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21-1
CHAPTER
21
Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield
Chapter
21-2
Learning
Learning Objectives
Objectives
1.
2.
3.
4.
5.
6.
7.
8.
9.
Chapter
21-3
Accounting
Accounting for
for Leases
Leases
Leasing
Environment
Accounting by
Lessee
Accounting by
Lessor
Who are
players?
Advantages of
leasing
Conceptual
nature of a lease
Capitalization
criteria
Accounting
differences
Capital lease
method
Operating
method
Comparison
Economics of
leasing
Classification
Direct-financing
method
Operating
method
Special
Accounting
Problems
Residual values
Sales-type
leases
Bargainpurchase option
Initial direct costs
Current versus
noncurrent
Disclosure
Unresolved
problems
Chapter
21-4
The
The Leasing
Leasing Environment
Environment
A lease is a contractual agreement between a lessor
and a lessee, that gives the lessee the right to use
specific property, owned by the lessor, for a
specified period of time.
Largest group of leased equipment involves:
Information technology
Transportation (trucks, aircraft, rail)
Construction
Agriculture
Chapter
21-5
The
The Leasing
Leasing Environment
Environment
Who Are the Players?
Three general categories:
Banks.
Captive leasing companies.
Independents.
Chapter
21-6
The
The Leasing
Leasing Environment
Environment
Advantages of Leasing
1. 100% Financing at Fixed Rates.
2. Protection Against Obsolescence.
3. Flexibility.
4. Less Costly Financing.
5. Tax Advantages.
6. Off-Balance-Sheet Financing.
Chapter
21-7
The
The Leasing
Leasing Environment
Environment
Conceptual Nature of a Lease
Capitalize a lease that transfers substantially all
of the benefits and risks of property ownership,
provided the lease is noncancelable.
Leases that do not transfer
substantially all the benefits
and risks of ownership
are operating leases.
Chapter
21-8
The
The Leasing
Leasing Environment
Environment
The issue of how to report leases is the case of substance versus
form. Although technically legal title may not pass, the benefits
from the use of the property do.
Operating Lease
Journal Entry:
Rent expense
Cash
xxx
xxx
Capital Lease
Journal Entry:
Leased equipment
Lease liability
xxx
xxx
Chapter
21-9
Accounting
Accounting by
by the
the Lessee
Lessee
If the lessee capitalizes a lease, the lessee records
an asset and a liability generally equal to the present
value of the rental payments.
Records depreciation on the leased asset.
Treats the lease payments as consisting of interest and
principal.
Typical Journal Entries for Capitalized Lease
Chapter
21-10
Illustration 21-2
Accounting
Accounting by
by the
the Lessee
Lessee
To record a lease as a capital lease, the lease must be
noncancelable.
One or more of four criteria must be met:
1.
Chapter
21-11
Accounting
Accounting by
by the
the Lessee
Lessee
Lease Agreement
Chapter
21-12
Accounting
Accounting by
by the
the Lessee
Lessee
Capitalization Criteria
Transfer of Ownership Test
Not controversial and easily implemented.
Accounting
Accounting by
by the
the Lessee
Lessee
Capitalization Criteria
Economic Life Test (75% Test)
Lease term is generally considered to be the fixed,
noncancelable term of the lease.
Bargain-renewal option can extend this period.
At the inception of the lease, the difference
between the renewal rental and the expected fair
rental must be great enough to make exercise of
the option to renew reasonably assured.
Chapter
21-14
Accounting
Accounting by
by the
the Lessee
Lessee
Capitalization Criteria
Recovery of Investment Test (90% Test)
Minimum Lease Payments:
Executory Costs:
Chapter
21-15
Insurance
Maintenance
Taxes
Exclude from PV of
Minimum Lease
Payment
Calculation
LO 2
Accounting
Accounting by
by the
the Lessee
Lessee
Capitalization Criteria
Recovery of Investment Test (90% Test)
Discount Rate
Lessee computes the present value of the minimum
lease payments using its incremental borrowing rate,
with one exception.
If the lessee knows the implicit interest rate
LO 2
Accounting
Accounting by
by the
the Lessee
Lessee
Asset and Liability Accounted for Differently
Asset and Liability Recorded at the lower of:
1. present value of the minimum lease payments
(excluding executory costs) or
2. fair-market value of the leased asset.
Chapter
21-17
Accounting
Accounting by
by the
the Lessee
Lessee
Asset and Liability Accounted for Differently
Depreciation Period
If lease transfers ownership, depreciate asset
over the economic life of the asset.
If lease does not transfer ownership,
depreciate over the term of the lease.
Chapter
21-18
Accounting
Accounting by
by the
the Lessee
Lessee
Asset and Liability Accounted for Differently
Effective-Interest Method
The effective-interest method is used to
allocate each lease payment between principal
and interest.
Depreciation Concept
Depreciation and the discharge of the obligation
are independent accounting processes.
Chapter
21-19
Accounting
Accounting by
by the
the Lessee
Lessee
E21-1 (Capital Lease with Unguaranteed Residual Value): On
January 1, 2011, Adams Corporation signed a 5-year noncancelable
lease for a machine. The terms of the lease called for Adams to
make annual payments of $9,968 at the beginning of each year,
starting January 1, 2011. The machine has an estimated useful life
of 6 years and a $5,000 unguaranteed residual value. Adams uses
the straight-line method of depreciation for all of its plant assets.
Adamss incremental borrowing rate is 10%, and the Lessors
implicit rate is unknown.
Instructions
(a) What type of lease is this? Explain.
(b) Compute the present value of the minimum lease payments.
(c) Prepare all necessary journal entries for Adams for this lease
Chapter through January 1, 2012.
21-20
LO 2
Accounting
Accounting by
by the
the Lessee
Lessee
E21-1: What type of lease is this? Explain.
Capitalization Criteria:
Capital Lease, #3
1. Transfer of ownership
NO
NO
Chapter
21-21
Lease term
5 yrs.
Economic life
FMV of leased
6 yrs.
property is unknown.
YES
Accounting
Accounting by
by the
the Lessee
Lessee
E21-1: Compute present value of the minimum lease
payments.
Payment
$ 9,968
4.16986
$41,565
41,565
Lease Liability
Lease Liability
Cash
Chapter
21-22
41,565
9,968
9,968
LO 2 Describe the accounting criteria and procedures
for capitalizing leases by the lessee.
Accounting
Accounting by
by the
the Lessee
Lessee
E21-1: Lease Amortization Schedule
Chapter
21-23
Accounting
Accounting by
by the
the Lessee
Lessee
E21-1: Journal entries for Adams through Jan. 1, 2012.
12/31/11
Depreciation Expense
8,313
8,313
($41,565 5 = $8,313)
Interest Expense
3,160
Interest Payable
3,160
Chapter
21-24
Accounting
Accounting by
by the
the Lessee
Lessee
E21-1: Journal entries for Adams through Jan. 1, 2012.
1/1/12
Lease Liability
6,808
Interest Payable
3,160
Cash
Chapter
21-25
9,968
Accounting
Accounting by
by the
the Lessee
Lessee
Operating Method
The lessee assigns rent to the periods benefiting from
the use of the asset and ignores, in the accounting, any
commitments to make future payments.
Illustration: Assume Adams accounts for it as an
operating lease. Adams records this payment on January
1, 2011, as follows.
Rent Expense
Cash
Chapter
21-26
9,968
9,968
Accounting
Accounting by
by the
the Lessee
Lessee
E21-1: Comparison of Capital Lease with Operating Lease
Chapter
21-27
Accounting
Accounting by
by the
the Lessor
Lessor
Benefits to the Lessor
1.
Interest Revenue.
2. Tax Incentives.
3. High Residual Value.
Chapter
21-28
Accounting
Accounting by
by the
the Lessor
Lessor
Economics of Leasing
A lessor determines the amount of the rental, based
on the rate of return needed to justify leasing the
asset.
If a residual value is involved (whether guaranteed or
not), the company would not have to recover as much
from the lease payments
Chapter
21-29
Accounting
Accounting by
by the
the Lessor
Lessor
E21-10 (Computation of Rental): Fieval Leasing Company signs an
agreement on January 1, 2010, to lease equipment to Reid
Company. The following information relates to this agreement.
1.
2.
The cost of the asset to the lessor is $343,000. The fair value of the
asset at January 1, 2010, is $343,000.
3.
The asset will revert to the lessor at the end of the lease term at
which time the asset is expected to have a residual value of $61,071,
none of which is guaranteed.
4.
5.
Chapter
21-30
Accounting
Accounting by
by the
the Lessor
Lessor
E21-10 (Computation of Rental): Assuming the lessor desires a
10% rate of return on its investment, calculate the amount of the
annual rental payment required.
x
Chapter
21-31
Accounting
Accounting by
by the
the Lessor
Lessor
Classification of Leases by the Lessor
a. Operating leases.
b. Direct-financing leases.
c. Sales-type leases.
Chapter
21-32
Accounting
Accounting by
by the
the Lessor
Lessor
Classification of Leases by the Lessor
Illustration 21-10
Accounting
Accounting by
by the
the Lessor
Lessor
Classification of Leases by the Lessor
Illustration 21-11
Accounting
Accounting by
by the
the Lessor
Lessor
Direct-Financing Method (Lessor)
In substance the financing of an asset purchase by
the lessee.
Chapter
21-35
Accounting
Accounting by
by the
the Lessor
Lessor
E21-10: Prepare an amortization schedule that would be
suitable for the lessor.
Chapter
21-36
Accounting
Accounting by
by the
the Lessor
Lessor
E21-10: Prepare all of the journal entries for the lessor for
2010 and 2011.
1/1/10
Lease Receivable
343,000
Equipment
1/1/10
Cash
343,000
64,400
Lease Receivable
12/31/10
Interest Receivable
Interest Revenue
Chapter
21-37
64,400
27,860
27,860
Accounting
Accounting by
by the
the Lessor
Lessor
E21-10: Prepare all of the journal entries for the lessor for
2010 and 2011.
1/1/11
12/31/11
Cash
Lease Receivable
36,540
Interest Receivable
27,860
Interest Receivable
Interest Revenue
Chapter
21-38
64,400
24,206
24,206
Accounting
Accounting by
by the
the Lessor
Lessor
Operating Method (Lessor)
Records each rental receipt as rental revenue.
Depreciates the leased asset in the normal manner.
Chapter
21-39
Accounting
Accounting by
by the
the Lessor
Lessor
Operating Method (Lessor)
Illustration: Assume Fieval accounts for the lease as an
operating lease. It records the cash rental receipt as
follows:
Cash
64,400
Rental Revenue
64,400
57,167
57,167
Special
Special Accounting
Accounting Problems
Problems
1. Residual values.
2. Sales-type leases (lessor).
3. Bargain-purchase options.
4. Initial direct costs.
5. Current versus noncurrent classification.
6. Disclosure.
Chapter
21-41
Special
Special Accounting
Accounting Problems
Problems
Residual Values
Meaning of Residual Value - Estimated fair value of
the leased asset at the end of the lease term.
Chapter
21-42
Special
Special Accounting
Accounting Problems
Problems
Residual Values
Lessee Accounting for Residual Value
The accounting consequence is that the minimum
lease payments, include the guaranteed residual
value but excludes the unguaranteed residual value.
Chapter
21-43
Special
Special Accounting
Accounting Problems
Problems
Illustration (Guaranteed Residual Value Lessee Accounting):
Caterpillar Financial Services Corp. (a subsidiary of Caterpillar) and
Sterling Construction Corp. sign a lease agreement dated January 1,
2011, that calls for Caterpillar to lease a front-end loader to Sterling
beginning January 1, 2011. The terms and provisions of the lease
agreement, and other pertinent data, are as follows.
The term of the lease is five years. The lease agreement is
noncancelable, requiring equal rental payments at the beginning of
each year (annuity due basis).
The loader has a fair value at the inception of the lease of
$100,000, an estimated economic life of five years, and no residual
value.
Chapter
21-44
Special
Special Accounting
Accounting Problems
Problems
Illustration (Guaranteed Residual Value Lessee Accounting):
Sterling pays all of the executory costs directly to third parties
except for the property taxes of $2,000 per year, which is included
as part of its annual payments to Caterpillar.
The lease contains no renewal options. The loader reverts to
Caterpillar at the termination of the lease.
Sterlings incremental borrowing rate is 11 percent per year.
Sterling depreciates on a straight-line basis.
Caterpillar sets the annual rental to earn a rate of return on its
investment of 10 percent per year; Sterling knows this fact.
Caterpillar estimates a residual value of $5,000 a the end of the
lease.
Chapter
21-45
Special
Special Accounting
Accounting Problems
Problems
Illustration (Guaranteed Residual Value Lessee Accounting):
Caterpillar would compute the amount of the lease payments as
follows:
Illustration 21-16
NOTE: For the Lessee, the minimum lease payment includes the guaranteed
residual value but excludes the unguaranteed residual value.
Chapter
21-46
Solution on
notes page
Special
Special Accounting
Accounting Problems
Problems
Illustration (Guaranteed Residual Value Lessee Accounting):
Computation of Lessees capitalized amount
Illustration 21-17
Chapter
21-47
Solution on
notes page
Special
Special Accounting
Accounting Problems
Problems
Illustration (Guaranteed Residual Value Lessee Accounting):
Computation of Lease Amortization Schedule
Illustration 21-18
Chapter
21-48
LO 7
Special
Special Accounting
Accounting Problems
Problems
Illustration (Guaranteed Residual Value Lessee Accounting):
At the end of the lease term, before the lessee transfers the
asset to Caterpillar, the lease asset and liability accounts have the
following balances.
Illustration 21-19
Chapter
21-49
Special
Special Accounting
Accounting Problems
Problems
Illustration (Guaranteed Residual Value Lessee Accounting):
Assume that Sterling depreciated the leased asset down to its
residual value of $5,000 but that the fair market value of the
residual value at December 31, 2015, was $3,000. Sterling would
make the following journal entry.
Loss on Capital Lease
Interest Expense (or Interest Payable)
Lease Liability
Leased Equipment under Capital Leases
Chapter
21-50
454.76
4,545.24
2,000.00
95,000.00
100,000.00
2,000.00
Special
Special Accounting
Accounting Problems
Problems
Illustration (Unguaranteed Residual Value Lessee Accounting):
Assume the same facts as those above except that the $5,000
residual value is unguaranteed instead of guaranteed. Caterpillar
would compute the amount of the lease payments as follows:
Illustration 21-20
Chapter
21-51
Solution on
notes page
Special
Special Accounting
Accounting Problems
Problems
Illustration (Unguaranteed Residual Value Lessee Accounting):
Computation of Lease Amortization Schedule
Illustration 21-21
Chapter
21-52
Special
Special Accounting
Accounting Problems
Problems
Illustration (Unguaranteed Residual Value Lessee Accounting):
At the end of the lease term, before Sterling transfers the asset
to Caterpillar, the lease asset and liability accounts have the
following balances.
Illustration 21-22
Chapter
21-53
Special
Special Accounting
Accounting Problems
Problems
Comparative Entries, Lessee Company
Chapter
21-54
Illustration 21-23
Special
Special Accounting
Accounting Problems
Problems
Lessor Accounting for Residual Value
The lessor works on the assumption that it will realize the residual
value at the end of the lease term whether guaranteed or
unguaranteed.
Illustration: Assume a direct-financing lease with a residual value
(either guaranteed or unguaranteed) of $5,000. Caterpillar
determines the payments as follows.
Illustration 21-24
Chapter
21-55
Special
Special Accounting
Accounting Problems
Problems
Lessor Accounting for Residual Value
Illustration: Lease Amortization Schedule, for Lessor
Guaranteed or Unguaranteed Residual Value
Illustration 21-25
Chapter
21-56
Special
Special Accounting
Accounting Problems
Problems
Lessor Accounting for Residual Value
Illustration: Caterpillar would make the following entries for this
direct-financing lease in the first year.
Illustration 21-26
Chapter
21-57
Solution on
notes page
Special
Special Accounting
Accounting Problems
Problems
Sales-Type Leases (Lessor)
Primary difference between a direct-financing
lease and a sales-type lease is the
manufacturers or dealers gross profit (or loss).
Lessor records the sale price of the asset, the
cost of goods sold and related inventory
reduction, and the lease receivable.
Difference in accounting for guaranteed and
unguaranteed residual values.
Chapter
21-58
Special
Special Accounting
Accounting Problems
Problems
Sales-Type Leases (Lessor)
Illustration: To illustrate a sales-type lease with a
guaranteed residual value and with an unguaranteed residual
value, assume the same facts as in the preceding directfinancing lease situation. The estimated residual value is
$5,000 (the present value of which is $3,104.60), and the
leased equipment has an $85,000 cost to the dealer,
Caterpillar. Assume that the fair market value of the
residual value is $3,000 at the end of the lease term.
Chapter
21-59
Special
Special Accounting
Accounting Problems
Problems
Sales-Type Leases (Lessor)
Illustration: Computation of Lease Amounts by Caterpillar
FinancialSales-Type Lease
Chapter
21-60
Illustration 21-28
Special
Special Accounting
Accounting Problems
Problems
Sales-Type Leases (Lessor)
Illustration: Caterpillar makes the following entries to
record this transaction on January 1, 2011, and the receipt of
the residual value at the end of the lease term.
Illustration 21-29
Chapter
21-61
Special
Special Accounting
Accounting Problems
Problems
Sales-Type Leases (Lessor)
Illustration: Caterpillar makes the following entries to
record this transaction on January 1, 2011, and the receipt of
the residual value at the end of the lease term.
Illustration 21-29
(January 1, 2012)
Chapter
21-62
Special
Special Accounting
Accounting Problems
Problems
Sales-Type Leases (Lessor)
Illustration: Caterpillar makes the following entries to
record this transaction on January 1, 2011, and the receipt of
the residual value at the end of the lease term.
Illustration 21-29
Chapter
21-63
Special
Special Accounting
Accounting Problems
Problems
Bargain Purchase Option (Lessee)
Present value of the minimum lease payments
must include the present value of the option.
Only difference between the accounting
treatment for a bargain-purchase option and a
guaranteed residual value of identical amounts
is in the computation of the annual
depreciation.
Chapter
21-64
Special
Special Accounting
Accounting Problems
Problems
Initial Direct Costs (Lessor)
The accounting for initial direct costs:
For operating leases, the lessor should defer
initial direct costs.
For sales-type leases, the lessor expenses the
initial direct costs.
For a direct-financing lease, the lessor adds
initial direct costs to the net investment.
Chapter
21-65
Special
Special Accounting
Accounting Problems
Problems
Current versus Noncurrent
FASB Statement No. 13 does not indicate how to
measure the current and noncurrent amounts.
It requires that for the lessee the obligations
shall be separately identified on the balance sheet
as obligations under capital leases and shall be
subject to the same considerations as other
obligations in classifying them with current and
noncurrent liabilities in classified balance sheets.
Chapter
21-66
Special
Special Accounting
Accounting Problems
Problems
Disclosing Lease Data
1.
Leasing was on the FASBs initial agenda in 1973 and SFAS No. 13
was issued in 1976 (before the conceptual framework was
developed). SFAS No. 13 has been the subject of more than 30
interpretations since its issuance.
The iGAAP leasing standard is IAS 17, first issued in 1982. This
standard is the subject of only three interpretations. One reason
for this small number of interpretations is that iGAAP does not
specifically address a number of leasing transactions that are
covered by U.S. GAAP. Examples include lease agreements for
natural resources, sale-leasebacks, real estate leases, and
leveraged leases.
Chapter
21-68
Both U.S. GAAP and iGAAP 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.
Chapter
21-69
Chapter
21-70
LO 10
Solution on
notes page
Illustration 21A-2
Chapter
21-71
Chapter
21-72
Solution on
notes page
Illustration 21A-3
Chapter
21-73
Chapter
21-74
Illustration 21A-4
Chapter
21-75
Chapter
21-76
Illustration 21A-5
Chapter
21-77
Chapter
21-79
Lessee
If the lease meets one of the four criteria for treatment
as a capital lease, the seller-lessee should
Account for the transaction as a sale and the lease as
a capital lease.
Defer any profit or loss it experiences from the sale
of the assets that are leased back under a capital
lease.
Amortize profit over the lease term .
Chapter
21-80
Lessee
If none of the capital lease criteria are satisfied, the
seller-lessee accounts for the transaction as a sale and the
lease as an operating lease.
Lessee defers such profit or loss and amortizes it in
proportion to the rental payments over the period
when it expects to use the assets.
Exceptions:
Losses Recognized and Minor Leaseback
Chapter
21-81
Lessor
If the lease meets one of the criteria in Group I and
both of the criteria in Group II, the purchaser-lessor
records the transaction as a purchase and a directfinancing lease.
If the lease does not meet the criteria, the purchaserlessor records the transaction as a purchase and an
operating lease.
Chapter
21-82
Sale-Leaseback Example
American Airlines on January 1, 2011, sells a used Boeing 757 having a carrying
amount on its books of $75,500,000 to CitiCapital for $80,000,000. American
immediately leases the aircraft back under the following conditions:
1.
2.
3.
4.
Chapter
21-83
5.
6.
Sale-Leaseback Example
This lease is a capital lease to American because
lease term exceeds 75 percent of the estimated life
of the aircraft and
present value of the lease payments exceeds 90
percent of the fair value of the aircraft to CitiCapital.
Assuming that collectibility of the lease payments is reasonably
predictable and that no important uncertainties exist in relation
to unreimbursable costs yet to be incurred by CitiCapital, it
should classify this lease as a direct-financing lease.
Chapter
21-84
Sale-Leaseback Example
Chapter
21-85
Illustration 21B-1
Sale-Leaseback Example
Chapter
21-86
Copyright
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Chapter
21-87