (b) (c) (d)
Initial PV $411,324
1 $ 60,000 $ 60,000 351,324
2 60,000 $ 35,132 24,868 326,456
3 60,000 32,646 27,354 299,102
4 60,000 29,910 30,090 269,012
5 60,000 26,901 33,099 235,913
6 60,000 23,591 36,409 199,504
7 60,000 19,950 40,050 159,454
8 60,000 15,945 44,055 115,399
9 60,000 11,540 48,460 66,939
10 60,000 6,694 53,306 13,633
End of 10 15,000 * 1,367* 13,633 0
$615,000 *$203,676 $411,324
*Rounding error is $4.
(c) (a) minus (b).

(c) Lessee s journal entries:
Leased Equipment Under Finance Leases ........... 411,324
Lease Liability.................................................. 411,324
(To record the lease of x-ray equipment
using finance lease method)
Lease Liability......................................................... 60,000
Cash.................................................................. 60,000
(To record payment of annual lease
liability)
End of the Year
Interest Expense..................................................... 35,132
Interest Payable ............................................... 35,132
(To record accrual of annual interest on
lease liability)
Depreciation Expense ............................................ 39,632
Accumulated Depreciation Leased
Assets........................................................... 39,632
(To record depreciation expense for
year 1 using straight-line method
[($411,324 $15,000) ÷ 10 years])

PROBLEM 21-15
Memorandum Prepared by: (Your Initials)
Date:
HOCKNEY, INC.
December 31, 2011
Reclassification of Leased Auto
As a Finance Lease
While performing a routine inspection of the client s garage, I found a 2010
Shirk automobile which was not listed among the company s assets in the
equipment subsidiary ledger. I asked Stacy Reeder, plant manager, about
the vehicle, and she indicated that because the Shirk was only being leased,
it was not listed along with other company assets. Having accounted for
this agreement as an operating lease, Hockney, Inc. had charged $3,240 to
2011 rent expense.
Examining the noncancelable lease agreement entered into with Crown New
and Used Cars on January 1, 2011, I determined that the Shirk should be
capitalized because its lease term (4 years) is greater than 75% of its useful
life (5 years).
I advised the client to capitalize this lease at the present value of its minimum
lease payments: $10,731 (the present value of the monthly payments), plus
$809 (the present value of the guaranteed residual). The following journal
entry was suggested:
Leased Asset Under Finance Leases ........................... 11,540
Lease Liability ($10,731 + $809) ............................. 11,540
To account for the first year s payments as well as to reverse the original
entries, I advised the client to make the following entry:
Lease Liability................................................................ 2,317
Interest Expense (8% X $11,540)................................... 923
Rent Expense .......................................................... 3,240

Finally, this Shirk must be depreciated over its lease term. Using straight-
line, I computed annual depreciation of $2,610 (the capitalized amount,
$11,540, minus the guaranteed residual, $1,100, divided by the 4 year lease
term). The client was advised to make the following entry to record 2011
depreciation:
Accumulated Depreciation..................................... 2,610

PROBLEM 21-16
(a) The lease agreement satisfies both the economic life (75% of useful
life) and the recovery of investment (90% of fair value) requirements.
For the lessee, it is a finance lease, and for the lessor, it is a direct-
financing lease (since cost equals fair value).
(b) January 1, 2011
Lessee:
Lease Liability ................................................. 220,404
(€30,300 X 6.99525= €211,956)
(€20,000 X .42241= 8,448)
= €220,404)
Lease Liability........................................................ 30,300
Cash................................................................. 30,300
January 1, 2011
Lessor:
Equipment ....................................................... 220,404
Cash........................................................................ 30,300
Lease Receivable ............................................ 30,300
December 31, 2011
Lessee:
Interest Payable
[(€220,404 €30,300) X .09]......................... 17,109
[(€220,404 €20,000) ÷ 10] .......................... 20,040

December 31, 2011
Lessor:
Interest Receivable.................................................... 17,109
Interest Revenue................................................. 17,109
(c) (1) and (2) are both €211,956, as the lessee has no obligation to pay the
residual value.
(d) (1) and (2) are both €220,404, as residual value exists whether or not it
is guaranteed.
(e) Since 90% of €220,404 is €198,364, the difference of €22,040 is the
present value of the residual value. The future value of €22,040 for n = 10,
i = .09 is €52,177 (€22,040 X 2.36736). Therefore, the residual value would
have had to be greater than €52,177.

TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 21-1 (Time 15 25 minutes)
Purpose to provide the student with an understanding of the theoretical reasons for requiring certain
leases to be capitalized by the lessee and how a finance lease is recorded at its inception and how the
amount to be recorded is determined. The student explains how to determine the lessee s expenses
during the first year and how the lessee will report the lease on the statement of financial position at the
end of the first year.
Purpose to provide an understanding of the factors underlying the accounting for a leasing arrangement
from the point of view of both the lessee and lessor. The student is required to determine the classifica-
tion of this leasing arrangement, the appropriate accounting treatment which should be accorded this
lease, and the financial statement disclosure requirements for both the lessee and lessor.
Purpose to provide the student with an understanding of the classification of three leases. The student
determines how the lessee should classify each lease, what amount should be recorded as a liability at
the inception of each lease, and how the lessee should record each minimum lease payment for each
lease.
Purpose to provide the student with an assignment to describe: (a) the accounting for a finance lease
both at inception and during the first year and (b) the accounting for an operating lease. The student is
also required to compare and contrast a sales-type lease with a direct-financing lease.
Purpose to provide the student with a lease situation containing a bargain purchase option and both
an implicit rate and a stated interest rate between which the student must choose. The student is
required to compute the appropriate amount at which to capitalize the lease and, in a second requirement,
given different interest rates, to prepare the statement of financial position and income statement
presentation of this lease by the lessee.
Purpose to provide the student with a lease arrangement with a bargain-purchase option in order to
examine the ethical issues of lease accounting.
*CA 21-7 (Time 15 25 minutes)
Purpose to provide the student with an assignment to discuss the theoretical justification for lease
capitalization. In addition, the student is required to discuss the accounting issues related to a sale-
leaseback.
*CA 21-8 (Time 20 25 minutes)
Purpose to provide the student with a sale-leaseback situation to which lease capitalization criteria
need to be applied, as well as disclosures discussed and the sale accounted for.

SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 21-1
(a) When a lease transfers substantially all of the benefits and risks incident to the ownership of
property to the lessee, it should be capitalized by the lessee. The economic effect of such a lease
on the lessee is similar, in many respects, to that of an installment purchase.
(b) Evans should account for this lease at its inception as an asset and a liability at an amount equal
to the present value at the beginning of the lease term of minimum lease payments during the
lease term, excluding that portion of the payments representing executory costs, together with
any profit thereon. However, if the amount so determined exceeds the fair value of the leased
machine at the inception of the lease, the amount recorded as the asset and liability should be
the machine s fair value.
(c) Evans will incur interest expense equal to the interest rate used to capitalize the lease at its
inception multiplied by the appropriate net carrying value of the liability at the beginning of the
period.
In addition, Evans will incur an expense relating to depreciation of the capitalized cost of the
leased asset. This depreciation should be based on the estimated useful life of the leased asset
and depreciated in a manner consistent with Evans normal depreciation policy for owned assets.
(d) The asset recorded under the finance lease and the accumulated depreciation should be classified
on Evans December 31, 2011, statement of financial position as non-current and should be
separately identified by Evans in its statement of financial position or notes thereto. The related
liability recorded under the finance lease should be reported on Evans December 31, 2011,
statement of financial position appropriately classified into current and non-current liabilities
categories and should be separately identified by Evans in its statement of financial position.
CA 21-2
(a) 1. Because the present value of the minimum lease payments is greater than 90 percent of
the fair value of the asset at the inception of the lease, Sylvan should record this as a
finance lease.
2. Since the given facts state that Sylvan (lessee) does not have access to information that
would enable determination of Breton Leasing Corporation s (lessor) implicit rate for this
lease, Sylvan should determine the present value of the minimum lease payments using
the incremental borrowing rate (10 percent). This is the rate that Sylvan would have to pay
for a like amount of debt obtained through normal third party sources (bank or other direct
financing).
3. The amount recorded as an asset on Sylvan s books should be shown in the fixed assets
section of the statement of financial position as Leased Equipment Under Finance Leases
or another similar title. Of course, at the same time as the asset is recorded, a corresponding
liability ( Lease Liability or similar titles) is recognized in the same amount. This liability is
classified as both current and non-current, with the current portion being that amount that
will be paid on the principal amount during the next year. The cost of the lease is recorded
in the same period as revenue through depreciation taken on the machine over the life of
the lease. Since ownership of the machine is not expressly conveyed to Sylvan in the terms
of the lease at its inception, the term of the lease is the appropriate depreciable life. The
minimum lease payments represent a payment of principal and interest at each payment
date. Interest expense is computed at the rate at which the minimum lease payments were
discounted and

CA 21-2 (Continued)
represents a fixed interest rate applied to the declining balance of the debt. Executory costs
(such as insurance, maintenance, or taxes) paid by Sylvan are charged to an appropriate
expense, accrual, or deferral account as incurred or paid.
4. For this lease, Sylvan must disclose the future minimum lease payments in the aggregate
and for the next year, years 2 5, and thereafter, with a separate deduction for the total
amount for imputed interest necessary to reduce the net minimum lease payments to the
present value of the liability (as shown on the statement of financial position).
(b) 1. Based on the given facts, Breton has entered into a direct-financing lease. There is no
dealer or manufacturer profit included in the transaction, and the discounted present value
of the minimum lease payments is in excess of 90 percent of the fair value of the asset at
the inception of the lease arrangement.
2. Breton should record a Lease Receivable for the present value of the minimum lease
payments and the present value of the residual value. It should also remove the machine
from the books by a credit to the applicable asset account.
3. During the life of the lease, Breton will record payments received as a reduction in the
receivable. Interest is recognized as interest revenue earned by applying the implicit
interest rate to the declining balance of the lease receivable. The implicit rate is the rate of
interest that will discount the sum of the payments and unguaranteed residual value to the
fair value of the machine at the date of the lease agreement. This method of earnings
recognition is termed the effective-interest method of amortization. In this case, Breton will
use the 9% implicit rate.
4. Breton must make the following disclosures with respect to this lease:
(a) The components of the lease receivable in direct-financing leases, which are (1) the
future minimum lease payments to be received, (2) any unguaranteed residual values
accruing to the benefit of the lessor, and (3) the amounts of unearned interest revenue.
(b) Future minimum lease payments to be received for the next year, years 2 5, and
thereafter as of the date of the latest statement of financial position presented.
CA 21-3
(a) A lease should be classified as a finance lease when it transfers substantially all of the benefits
and risks inherent to the ownership of property by meeting any one of the four criteria established
by IFRS for classifying a lease as a finance lease.
Lease L should be classified as a finance lease because the lease term is equal to 85 percent of
the estimated economic life of the equipment, which exceeds the 75 percent or more criterion.
Lease M should be classified as a finance lease because the lease contains a bargain-purchase
option.
Lease N should be classified as an operating lease because it does not meet any of the four criteria
for classifying a lease as a finance lease.

CA 21-3 (Continued)
(b) For Lease L, Santiago Company should record as a liability at the inception of the lease an
amount equal to the present value at the beginning of the lease term of the minimum lease
payments during the lease term. This amount excludes that portion of the payments representing
executory costs such as insurance, maintenance, and taxes to be paid by the lessor, including
any profit thereon. However, if the amount so determined exceeds the fair value of the equipment
at the inception of the lease, the amount recorded as a liability should be the fair value.
For Lease M, Santiago Company should record as a liability at the inception of the lease an
amount determined in the same manner as for Lease L, and the payment called for in the
bargain-purchase option should be included in the minimum lease payments at its present value.
For Lease N, Santiago Company should not record a liability at the inception of the lease.
(c) For Lease L, Santiago Company should allocate each minimum lease payment between a reduc-
tion of the liability and interest expense so as to produce a constant periodic rate of interest on
the remaining balance of the liability.
For Lease M, Santiago Company should allocate each minimum lease payment in the same
manner as for Lease L.
For Lease N, Santiago Company should charge minimum lease (rental) payments to rental expense
as they become payable.
CA 21-4
Part 1
(a) A lessee would account for a finance lease as an asset and a liability at the inception of the
lease. Rental payments during the year would be allocated between a reduction in the liability
and interest expense. The asset would be amortized in a manner consistent with the lessee s
normal depreciation policy for owned assets, except that in some circumstances, the period of
amortization would be the lease term.
(b) No asset or liability would be recorded at the inception of the lease. Normally, rental on an oper-
ating lease would be charged to expense over the lease term as it becomes payable.
Part 2
(a) The lease receivable in the lease is the same for both a sales-type and a direct-financing lease.
The lease receivable is the present value of the minimum lease payments (net of amounts, if any,
included therein for executory costs such as maintenance, taxes, and insurance to be paid by the
lessor, together with any profit thereon) plus the present value of the unguaranteed residual value
accruing to the benefit of the lessor.
(b) For both a sales-type lease and a direct-financing lease, the interest revenue is recognized over
the lease term by use of the interest method to produce a constant periodic rate of return on the
lease receivable. However, other methods of income recognition may be used if the results
obtained are not materially different from the interest method.

CA 21-4 (Continued)
(c) In a sales-type lease, the excess of the sales price over the carrying amount of the leased
equipment is considered manufacturer s or dealer s profit and would be included in income in the
period when the lease transaction is recorded.
In a direct-financing lease, there is no manufacturer s or dealer s profit. The income on the lease
transaction is composed solely of interest.
CA 21-5
(a) The appropriate amount for the leased aircraft on Albertsen Corporation s statement of financial
position after the lease is signed is £1,000,000, the fair value of the plane. In this case, fair value
is less than the present value of the net rental payments plus purchase option (£1,022,226).
When this occurs, the asset is recorded at the fair value.
(b) The leased aircraft will be reflected on Albertsen Corporation s statement of financial position as
follows:
Non-current assets
Leased property under finance leases .................................................. £1,000,000
Less: Accumulated depreciation............................................................ 61,667
£ 938,333
Non-current liabilities
Lease liability (Note A) .......................................................................... £ 802,040
Current liabilities
Lease liability
Interest payable .................................................................................... £ 77,600
Lease liability (Note A) .......................................................................... 60,180
£ 137,780
The following items relating to the leased aircraft will be reflected on Albertsen Corporation s income
statement:
Depreciation expense (Note A) ............................................................. £61,667
Interest expense ................................................................................... 77,600
Maintenance expense........................................................................... 6,900
Insurance and tax expense ................................................................... 4,000
Note A
The company leases a Viking turboprop aircraft under a finance lease. The lease runs until
December 31, 2020. The annual lease payment is paid in advance on January 1 and amounts to
£141,780, of which £4,000 is for insurance and property taxes. The aircraft is being depreciated on
the straight-line basis over the economic life of the asset. The depreciation on the aircraft included
in the current year s depreciation expense and the accumulated depreciation on the aircraft
amount to £61,667.

CA 21-5 (Continued)
Computations
Depreciation expense:
Capitalized amount................................................................................ £1,000,000
Less: Salvage value.............................................................................. 75,000
£ 925,000
Economic life ......................................................................................... 15 years
Annual depreciation............................................................................... £61,667
Liability amounts:
Lease liability 1/1/11 .............................................................................. £1,000,000
Less: Payment 1/1/11........................................................................... 137,780
Lease liability 12/31/11 .......................................................................... 862,220
Less: Lease payment due 1/1/12.......................................................... 137,780
Add: Interest on lease (£862,220 X .09)............................................... 77,600
Noncurrent liability 12/31/11 .................................................................. £ 802,040
CA 21-6
(a) The ethical issues are fairness and integrity of financial reporting versus profits and possibly
misleading financial statements. On one hand, if Buchanan can substantiate her position, it is
possible that the agreement should be considered an operating lease. On the other hand, if
Buchanan cannot or will not provide substantiation, she would appear to be trying to manipulate
the financial statements for some reason, possibly debt covenants or minimum levels of certain
ratios.
(b) If Buchanan has no particular expertise in copier technology, she has no rational case for her
suggestion. If she has expertise, then her suggestion may be rational and would not be merely a
means to manipulate the statement of financial position to avoid recording a liability.
(c) Suffolk must decide whether the situation presents a legitimate difference of opinion where pro-
fessional judgment could take the answer either way or an attempt by Buchanan to mislead.
Suffolk must decide whether he wishes to argue with Buchanan or simply accept Buchanan s
position. Suffolk should assess the consequences of both alternatives. Suffolk might conduct
further research regarding copier technology before reaching a decision.
*CA 21-7
(a) The economic effect of a long-term finance lease on the lessee is similar to that of an installment
purchase. Such a lease transfers substantially all of the benefits and risks incident to the ownership
of property to the lessee. Therefore, the lease should be capitalized.
(b) 1. Perriman should account for the sale portion of the sale-leaseback transaction at January 1,
2011, by recording cash for the sale price, decreasing equipment at the undepreciated cost (net
carrying amount) of the equipment, and establishing a deferred gain on sale-leaseback for
the excess of the sale price of the equipment over its undepreciated cost (net carrying
amount).

*CA 21-7 (Continued)
2. Perriman should account for the leaseback portion of the sale-leaseback transaction at
January 1, 2011, by recording both an asset and a liability at an amount equal to the
present value at the beginning of the lease term of minimum lease payments during the
lease term, excluding any portion of the payments representing executory costs, together
with any profit. However, if the present value exceeds the fair value of the leased equipment
at January 1, 2011, the amount recorded for the asset and liability should be the equipment s
fair value.
(c) The deferred gain should be amortized over the lease term or life of the asset, whichever is
appropriate. During the first year of the lease, the amortization will be an amount proportionate to
the amortization of the asset. This deferral and amortization method for a sale-leaseback transac-
tion is required because the sale and the leaseback are two components of a single transaction
rather than two independent transactions. Because of this interdependence of the sale and
leaseback portions of the transaction, the gain (unearned profit) should be deferred and amortized
over the lease term.
*CA 21-8
(a) 1. Comparisons of an equipment s fair value to its lease payments present value, and of its
useful life to the lease term, are used to determine whether the lease is equivalent to an
installment sale and is therefore a finance lease.
2. A lease is categorized as a finance lease if, at the date of the lease agreement, it meets any
one of four criteria. As the lease has no provision for Shellhammer to reacquire ownership
of the equipment, it fails the two criteria of transfer of ownership at the end of the lease and
a bargain purchase option. Shellhammer s lease payments, with a present value equaling
80% of the equipment s fair value, fail the criterion for a present value equaling or
exceeding substantially all (90%) of the equipment s fair value. However, the lease would
be classified as a finance lease because its term of 85% of the equipment s estimated
useful life exceeds the criterion of being the major part (at least 75%) of the equipment s
estimated useful life.
(b) Shellhammer should account for the sale portion of the sale-leaseback transaction at December
31, 2010, by increasing cash for the sale price, decreasing equipment by the carrying amount,
and recognizing a loss for the excess of the equipment s carrying amount over its sale price.
(c) On the December 31, 2011, statement of financial position, the equipment should be included as
a plant asset at the lease payments present value at December 31, 2010, less 2011 depreciation.
On the December 31, 2011, statement of financial position, the lease liability will equal the lease
payments present value at December 31, 2010, less principal repaid December 31, 2011. This
amount will be reported in current liabilities for the principal to be repaid in 2012, and the balance
in non-current liabilities.

FINANCIAL REPORTING PROBLEM
(a) M&S uses both finance leases and operating leases.
(b) M&S reported finance leases of £83.5 million in total, and £11.6 million
for less than 1 year.
(c) M&S disclosed future minimum rentals (in millions) under non-cancelable
operating lease agreements as of 29 March 2008, of:
Not later than one year .................................... £ 17.9
Later than one year and
not later than five years................................ 90.4
Later than five years and
not later than 25 years.................................. 2,223.6
Later than 25 years .......................................... 1,492.4
Total.................................................................. £3,824.3

COMPARATIVE ANALYSIS CASE
(a) Air France uses both finance leases and operating leases on its
aircraft, buildings, and other property, plant, and equipment.
(b) Some of Air France s leases are longer than five years. Some character-
istics of the leases are the assets held under a finance lease are recog-
nized as assets at the lower of the following two values: the present
value of the minimum lease payments under the lease arrangement or
their fair value determined at inception of the lease. The corresponding
obligation to the lessor is accounted for as long-term debt. These assets
are depreciated over the shorter of the useful life of the assets and the
lease term when there is no reasonable certainty that the lessee will
obtain ownership by the end of the lease term.
(c) Future minimum commitments under non-cancelable leases are set forth
below (in millions):
Finance Operating
One year ............................................ € 669 € 992
Two years .......................................... 634 904
Three years........................................ 644 733
Four years ......................................... 412 665
Five years .......................................... 469 589
Over 5 years ...................................... 1,967 1,501
€4,795 €5,384
(d) At year-end 2009, the present value of minimum lease payments under
capital leases was €3,893 million. Imputed interest deducted from the
future minimum annual rental commitments was €902 million.
(e) The details of rental expense (in millions) are set forth below:
2009 2008
€646 €611

COMPARATIVE ANALYSIS CASE (Continued)
(f) British Airways uses leases for its aircraft fleet and property and
equipment, while Air France uses leases for its aircraft, buildings, and
other property, plant, and equipment. Both companies have leases that
extend beyond five years, while some of British Airways leases extend
up to 150 years. Air France did not give a definite length for the leases
that extend beyond five years. In general, the two companies rely on
both finance and operating leases for its aircrafts and they have lease
commitments for more than five years into the future.

FINANCIAL STATEMENT ANALYSIS CASE
(a) The total obligations under finance leases at year-end 2008 for Delhaize is
€1,687,000 (the present value of the future lease payments).
(b) The total rental expense for Delhaize in 2008 was €245,000,000.
(c) To estimate the present value of the operating leases, the same portion
of interest to net minimum lease payments under finance leases must
be determined. For example, the following proportion for capital leases
as of December 31, 2008, is 53.5% or (€790,000/€1,477,000). The total
payments under operating leases are €2,185,000 and, therefore, the
amount representing interest might be estimated to be €1,168,975 or
(€2,185,000 X 53.5%). Thus, the present value of the net operating
payments might be €1,016,025.
Total operating lease payments due ................................ €2,185,000
Less estimated interest ..................................................... 1,168,975
Estimated present value of net operating
lease payments .............................................................. €1,016,025
This answer is an approximation. This answer is somewhat incorrect
because the proportion of payments after five years may be different
between an operating and finance lease arrangement. Another approach
would be to discount the future operating lease payments. However,
from the information provided, it is difficult to determine exactly what
the payment schedules are beyond five years, although it is likely that
the operating leases have shorter payment schedules and therefore
higher present values. In addition, selecting the appropriate discount
rate requires judgment. Some companies provide the present value of
the operating leases in order to curb speculation as to what this amount
should be.

ACCOUNTING, ANALYSIS, AND PRINCIPLES
ACCOUNTING
There are four lease capitalization criteria. They are (1) transfer of title,
(2) bargain-purchase option, (3) lease term is a major part (75% or more) of
the economic life of the leased asset, and (4) the present value of the
minimum lease payments is substantially all (90% or more) of the leased
asset s fair value.
This lease does not transfer title. The option to purchase at the end of the
lease is clearly not a bargain. The lease term is (3 ÷ 5) = 0.6 or 60% of the
economic life, so the economic life test is not met. The recovery of
investment test is as follows:
Minimum lease payments
= rental payments executory costs
= $3,557.25 $500 = $3,057.25.
Present value of min. lease payments
= $3,057.25 X (PVF-AD3,12)
= ($3,057.25 X 2.69005)
= $8,224.16.
Present value of min. lease payments as % of fair value
= $8,224.16 ÷ $10,000 = 0.8224 or 82.24 percent.
Therefore, the recovery of investment test is not met either. Therefore, this
lease is accounted for as an operating lease. Therefore the journal entry
that Salaur makes on January 1, 2011 is:
Rent Expense........................................................... 3,557.25
Cash................................................................... 3,557.25

ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued)
ANALYSIS
When companies structure leases to avoid capitalization, both the leased
asset and the liability for the noncancelable lease payments are off-
balance-sheet. As a result, the denominator of the return on assets ratio
(ROA = Net income ÷ Average assets) will be understated, and a company
will look more profitable than it really is. The debt to total assets ratio (Total
debt ÷ Total assets) will be understated, thereby giving the impression that
the company is more solvent than is really the case. If companies capitalize
differing percentages of their leases, it will be difficult to compare the
companies based on ROAs and debt to total asset ratios.
PRINCIPLES
The fundamental quality of faithful representation is being addressed in
this case. The lease criteria are designed to report leases according to their
economic substance. Thus, if through a lease arrangement a company
controls the risks and rewards of the leased asset, it meets the definition of
an asset and should be recognized on the statement of financial position.
Similarly, the associated liability should be recognized if it represents an
unavoidable obligation and thereby meets the definition of a liability. That is,
the financial statements faithfully represent if they report all assets and
liabilities of the company. Of course, structuring a lease to avoid capitaliza-
tion detracts from representational faithful reporting of the lease arrangement.

PROFESSIONAL RESEARCH
(a) According to IAS 17, paragraph 7, The classification of leases
adopted in this Standard is based on the extent to which risks and
rewards incidental to ownership of a leased asset lie with the lessor or
the lessee. Risks include the possibilities of losses from idle capacity
or technological obsolescence and of variations in return because of
changing economic conditions. Rewards may be represented by the
expectation of profitable operation over the asset s economic life and
of gain from appreciation in value or realisation of a residual value.
Also, paragraph 8 states A lease is classified as a finance lease if it
transfers substantially all the risks and rewards incidental to ownership.
A lease is classified as an operating lease if it does not transfer
substantially all the risks and rewards incidental to ownership.
(b) IAS 17 does not define substantially all.
(c) IAS 17 does not name other considerations in determining lease term,
but paragraph 4 defines lease term as the non-cancellable period
for which the lessee has contracted to lease the asset together with any
further terms for which the lessee has the option to continue to lease
the asset, with or without further payment, when at the inception of the
lease it is reasonably certain that the lessee will exercise the option.

PROFESSIONAL SIMULATION 1
Resources
Note: This lease is a finance lease to the lessee because the lease term
(six years) exceeds the major part (75%) of the economic life of the asset (six
years). Also, the present value of the minimum lease payments exceeds
substantially all (90%) of the fair value of the asset.
$ 81,365 Annual rental payment
$ 374,668 PV of periodic rental payments
$ 50,000 Guaranteed residual value
X .50663 PV of 1 for n = 6, i = 12%
$ 25,332 PV of guaranteed residual value
$ 374,668 PV of periodic rental payments
+ 25,332 PV of guaranteed residual value
$ 400,000 PV of minimum lease payments

PROFESSIONAL SIMULATION 1 (Continued)
Journal Entries
January 1, 2010
Leased Equipment Under Finance Leases................... 400,000
Lease Liability......................................................... 400,000
Lease Liability ................................................................ 81,365
Cash......................................................................... 81,365
During 2010
Lease Executory Expense ............................................. 4,000
Cash......................................................................... 4,000
December 31, 2010
Interest Expense ............................................................ 38,236
Leases ([$400,000 $50,000] ÷ 6) ...................... 58,333
January 1, 2011
Interest Payable.............................................................. 38,236
Interest Expense..................................................... 38,236
Lease liability.................................................................. 43,129
Cash......................................................................... 81,365
During 2011
Lease Executory Expense ............................................. 4,000
Cash......................................................................... 4,000
December 31, 2011
Leases ................................................................. 58,333

PROFESSIONAL SIMULATION 1 (Continued)
(Note to instructor: The guaranteed residual value was subtracted for
purposes of determining the depreciable base. The reason is that at the
end of the lease term, this balance will offset the remaining lease obligation
balance. To depreciate the leased asset to zero might lead to a large gain in
the final years if the residual value has a value at least equal to its
guaranteed amount.)

PROFESSIONAL SIMULATION 2
Explanation
This is a finance lease to Dexter Labs since the lease term (5 years) is greater
than 75% of the economic life (6 years) of the leased asset. The lease term
is a major part [831
/3% (5 ÷ 6)] of the asset s economic life.
Measurement
Computation of present value of minimum lease payments:
$8,668 X 4.16986* = $36,144
Journal Entries
1/1/10 Leased Machine Under Finance Leases....... 36,144
Lease Liability......................................... 36,144
Lease Liability ................................................ 8,668
Cash......................................................... 8,668
12/31/10 Depreciation Expense.................................... 7,229
Finance Leases................................... 7,229
($36,144 ÷ 5 = $7,229)
Interest Expense ............................................ 2,748
Interest Payable
[($36,144 $8,668) X .10].................... 2,748
1/1/11 Lease Liability ................................................ 5,920
Interest Payable ............................................. 2,748
Cash......................................................... 8,668

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