CH 21

CHAPTER 21
Accounting for Leases

ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Brief Concepts
Topics Questions Exercises Exercises Problems for
Analysis
1. Rationale for leasing. 1, 2, 3
2. Concepts, and 4, 5, 6, 7, 8, 1, 2, 3, 4, 1, 2, 3, 4, 7, 1, 2, 3, 4, 1, 2, 3, 4,5

measurement of 9, 10, 11, 12, 5, 6, 9, 15, 8, 9, 10, 12, 5, 8, 9, 10,
leases by lessees. 13, 14, 15, 23 17, 18, 19 14, 15, 16 11, 12, 13,
14, 15
3. Finance / Sales – 11, 15, 16, 7, 8, 9, 10, 5, 7, 8, 9, 11, 6, 7, 9, 11, 2, 5

Type Leases. 17, 18, 19, 11, 12, 13, 12, 13, 17 12, 13, 14,
20, 21, 22, 23 14, 16, 20 15
4. Special Issues 26, 27 15, 16, 21, 9, 16, 17 6, 7, 8, 12, 3, 4, 5

22, 23, 24, 13, 14
Other lease costs; 25
initial direct costs,
presentation and
disclosure.
*5. Sale-leaseback. 28, 29 26, 27 18, 19 6
*This material is dealt with in an Appendix to the chapter.
Copyright © 2018 Wiley Kieso, IFRS, 3/e, Solutions Manual (For Instructor Use Only) 21-1
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Concepts for
Brief Analysis
Learning Questions Exercises Exercises Problems
Objectives
1. Describe the 1, 2, 3
environment
related to
leasing
transactions.
2. Explain the 4, 5, 6, 7, 1, 2, 3, 4, 1, 2, 3, 4, 7, 1, 2, 3, 4, 1, 2, 3, 4 5
accounting for 8, 9, 10, 5, 6, 9, 14, 8, 9, 10, 12, 5, 6, 8, 10,
leases by 11, 12, 21 15, 16, 17, 13, 14, 18, 11, 12, 13,
lessees. 18, 19 19, 20 14, 15
3. Explain the 11, 13, 6, 7, 8, 9, 5, 6, 7, 8, 9, 6, 7, 9, 2, 5

accounting for 14, 15, 10, 11, 12, 10, 11, 12, 11, 12,
leases by 16, 17, 13, 14, 15, 13, 17 13, 14, 15
lessors. 18, 19, 16, 20
20, 22
4. Discuss the 10, 21, 22, 23, 24, 6, 9, 10, 11, 1, 2, 7, 8, 3, 4, 5

accounting and 23, 26, 25 12, 14, 16, 12, 13, 14
reporting for 27 17
special
features of
lease
arrangements.
*5. Describe the 28, 29 26, 27 18, 19 6

lessee’s
accounting for
sale-leaseback
transactions.
*This material is dealt with in an Appendix to the chapter.
21-2 Copyright © 2018 Wiley Kieso, IFRS, 3/e, Solutions Manual (For Instructor Use Only)
ASSIGNMENT CHARACTERISTICS TABLE
Level of Time
Item Description Difficulty (minutes)
E21.1 Lessee Entries; No Residual Value Moderate 15–20
E21.2 Lessee Entries; Lease with Unguaranteed Residual Moderate 15–20
Value
E21.3 Lessee Computations and Entries; Lease with Moderate 20–25
Guaranteed Residual Value
E21.4 Lessee Entries; Lease and Unguaranteed Residual Moderate 20–30
Value
E21.5 Computation of Rental; Journal Entries for Lessor Simple 15–25
E21.6 Lessor Entries; Sales-Type Lease with Option to Moderate 20-25
Purchase
E21.7 Type of Lease; Amortization Schedule Moderate 15-20
E21.8 Lessor Entries; Sales-Type Lease Moderate 15-20
E21.9 Lessee Entries; Initial Direct Costs Moderate 20–25
E21.10 Lessee Entries with Bargain-Purchase Option Moderate 20-30
E21.11 Lessor Entries with Bargain-Purchase Option Moderate 20–30
E21.12 Lessee-Lessor Entries; Sales-Type Lease with a Moderate 20-25
Bargain Purchase Option
E21.13 Lessee-Lessor Entries; Sales-Type Lease; Moderate 20-25
Guaranteed Residual Value
E21.14 Lessee Entries; Initial Direct Costs Simple 20-25
E21.15 Amortization Schedule and Journal Entries for Moderate 20–30
Lessee.
E21.16 Lessee Accounting Moderate 20–25
E21.17 Lessor Accounting for an Operating Lease Moderate 25-30
*E21.18 Sale-Leaseback Moderate 20-30
*E21.19 Lessee-Lessor, Sale-Leaseback Moderate 20–30
P21.1 Lessee Entries. Simple 20–25
P21.2 Lessee Entries and Statement of Financial Position Simple 20–30
Presentation.
P21.3 Lessee Entries and Statement of Financial Position Moderate 35–45
Finance Lease.
P21.4 Lessee Entries, Lease with Monthly Payments. Moderate 30–40
P21.5 Basic Lessee Accounting with Difficult PV Calculation Moderate 40-50
P21.6 Lessee-Lessor Entries, Finance Lease with a Simple 25–35
Guaranteed Residual Value.
P21.7 Lessor Computations and Entries, Sales-Type Lease Complex 30-40
with Guaranteed Residual Value.
P21.8 Lessee Computations and Entries, Lease with Complex 30–40
Guaranteed Residual Value.
P21.9 Lessor Computations and Entries, Sales-Type Lease Complex 30-40
with Unguaranteed Residual Value.
P21.10 Lessee Computations and Entries, Finance Lease with Complex 30–40
Unguaranteed Residual Value.
P21.11 Lessee-Lessor Accounting for Residual Values. Complex 30–40
P21.12 Lessee-Lessor Entries, Statement of Financial Position Moderate 35-45
Presentation, Finance and Sales-Type Lease.
P21.13 Statement of Financial Position and Income Statement Moderate 35–45
Disclosure—Lessee.
P21.14 Operating lease. Moderate 30–40
P21.15 Lessee-Lessor Entries, Operating Lease with an Moderate 30–40
Unguaranteed Residual Value.
CA21.1 Lessee accounting and reporting. Moderate 15–25
CA21.2 Lessor and lessee accounting and disclosure. Moderate 25–35
CA21.3 Lessee accounting. Moderate 20–30
CA21.4 Lease capitalization, bargain-purchase option. Moderate 20–25
CA21.5 Short-Term lease vs. finance lease. Moderate 20–30
*CA21.6 Sale-Leaseback. Moderate 15–25
ANSWERS TO QUESTIONS
1. The major lessor groups in the United States are banks, captives, and independents. Banks are the
largest players in the leasing business. Captives are subsidiaries whose primary business is to perform
leasing operations for the parent company. They have the point of sale advantage in finding leasing
customers for 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. Last, independents are often good at
developing innovative contracts for lessees.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Reflective Thinking, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
2. (a) Possible advantages of leasing for the lessee:

1. Leasing may be more flexible in that the lease agreement may contain less
restrictive provisions than the bond indenture.
2. Leasing permits 100% financing of assets, as the lease is often signed without
requiring any money down from the lessee.
3. 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.
4. Leasing may have favorable tax advantages.
Assuming that funds are readily available through debt financing, there may not be great advantages (in
addition to the above-mentioned) to signing a noncancelable, long-term lease. One additional advantage
of leasing is its availability when other debt financing is unavailable.
(b) Given the new reporting standard on leasing the financial statement effects of a long-term
noncancelable lease versus the purchase of the asset are somewhat similar. That is assets under a
long-term lease are capitalized at the present value of the future lease payments and this value is
probably equivalent to the purchase price of the assets. On the liability side, the bond payable amount
would be equivalent to the present value of the future lease payments. In summary, the amounts
presented in the statement of financial position would be quite comparable. The description of the leased
asset (right-of-use asset) and related liability would however be different than under a bond financing as
would the general classifications; the specific labels (leased assets and lease liability) would be different.
LO: 1, Bloom: C, Difficulty: Moderate, Time: 5-10, AACSB: Reflective Thinking, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
3. Possible advantages of leasing for a lessor:

1. It often provides profitable interest margins.
2. It can stimulate sales of a lessor’s product whether it be from a dealer (lessor) or
a manufacturer (lessor).
3. It often provides tax benefits which enhances the return for the lessor and other
parties to the lease.
4. It can provide a high residual value to the lessor upon the return of the property at
the end of the lease term, which can potentially provide very large profits.
4. The discount rate used by the lessee in the present value test and for valuing the lease liability is the
implicit interest rate used by the lessor. This rate is defined as the discount rate that, at the
commencement of the lease, causes the aggregate present value of the lease payments and
unguaranteed residual value to be equal to the fair value of the leased asset. However, if it is
impracticable for the lessee to determine the implicit rate of the lessor, the lessee should use its
incremental borrowing rate. The incremental borrowing rate is the rate of interest the lessee would have
to pay on a similar lease or incur to borrow over a similar term the funds necessary to purchase the
asset.
Questions Chapter 21 (Continued)
5. Paul Singer is for the most part correct. As long as the lease has a lease term of over 12 months and the
lease is not low value, Paul is correct that the lease must be recognized on the statement of financial
position of the lessee. However, the new lease standard allows for a short-term lease exception. Under
the short-term lease or low value lease exceptions for lessees, rather than recording a right-of-use asset
and lease liability, lessees may elect to expense the lease payments as incurred. In this case, the lease
is not capitalized on the statement of financial position as Paul suggested.
6. (a) Residual value is the expected value of the leased asset at the end of the lease term.
(b) A guaranteed residual value is a guarantee made to a lessor that the value of the leased asset
returned to the lessor at the end of a lease will be at least a specified amount. Any amounts probable to
be paid under the residual value guarantee should be included in the present value of payments.
(c) Initial direct costs are incremental costs of a lease that would not have been incurred had the lease
not been executed. Initial direct costs incurred by the lessee are included in the cost of the right-of-use
asset but are not recorded as part of the lease liability.
7. A bargain purchase option is a lease purchase option in which the lessee can buy the asset for a price
that is significantly lower than the underlying asset’s expected fair value at the date the option becomes
exercisable, thus making the exercise of the option reasonably certain. A bargain renewal option is
essentially the same conceptually as a bargain purchase option, except the option is to renew the lease
as opposed to purchasing the asset. That is, a bargain renewal option is an option in which the price of
renewal at which the lessee can buy the asset is significantly lower than the underlying asset’s expected
fair value at the date the option becomes exercisable, thus making the exercise of the option reasonably
certain.
A bargain purchase option and a bargain renewal option have similar impacts on the initial classification
and measurement of the lease. With respect to classification, the existence of a bargain purchase option
is one way a lessor can meet the finance/sales-type lease classification criteria. In the case of a bargain
renewal option, the additional lease term that would be added by exercising the option should be
included in the lease term when assessing whether or not the lessor meets the lease term test. The
present value of the option price would also be used in assessing whether the lessor meets the present
value test. For measurement purposes, the present value of both a bargain purchase option and a
bargain renewal option should be included in the initial value of the lease receivable.
8. The lease liability is recorded at the present value of the lease payments. This includes the periodic
rental payments made by the lessee, bargain-purchase option if any, and amounts probable to be owed
under a residual value guarantee. The present value of the lease payments is recorded as a lease
liability by the lessee.
9. Wonda Stone is correct in her interpretation. For purposes of lease classification by the lessor the
present value of the guaranteed residual value is used in determining whether the present value (90%)
test is met. The amount included in the measurement of the lease liability is only the amount that the
lessee expects to owe under the residual value guarantee at the end of the lease. For example, if a
lessee guarantees a residual value of $10,000, but it is also probable that the lessee does not expect to
owe any additional money at the end of the lease, then the guaranteed residual value would not be
included in the initial measurement of the lease liability.
10. The right-of-use asset is initially measured as the same amount as the lease liability (i.e. present value of
lease payments), adjusted for initial direct costs, prepayments and lease incentives. Initial direct costs
paid by the lessee will increase the initial value of the right-of-use asset. Similarly, prepaid rent paid by
the lessee will increase the amount of the right-of-use asset recorded. Lease incentives granted to the
lessee by the lessor will decrease the initial value of the right-of-use asset.
LO: 2, 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Reflective Thinking, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
11. Variable lease payments should be included at the level of the index/rate at the commencement date.
Increases or decreases in the index should not be assumed when valuing the lease liability. Thus, for the
lease in this question, the lessee should not assume any changes in the price index. The difference in
the monthly payment in the second year from the first year of $100 ($5,100 - $5,000) is expensed in the
period incurred. Only if the lessee knows the amount of the variable payment in subsequent periods
should it include these payments in the lease liability computation. The lease payment in the second
year is $5,150 ($5,000 X 1.03).
12. The lessee records a right-of-use asset and lease liability at commencement of the lease. The lessee
then recognizes interest expense on the lease liability over the life of the lease using the effective
interest method and records depreciation expense on the right-of-use asset generally on a straight-line
basis. A lessee therefore reports both interest expense and depreciation of the right to use asset on the
income statement. As a result, the total expense for the lease transaction is generally higher in the
earlier years of the lease arrangement under the finance lease method. The lessee continues to
depreciate the right-of-use asset and decrease the principal of the lease liability until both are reduced to
zero at the end of the lease. The right-of-use asset should be depreciated over the lease term, unless
there is a bargain-purchase option or ownership of the asset transfers to the lessee at the end of the
lease. If either of these criteria are met, then the lessee depreciates the right-of-use asset over the
economic life of the asset.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Reflective Thinking, AICPA BB: None, AICPA FC: Reporting, Measurement, AICPA PC: None
13. A low value lease is a lease of an underlying asset with a value of $5,000 or less. Rather than recording
a right-of-use asset and lease liability, a lessee may elect to expense the lease payments as incurred.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Reflective Thinking, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
14. A short-term lease is a lease that, at the commencement date, has a lease term of 12 months or less.
Rather than recording a right-of-use asset and lease liability, lessees may elect to expense lease payments
as incurred.
15. If a bargain-purchase option exists, the lessee must increase the present value of the lease payments by
the present value of the option price. This is the case for both classification and initial measurement of
the lease liability and right-of-use asset. A bargain purchase option also affects the period over which the
right-of-use asset is depreciated, since the lessee amortizes 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 book value of the right-of-use asset in the period that the option expired.
16. From the standpoint of the lessor, leases will (with few exceptions) be classified for accounting purposes as
either (a) operating leases or (b) finance (sales-type) leases.
A finance (sales-type) lease meets one or more of the following five tests:
1. The lease transfers ownership,
2. The lease contains a bargain-purchase option,
3. The lease term is a major part of the remaining economic life of the underlying asset (i.e. equal
to 75% or more of the estimated economic life of the property),
4. The present value of the lease payments equals or exceeds substantially all of the underlying
asset’s fair value (i.e. 90% of the fair value of the property),
5. The asset is of such a specialized nature that it is expected to have no alternative use to the
lessor at the end of the lease term.
If none of the above five tests are met, the lease will be treated as an operating lease. The IASB
concluded that by meeting any one of the lease classification tests, the lessor transfers control of the
leased asset and therefore satisfies a performance obligation, which is required for revenue recognition
under the IASB’s recent standard on revenue. That is, if the lessee takes ownership or consumes a
substantial portion of the underlying asset over the lease term, the lessor has in substance transferred
control of the right-of-use asset and the lessor has a sales-type lease. On the other hand, if the lease
does not transfer control of the asset over the lease term, the lessor generally uses the operating
approach in accounting for the lease.
17. (a) If a lease is for a major part of the economic life of the lease, the lease is classified as a finance
lease. In practice, 75% of the economic life of the asset is generally used to meet this classification test.
That is, if the lease term is 75% or greater of the economic life of the asset, the lease is classified as a
finance lease.
(b) If the lease term is 12 months or less the lessee may elect to use the short-term lease exception, and
thus the lease would not be classified as finance lease. The lessee would expense the lease payment in
the applicable year.
(c) If the lease transfers ownership of the asset at the end of the lease, the lease is classified as a
finance lease. This situation meets one of the classification tests for a finance lease.
18. A lease receivable is defined as the present value of the periodic rental payments plus any guaranteed
residual value. A net investment in the lease includes not only the components of the lease receivable but
also any unguaranteed residual value. In other words, the net investment in the lease is equal to the present
value of the rental payments, plus any guaranteed residual value plus any unguaranteed residual value. As
indicated in the text, for homework problems, we assume that the present value of the unguaranteed residual
value should be included as part of the lease receivable.
19. Under the operating method, each rental receipt of the lessor is recorded as lease revenue. The
underlying leased asset is still recognized on the statement of financial position of the lessor and
depreciated in the normal manner. In addition to depreciation, any other related costs to the lease
arrangement (i.e. insurance, maintenance, taxes, etc.) are recorded in the period incurred.
20. Under a finance (sales-type) lease, lessors report in the income statement Sales Revenue and Cost of
Goods Sold (and resultant gross profit) at commencement of the lease. During the lease term Interest
Revenue on the Lease Receivable is reported. Under an operating lease, lessors report Lease Revenue
(generally when payments are received) and Depreciation Expense on the leased asset.
21. Walker Company can use the finance (sales-type) lease method if the lease meets one or more of the
following five tests:
(1) The lease transfers ownership of the property to the lessee,
(2) The lease contains a bargain-purchase option,
(3) The lease term is a major part of the remaining economic life of the underlying asset (i.e. equal
to 75% or more of the estimated economic life of the property),
(4) The present value of the lease payments equals or exceeds substantially all of the underlying
asset’s fair value (i.e. 90% of the fair value of the property),
(5) The asset is of such a specialized nature that it is expected to have no alternative use to the
lessor at the end of the lease term.
22. Metheny Group should recognize the present value of the lease payments (normal sales price) as sales
revenue, and the carrying amount (book value) of the asset as cost of goods sold. Thus, the gross profit
from the lease should be recognized at the commencement of the lease as the difference between the
sales revenue and cost of goods sold. Subsequent to lease commencement, the company will recognize
interest revenue on the lease receivable. If an unguaranteed residual value is involved, the lessor should
reduce both the sales revenue and cost of goods sold by the present value of the unguaranteed residual
value. The gross profit, however, will not change.
23. Although not part of the classification tests, the lessor must also determine whether the collectibility of
payments from the lessee is probable, as it has implications for the subsequent accounting of the lease.
Because collection of the lease payments is not probable for Packer plc, it should record the receipt of
the payments as a deposit liability and not derecognize the leased asset.
24. (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. That is, unguaranteed residual values
are not included in the lessee’s lease payments, either for classification or measurement
purposes.
(2) A guaranteed residual value may be included, depending on how much a lessee
expects to owe under the guarantee.
(b) The value of the lease liability may be made up of two components—the periodic rental payments
and amounts probable to be owed under a guaranteed residual value. That is, if the expected
residual value at the end of the lease term is less than the guaranteed residual value, then the
lessee will expect to pay in cash a certain amount to the lessor at the end of the lease term. As
such, the lessee should include the present value of the difference between the guaranteed
residual and expected residual if the expected residual is less than the guarantee. If the residual
value at the end of the lease term differs in any way from the expected residual at the
commencement of the lease, the lessee recognizes a loss or gain when the final payment of the
guaranteed residual is made.
25. 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 rental payments is set the same way by the lessor
whether the residual value is guaranteed or unguaranteed.
26. Initial direct costs are the incremental costs of a lease that would not have been incurred had the lease not
been executed. For the lessee, some costs that are included in the right-of-use asset are commissions,
legal fees from the execution of the lease, lease documentation preparation costs incurred after the
execution of the lease, and consideration paid for a guarantee of residual value by an unrelated third
party.
For operating leases, the lessor should defer initial direct costs and amortize them as expenses over the
term of the lease. In a sales-type lease transaction, the lessor expenses the initial direct costs at lease
commencement (in the period in which it recognizes the profit on the sale). An exception is when there is
no selling profit or loss on the transaction, in which case the initial direct costs are deferred and
recognized over the lease term.
27. Lessees and lessors must provide additional qualitative and quantitative disclosures to help financial
statement users to assess the amount, timing, and uncertainty of future cash flows. Qualitative lease
disclosures include the nature of the leases, how variable lease payments are determined, the existence
and terms and conditions for options to extend or terminate the lease and for residual value guarantees,
and information about significant assumptions and judgments such as discount rates. Quantitative
disclosures include total lease cost, finance lease cost segregated between the amortization of the right-
of-use assets and interest on the lease liabilities, operating and short-term lease cost, weighted-average
remaining lease term and weighted-average discount rate (segregated between finance and operating
leases), and maturity analysis of finance and operating lease liabilities on an annual basis for a minimum
of each of the next five years and the sum of the undiscounted cash flows for all years thereafter.
*28. In a sale-leaseback arrangement, a company (the seller-lessee) transfers an asset to another company
(the buyer-lessor) and then leases that asset back from the buyer-lessor. In order to qualify for sale-
leaseback treatment, the initial transfer of the asset must be such that the seller-lessee gives up control
of the asset to the buyer-lessor. In this way, the transaction is a sale, and gain or loss recognition is
appropriate. In addition, the subsequent leaseback must be classified as an operating lease for the
seller-lessee. This is because if any of the lease classification tests are met, the seller-lessee never
actually gave up control of the asset, and thus a sale is deemed to never have happened. As long as the
initial owner of the asset continues to control the asset, it should not record a sale nor recognize a gain
or loss. Instead, the transaction is treated as borrowing money from the ‘buyer-lessor’ in a financing
arrangement, often labeled a “failed sale.”
*29. The sale and subsequent lease will receive sale-leaseback accounting treatment. The initial transfer of
the asset was a sale, and the seller-lessee gave control of the asset to the buyer-lessor. In addition, the
subsequent leaseback is classified as an operating lease, and thus Sanchez never takes control of the
asset back from Harper. Had the leaseback been classified as a financing lease, the transaction would
have been considered a ‘failed sale’ and would have simply been accounted for as a borrowing
arrangement. However, because it qualifies for sale-leaseback treatment, Sanchez should recognize
the R$4 million gross profit at the commencement of the lease, and record a right-of-use asset and
lease liability at the present value of the lease payments.
LO: 5, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Reflective Thinking, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 21.1
The lease payments in the lease arrangement will include both the annual fixed
payments of $800,000 each year, plus the €11,000,000 bargain purchase option at
the end of the lease term (as it is reasonably certain to be exercised). Thus, the
lease payments for the lease agreement total (€800,000 x 6) + €11,000,000 =
€15,800,000.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
BRIEF EXERCISE 21.2
The lease payments for years 1 and 2 will be $1,700 ($2,000 annual rental minus
$300 lease incentive). In year 3, Fieger will receive no lease incentive, and will
have a full lease payment of $2,000. Thus, in total over the first 3 years, the lease
payments will be $5,400 ($1,700 + $1,700 + $2,000).
BRIEF EXERCISE 21.3
Variable payments in a lease are not considered in determining the initial value
of the lease liability and right-of-use asset. Because the lease payments are
based on 4% of net sales, these payments are considered variable, as they are
not based on an index or rate, the future level of which in not known at lease
commencement. It does not matter that it is highly certain that Sanders will
achieve a minimum of £1,000,000 in net sales each year. Thus, these variable
lease payments are not included in the initial valuation of the lease liability and
right-of-use asset. Since they are the only payments being made in the lease
agreement, Sanders would record the right-of-use asset at zero and record lease
expense when payments are made.
BRIEF EXERCISE 21.4
12/31/18
Right-of-Use Asset ($41,933 X 3.57710*)....................... 150,000**
..................................................................Lease Liability
.............................................................................150,000
Lease Liability.................................................................. 41,933
.................................................................................Cash
............................................................................. 41,933
BRIEF EXERCISE 21.4 (Continued)
*Present value of an annuity-due of 1 for 4 periods at 8%.

**Rounded by $1.
12/31/19
Interest Expense [($150,000 – $41,933) X 8%].............. 8,645
Lease Liability.................................................................. 33,288
.................................................................................Cash
...............................................................................41,933
Depreciation Expense..................................................... 37,500

..........................................................Right-of-Use Asset
............................................................. ($150,000 ÷ 4)
............................................................................. 37,500
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 21.5
12/31/19
Interest Expense [(€300,000 – €48,337) X 8%].............. 20,133
Lease Liability.................................................................. 28,204
.................................................................................Cash
........................................................................... 48,337

............................................................. (€300,000 ÷ 8)
............................................................................. 37,500
BRIEF EXERCISE 21.6

1/1/19
Right-of-Use Asset.......................................................... 33,975*
..................................................................Lease Liability
...............................................................................33,975
*PV of rentals (£5,300 X 6.20637*)
£32,894
PV bargain purchase option (£2,000 X 0.54027)**
1,081
£33,975
**Present value of 1 for 8 periods at 8%.
Lease Liability.................................................................. 5,300

.................................................................................Cash
............................................................................... 5,300

12/31/19
Interest Expense [(£33,975 – £5,300) X 8%].................. 2,294
..................................................................Lease Liability
.................................................................................2,294

............................................................... ($33,975 ÷ 10*)
.................................................................................3,398
*The right-of-use asset is amortized over the economic life of the asset instead
of the lease term because of the bargain-purchase option included in the lease
contract, given that the lessee plans to take ownership of the asset.
BRIEF EXERCISE 21.7
Fair value of leased asset £70,000

Less: Present value of guaranteed residual value
(£5,000 X .50025*) 2,501
Amount to be recovered through lease payments £67,499
Amount of equal annual lease payments (£67,499 ÷ 6.74664**) £10,005
*Present value of 1 for 9 periods at 8%.
**Present value of an annuity-due of 1 for 9 periods at 8%.
LO: 3 Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 21.8
Fair value of leased asset $47,000
Less: Present value of lessor’s expected residual value*
($30,000 X .79209**) 23,763
Amount to be recovered through lease payments $23,237
Amount of equal annual lease payments ($23,237 ÷ 3.46511***) $6,706
*The expectation of the residual value of the lessee would not matter in this
case. The lessor uses its own expectation of the residual value in determining
the annual lease payments. The lessor probably would not even be aware of the
lessee’s expectations.

***Present value of an ordinary annuity for 4 periods at 6%.
BRIEF EXERCISE 21.9
Lease Receivable (4.99271* X £30,044)......................... 150,001

Cost of Goods Sold......................................................... 120,000
.................................................................Sales Revenue
.............................................................................150,001
..........................................................................Inventory
.............................................................................120,000
Cash................................................................................. 30,044
............................................................Lease Receivable
............................................................................. 30,044

BRIEF EXERCISE 21.10
Cash................................................................................. 30,044
...............................................................................20,447
.................Lease Revenue [(£150,001 – £30,044) X 8%]
.................................................................................9,597
Lease Receivable (€40,800 X 4.31213*)......................... 175,935
.................................................................Sales Revenue
.............................................................................175,935
..........................................................................Inventory
.............................................................................120,000
Cash................................................................................. 40,800
............................................................................. 40,800
Cash................................................................................. 40,800
.............................................................Deposit Liability*
............................................................................. 40,800
*When collectibility of lease payments is not probable, the lessor does not
derecognize the asset or recognize selling profit on the lease. Instead, Geiberger
would recognize any cash receipts as a deposit liability.
Lease Receivable............................................................ 57
.............................................................Interest Revenue
.................................................................................... 57
Inventory.......................................................................... 1,000
............................................................................... 1,000
Note to Instructor: The above two entries can be combined into one entry at the
end of the year, as shown below:
Inventory.......................................................................... 1,000
.............................................................Interest Revenue
.................................................................................... 57
.................................................................................. 943
1/1/19
Right-of-Use Asset (2.83339* X £35,000)....................... 99,169

..................................................................Lease Liability
............................................................................. 99,169
Lease Liability.................................................................. 35,000

.................................................................................Cash
............................................................................. 35,000
Schedule A
KINGSTON PLC
Lease Amortization Schedule
Annuity-Due Basis
Reduction
Interest (6%) of Lease
Date Annual Payment on Liability Liability Lease Liability
1/1/19 £99,169
1/1/19 £35,000 £ 0 £35,000 64,169
1/1/20 35,000 3,850 31,150 33,019
1/1/21 35,000 1,981 33,019 0
12/31/19
Interest Expense.............................................................. 3,850

..................................................................Lease Liability
............................................................................... 3,850
Depreciation Expense (£99,169 ÷ 3).............................. 33,056

...............................................................................33,056
1/1/19
Cash................................................................................. 35,000
...............................................Unearned Lease Revenue
...............................................................................35,000
12/31/19
Unearned Lease Revenue.............................................. 35,000
................................................................Lease Revenue
............................................................................. 35,000

.........................................Accumulated Depreciation –
............................... Leased Equipment (£200,000 ÷ 8)
............................................................................. 25,000
1/1/19
Right-of-Use Asset (2.78326* X $12,000)....................... 33,399

..................................................................Lease Liability
33,399
Lease Liability.................................................................. 12,000

.................................................................................Cash
...............................................................................12,000
Schedule A
RODGERS CORPORATION
Annuity-Due Basis
Reduction
Annual Interest (8%) on of Lease
Date Payment Liability Liability Lease Liability
1/1/19 $33,399
1/1/19 $12,000 $ 0 $12,000 21,399
1/1/20 12,000 1,712 10,288 11,111
1/1/21 12,000 889 11,111 0
12/31/19

..................................................................Lease Liability
............................................................................... 1,712
Depreciation Expense ($33,399 ÷ 3).............................. 11,133

...............................................................................11,133

1/1/19
Cash................................................................................. 12,000
...............................................Unearned Lease Revenue
...............................................................................12,000
12/31/19
Unearned Lease Revenue............................................... 12,000
................................................................Lease Revenue
12,000

...........................................Accumulated Depreciation–
..................................Leased Equipment [$60,000 ÷ 10]
6,000
£17,000 X 2.83339* = £48,168
Because the residual value is unguaranteed, Escapee plc does not include it in
its computation of the annual lease payments. If the residual value was
guaranteed, the lessee may or may not be required to include the residual in the
calculation of the lease payments, depending on whether the expected residual
value was higher, equal to, or lower than the guaranteed residual value.
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
(a) The value of the lease liability would remain the same if the only fact changed
from BE21.18 was the guarantee of the expected residual value. Residual
values should only be included in the lease liability when the expected
residual value is less than the guaranteed residual value (i.e. when the lessee
expects to make an additional payment at the end of the lease term to the
lessor).
(b) Following from the above reasoning, if the expected residual value drops to
£5,000 and Escapee guarantees a residual of £9,000, Escapee will need to
account for the difference between the expected and guaranteed residual
value in calculating the initial lease liability as follows:
PV of lease payments (£17,000 X 2.83339*) £48,168
PV of residual value [(£9,000 – £5,000) X 0.83962**] 3,358
Lease liability £51,526

Note to Instructor: The measurement of the lease liability/right-of-use asset

only uses the amount probable to be owed under a residual value guarantee.
The classification test related to the present value test uses the full amount
of the guaranteed residual value to determine whether the finance or
operating method of accounting for the lease is followed by the lessor.
12/31/2018

..................................................................Lease Liability
.............................................................................215,544
*PV of rentals (€40,000 X 5.21236*) €208,494

PV of guaranteed
residual value (€20,000 – €10,000***) X 0.70496**
7,050
Lease liability €215,544
Lease Liability.................................................................. 40,000

.................................................................................Cash
............................................................................. 40,000

***The lessee need only include in the initial lease liability the amount of the
residual value that it expects to pay at the end of the lease term. Thus, in this
case, only the residual value in excess of the expected residual value (up to the
guaranteed residual) should be discounted to present value and included in the
computation of the lease liability.
12/31/18
Lease Receivable............................................................ 222,593*
.................................................................Sales Revenue
.............................................................................222,593
..........................................................................Inventory
.............................................................................180,000
*([€40,000 X 5.21236] + [€20,000 X .70496])
Cash................................................................................. 40,000
............................................................................. 40,000
12/31/19
Cash................................................................................. 40,000
...............................................................................29,044
..............Interest Revenue [(€222,593 – €40,000) X 6%]
...............................................................................10,956
Lease Liability
In calculating the lease liability, Forrest must determine which of the executory
costs are considered a component of the lease (to be considered in the
measurement of the lease liability).
 The real estate taxes in this case are variable payments and therefore are not
considered in the measurement of the lease liability and related right-of-use
asset.
 The fixed $500 insurance payments are included in the measurement of the
lease liability because the insurance costs are a fixed part of the rental
payments. The lease liability is computed as follows:
PV of rental payments (4.31213* X $4,638): $20,000

PV of insurance payments (4.31213* X $500): 2,156
Initial lease liability: $22,156
Right-of-Use Asset
The right-of-use asset is initially measured the same as the lease liability, though it
is also adjusted for any initial direct costs, prepaid rent, and lease incentives
associated with the lease. The legal fees resulting from the execution of the lease
are considered initial direct costs, and must be included in the calculation of the
right-of-use asset:
Lease liability: $22,156

Legal fees: 1,000
Right-of-use asset: $23,156
Thus, the journal entry to record the initial lease liability and right-of-use asset is
as follows:

............................................................Cash (Legal Fees)
.................................................................................1,000
..................................................................Lease Liability
...............................................................................22,156
Answer: $78,998
PV of lease payments: $83,498

Cash incentive received from Badger (lessor): (5,000)
Lease document preparation costs: 500
Measurement of right-of-use asset at 1/1/19: $78,998
Employee salaries are specifically excluded as initial direct costs, and would not
be included in the calculation of the right-of-use asset.
Note to Instructor: The lease liability would not include any adjustments for cash
incentive received, or any included initial direct costs. The lease liability would
only reflect the present value of future lease payments.
Answer: €46,551
PV of lease payments: €44,651

Cash incentive received from Highlander (lessor): (2,000)
Commissions for selling agents: 900
Legal fees resulting from the execution of the lease: 3,000
Measurement of right-of-use asset at 1/1/19: €46,551
Internal engineering costs are specifically excluded as initial direct costs, and
would not be included in the calculation of the right-of-use asset.
Note to Instructor: The lease liability would not include any adjustments for cash
incentive received, or any included initial direct costs. The lease liability would
only reflect the present value of future lease payments.
Lease Expense................................................................ 15,000

.................................................................................Cash
............................................................................. 15,000
*Because the lease term is only 1 year, the lessee treats the lease as a short-
term lease, does not capitalize the asset on its books, and records lease
payments as expenses when paid.
*BRIEF EXERCISE 21.26
The transaction between Irwin and Peete will qualify as a sale-leaseback, as Irwin
has transferred control of the asset to Peete. That is, the terms of the leaseback
do not meet any of the tests to be classified as a finance lease, and thus does
not transfer control back to Irwin. Irwin will recognize a gain on the sale of the
asset, and record a right-of-use asset and corresponding lease liability for the
operating lease entered into with Peete. Subsequent accounting treatment will
follow the normal accounting for an operating lease.
1/1/19
Cash................................................................................. 35,000
...............................................................................Trucks
............................................................................. 28,000
..................................Gain on Disposal of Plant Assets
............................................................................. 7,000
Right-of-Use Asset.......................................................... 23,245

................................Lease Liability (€8,696 X 2.67301*)
............................................................................. 23,245
*Present value of an ordinary annuity for 3 periods at 6%.
IRWIN ANIMATION
Ordinary-Annuity Basis
Reduction
1/1/19 €23,245
1/1/20 €8,696 € 1,395 €7,301 15,944
1/1/21 8,696 957 7,739 8,205
1/1/22 8,696 491* 8,205 0
*Rounded $1
12/31/19

..................................................................Lease Liability
............................................................................... 1,395
Depreciation Expense (€23,245 ÷ 3).............................. 7,748

.................................................................................7,748
Note to Instructor: The lease payment on 1/1/20 would be as follows:
Lease Liability.................................................................. 8,696
.................................................................................Cash
.................................................................................8,696
*BRIEF EXERCISE 21.27
With the change of facts, the leaseback meets the lease term and present value
classification tests (5/5 = 100% of asset’s economic life; €8,309 x 4.21236 =
€35,000 = 100% of asset’s fair value). As a result, the lease is a finance lease.
Consequently, Irwin has control of the asset from the lease arrangement, and
has never given up control of the asset (i.e., a failed sale). Therefore, Irwin will
not recognize any gain on the sale of the asset, but instead record a note
payable to demonstrate the financing-nature of the transaction as shown in the
following entry on January 1, 2019.
1/1/19
Cash................................................................................. 35,000
.................................Notes Payable [€8,309 X 4.21236*]
...............................................................................35,000
* Present value of an ordinary annuity for 5 periods at 6%.
At December 31, 2019, it makes the following entry to record interest on the note
payable.
12/31/19
.....................................Interest Payable [€35,000 X 6%]
.................................................................................2,100
This sale-leaseback arrangement is a financing transaction and is often

referred to as a failed sale.
SOLUTIONS TO EXERCISES
EXERCISE 21.1 (15–20 minutes)
Note to Instructor: The lease term is 100% of the asset’s economic life, and the
present value of the rental payments are 100% of the asset’s fair value, as shown
below:
Present value of first payment

(£5,552.82 X .92593).............. £ 5,141.52
Present value of second payment
(£5,830.46 X .85734).............. 4,998.69
Present value of third payment
(£6,121.98 X .79383).............. 4,859.81
Present value of the rental payments £15,000.00*
*Two cents rounding error.
12/31/18
Right-of-Use Asset.................. 15,000
.........................Lease Liability
15,000
12/31/19
Interest Expense (£15,000 X 8%) 1,200.00
Lease Liability......................... 4,352.82
.........................................Cash
5,552.82
Depreciation Expense (£15,000 ÷ 3) 5,000.00

..................Right-of-Use Asset
5,000.00
12/31/20
Interest Expense
[(£15,000 - £4,352.82) X 8%] 851.77
Lease Liability......................... 4,978.69
.........................................Cash
5,830.46
Depreciation Expense (£15,000 ÷ 3) 5,000.00

..................Right-of-Use Asset
5,000.00
EXERCISE 21.1 (Continued)
(b) The initial valuation of the lease liability and related right-of-use asset should
not include any unknown increases or decreases in lease payments due to
increases or decreases in the CPI. Rather, for the initial measurement of the
lease liability, the lessee assumes that all payments will be made as if the CPI
level at the commencement date of the lease does not change. Thus, DU
Journeys should discount the annual lease payments using the ordinary annuity
factor applied to the first lease payment.
LO: 1, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
(a) Computation of present value of lease payments:

$8,668 X 4.54595* = $39,404
12/31/18
(b) ...........................Right-of-Use Asset 39,404

...........................................................Lease Liability
39,404
..................................Lease Liability 8,668

........................................................... Cash
8,668
12/31/19
.....................Depreciation Expense 7,881

...........................................................Right-of-Use Asset
7,881
........................................................... ($39,404 ÷ 5)
Lease Liability.................................. 7,131
Interest Expense
.................[($39,404 – $8,668) X .05] 1,537
........................................................... Cash
8,668
(a) The present value of lease payments, for purposes of determining the lease
liability for the lessee, should only include the present value of any
guaranteed residual value probable to be owed under the lease agreement
(i.e. the amount of guaranteed residual value over the expected residual
value). Because the expected residual value is the same as the guaranteed
residual value, no amounts are probable to be owed under the lease
agreement, and the present value of lease payments to determine the lease
liability therefore is:
PV of monthly payment of €200 for 50 months

...............................................[€200 X 44.36350*]
€8,873
*Present value of an annuity-due of 1 for 50 periods at 0.5%.
(b) Right-of-Use Asset.............................................. 8,873
.....................................................Lease Liability
8,873
(c) Lease Liability..................................................... 200
.....................................................................Cash
200
(d) Lease Liability..................................................... 157
Interest Expense (0.5% X [€8,873 – €200])........ 43
.....................................................................Cash
200
(e) Amortization Expense........................................ 177
..............................................Right-of-Use Asset
177
....................................... (€8,873 ÷ 50 months)
(f) As explained in part (a), the lessee should include the present value of
any guaranteed residual value probable to be owed under the lease agreement.
Because the expected residual value (€500) is less than the guaranteed residual
value (€1,180), Delaney should include the present value of the difference in the
initial measurement of the lease liability. Thus, the present value of the lease
payments is calculated as follows:
PV of monthly payment of €200 for 50 months

[€200 X 44.36350*]
€8,873
PV of guaranteed residual value probable to be owed
[(€1,180 - €500) X .77929**]
530
PV of lease payments €9,403
*Present value of an annuity-due of 1 for 50 periods at 0.5%.
(a) For purposes of calculating the initial lease liability, the present value of the
lease payments will only include the amount of a residual value guarantee
probable to be owed at the end of the lease term. Thus, the initial lease liability
and right-of-use asset to be recorded on the books of Stora Enso is calculated
as follows:
€ 71,830 Annual rental payment

X 7.24689 PV of annuity-due of 1 for n = 10, i = 8%
€ 520,544 PV of periodic rental payments
€ 3,000 Amount probable to be owed under

residual value guarantee (€10,000 - €7,000)
X .46319 PV of 1 for n = 10, i = 8%
€ 1,390 PV of amount probable to be owed
on residual value guarantee

+ 1,390 PV of the residual value
€ 521,934 Lease liability
12/31/18
Right-of-Use Asset..................... 521,934

.....................................................Lease Liability
521,934
Lease Liability............................ 71,830

..................................................... Cash
71,830
12/31/19
Depreciation Expense............... 52,193

.....................................................Right-of-Use Asset
52,193
..................................................... (€521,934 ÷ 10)
Lease Liability............................ 35,822

Interest Expense
(See Schedule 1)...................... 36,008
..................................................... Cash
71,830
12/31/20
...............Depreciation Expense 52,193

52,193
............................Lease Liability 38,687

........................Interest Expense
.................... (See Schedule 1) 33,143
..................................................... Cash
71,830
Schedule 1 Stora Enso

Lease Amortization Schedule (partial)
(Lessee)
Reduction
Annual Lease Interest (8%) on of Lease
12/31/18 €521,934
12/31/18 €71,830 € 0 €71,830 450,104
12/31/19 71,830 36,008 35,822 414,282
12/31/20 71,830 33,143 38,687 375,595
LO: 2, 4, Bloom: AN, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
(b) Initial direct costs and lease incentives do not affect the initial measurement
of the lease liability. Instead, they only affect the measurement of the right-of-use
asset. Initial direct costs incurred by the lessee increase the right-of-use asset,
whereas a lease incentive decreases the value of the right-of-use asset. The
calculation of the right-of-use asset is as follows:

- 1,000Lease incentive
+ 5,000 Legal fees
€ 525,934 Right-of-use asset
(c) The annual insurance payments of €5,000 are considered part of the annual
payments to the lessor similar to the rental payments, as they do not transfer a
separate good or service to the lessee, but rather are part of the payment to use
the leased asset and are attributable to the lease component. Therefore, the
present value of the €5,000 annual payments should be included in the initial
measurement of the lease liability, and thus the right-of-use asset as well. The
calculation is as follows:
€71,830 Annual rental payment

€520,544 PV of periodic rental payments
€5,000 Annual insurance payment

€36,234 PV of periodic insurance payments
€ 3,000 Amount probable to be owed under

residual value guarantee (€10,000 - €7,000)
X .46319 PV of 1 for n = 10, i = 8%
€ 1,390 PV of amount probable to be owed
of residual value guarantee

+ 36,234 PV of periodic insurance payments
+ 1,390 PV of the residual value
Note how the inclusion of the executory costs leads to an inflated lease liability
and related right-of-use asset. Additionally, note that had the insurance
payments been variable, they would not have been included at all in the
measurement of the lease liability, which would have led to a very different initial
measurement of the liability and asset.
(d) Because Stora Enso expected the residual value of the asset at the end of the
lease to be €7,000, it expected to owe Sheffield an additional €3,000 in addition to
returning the asset under the residual value guarantee. Thus, Stora Enso has a
lease liability of €3,000 remaining on the books. However, the value of the asset
covers the entire guarantee, and thus no additional cash payment is required by
Stora Enso. As a result, they will book a gain, as shown below:
Lease Liability............................ 3,000

...........................Gain on Lease
3,000
(a) Fair value of leased asset to lessor

£245,000
Less: Present value of unguaranteed
residual value £24,335 X .63017
(present value of 1 at 8% for 6 periods)
15,335
Amount to be recovered through lease payments
£229,665
Six periodic lease payments £229,665 ÷ 4.99271*
£46,000**

**Rounded to the nearest pound.
(b) MORGAN LEASING GROUP (Lessor)

Annual
Lease Interest (8%) on Recovery
Payment Lease of Lease Lease
Date Plus URV Receivable Receivable Receivable
1/1/19 £245,000
1/1/19 £ 46,000 £ –0– £ 46,000 199,000
1/1/20 46,000 15,920 30,080 168,920
1/1/21 46,000 13,514 32,486 136,434
1/1/22 46,000 10,915 35,085 101,349
1/1/23 46,000 8,108 37,892 63,457
1/1/24 46,000 5,077 40,923 22,534
12/31/24 24,335 1,801* 22,534 0
£300,335 £55,335 £245,000
*Rounded by £2.
1/1/19
(c) ..........................Lease Receivable 245,000*

Cost of Goods Sold
229,665**
........................................................Sales Revenue
229,665***
........................................................ Inventory
245,000
*The lease receivable will include both the present value of
the
rental payments (£46,000 X 4.99271) plus the present value
of the
residual value (£24,335 X .63017), as the lessor believes it
will
receive both of these amounts over the life of the lease.
**While cost of goods sold normally mirrors the value of the
inventory being sold, in this case it is reduced by the present
value of the residual value [£245,000 – (£24,335 X .63017)], as the
lessor will receive the inventory again at the amount of the
residual value.
***Sales revenue represents the present value of the rental
payments (£46,000 X 4.99271), but it does not include the present
value of the residual value. That is, the lessor will get the residual
value back at the end of the lease, and thus has not “sold” that
portion of the asset.
1/1/19
.........................................................Cash
46,000
..................................................................Lease Receivable
46,000
12/31/19
....................................Lease Receivable 15,920

..................................................................Interest Revenue
15,920
1/1/20
.........................................................Cash
46,000
..................................................................Lease Receivable
46,000
12/31/20
....................................Lease Receivable 13,514

..................................................................Interest Revenue
13,514
Computation of annual payments

Fair value of leased asset to lessor $160,000
Less: Present value of residual value
($16,000 X .90703*) 14,512
Amount to be recovered through lease payments $145,488
Two periodic lease payments ($145,488 ÷ 1.85941**) $78,244
*Present value of 1 at 5% for 2 periods

**Present value of an ordinary annuity of 1 for 2 periods at 5%
Castle will classify the lease as a sales-type lease, because the agreement meets
both the present value test ($145,488/$160,000 = 91% which is greater than 90%)
and the lease term test (2/2 = 100%) which is greater than 75%. The $16,000
option to purchase does not count as a bargain purchase, the expected residual
value at the end of the lease term is also $16,000.
CASTLE LEASING COMPANY (Lessor)

Interest (5%) Recovery

Annual Lease on Lease of Lease Lease
Date Payment Receivable Receivable Receivable
1/1/19 $160,000
12/31/19 $78,244 $8,000 $70,244 89,756
12/31/20 78,244 4,488 73,756 16,000
12/31/20 16,000 0 16,000 0
1/1/19
(a) Lease Receivable...................... 160,000*

Cost of Goods Sold.................. 105,488**
.............................................Sales Revenue
............................................. 145,488***
............................................. Inventory
120,000
............................................................*($78,244 X 1.85941) +
($16,000 X .90703), rounded
............................................................**$120,000 – ($16,000 X .
90703), rounded
.............................................................***$160,000 – (16,000 x .
90703), rounded
12/31/19
Cash........................................... 78,244
.............................................Lease Receivable
70,244
.............................................Interest Revenue
8,000
12/31/20
Cash........................................... 78,244
73,756
4,488
12/31/20
(b) Cash........................................... 16,000

16,000
(a) The lessee accounts for all leases using the finance lease method and
records the right-of-use asset and lease liability at the present value of the
lease payments using the incremental borrowing rate if it is impracticable to
determine the interest rate implicit in the lease. The lessee’s amortization
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
amortized 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 account for the lease as a sales-type lease. Because title
to the asset passes to the lessee, the lease term is longer than 75% of the
economic life of the asset (3/3 = 100%), and the present value of the lease
payments is more than 90% of the fair value of the asset (€95,000/€95,000 =
100%), it is a finance (sales-type) lease by the lessor. Assuming collectibility
of the rents is probable, the lease is accounted for as a sales-type lease to
the lessor.
The lessor should record a lease receivable and sales revenue equal to the
present value of the lease payments of €95,000. In addition, the lessor
should remove the asset (inventory) from its books at $70,000, and the
related cost of goods sold €70,000. Interest is recognized annually at a
constant rate relative to the unrecovered lease receivable (See lease
amortization schedule).
................................................................Fair value of leased asset

........................(Amount to be recovered by lessor through lease
...................................................................................... payments)
...............................................................................................€95,000
.......................Three annual lease payments: €95,000 ÷ 2.57710*

...............................................................................................€36,863
...*Present value of an ordinary annuity of 1 for 3 periods at 8%.
(b) Amortization Schedule
Interest (8%)
Rent Receipt/ Revenue/ Reduction of Receivable/
Payment Expense Principal Liability
1/1/19 — — — €95,000
12/31/19 €36,863 €7,600* €29,263 65,737
12/31/20 36,863 5,259 31,604 34,133
12/31/21 36,863 2,730 34,133 0
*€95,000 X .08 = €7,600
(c) 1/1/19
Lease Receivable....................... 95,000

Cost of Goods Sold................... 70,000
.....................................................Sales Revenue
95,000
..................................................... Inventory
70,000
(d) 1/1/19

.....................................................Lease Liability
95,000
(e) 1/1/19

..................................................... Cash
10,000
.....................................................Lease Liability
..................................................... (€36,863 X 2.53130*)
93,311
*Present value of an ordinary annuity of 1 for 3 periods at 9%.

LO: 2, 3, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Reporting, Measurement, AICPA PC:
Communication
(a) $35,004 X 6.58238* = $230,410

(b)Because the lease term test is met (8/10 = 80% > 75%), the lease is classified
as a sales-type lease.
1/1/19
........................Lease Receivable 230,410

.....................Cost of Goods Sold 160,000
......................................................Sales Revenue
230,410
...................................................... Inventory
160,000
.............................................................. Cash
35,004
......................................................Lease Receivable
35,004
12/31/19
..............................................................Lease Receivable
11,724.................................................
............................ Interest Revenue
11,724
...................................................... [($230,410 – $35,004) X .
06]
(c) If the collectibility of lease payments is not probable for the

lessor, the lessor does not derecognize the asset or recognize selling profit on
the lease. Instead, Crosley would recognize any cash receipts as a deposit
liability.
1/1/19
Cash................................................................................. 35,004
...............................................................Deposit Liability
............................................................................. 35,004
A lessor does not derecognize the asset and recognize selling profit until
collectibility becomes probable.
(d) .....................................................................Inventory 1,000

..........................................................................................Gain on Lease (Residual
Value)................................................................................ 1,000
LO: 2, 3, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
EXERCISE 21.9 (20-25 minutes)
(a) Lease Liability = $35,004 x 6.20637* = $217,248

Right-of-Use Asset = $217,248 + $15,000** = $232,248

**The right-of-use asset is initially valued at the same amount as the lease
liability, plus the initial direct costs, minus any lease incentives received.
(b) The lease is accounted for using the finance lease method.
1/1/19
..................................................... Cash
15,000
.....................................................Lease Liability
217,248
.....................................Lease Liability 35,004

..............................................Cash
35,004
12/31/19
.................................Interest Expense 14,580
..............................................................
Lease Liability..................................... 14,580
...... [($217,248 – $35,004) X .08]
.........................Depreciation Expense
.................................... ($232,248 ÷ 8) 29,031
..............................................................
Right-of-Use Asset.............................. 29,031

(a) Computation of lease liability:
¥20,471.94 Annual rental payment
¥88,277.67 PV of periodic rental payments
¥ 4,000.00 Bargain purchase option
X .68058 PV of 1 for n = 5, i = 8%
¥ 2,722.32 PV of bargain-purchase option
+ 2,722.32 PV of bargain-purchase option
¥91,000.00 Lease liability (rounded)

Choi Group (Lessee)
Annual Lease Interest Reduction

Payment Plus (8%) on of Lease Lease
Date BPO Liability Liability Liability
5/1/19 ¥91,000.00
5/1/19 ¥ 20,471.94 ¥20,471.94 70,528.06
5/1/20 20,471.94 ¥ 5,642.24 14,829.70 55,698.36
5/1/21 20,471.94 4,455.87 16,016.07 39,682.29
5/1/22 20,471.94 3,174.58 17,297.36 22,384.93
5/1/23 20,471.94 1,790.79 18,681.15 3,703.78
4/30/24 4,000.00 296.22* 3,703.78 0
¥106,359.70 ¥15,359.70 ¥91,000.00
*Rounding error is 8 Yen.
5/1/19
(b) ...............Right-of-Use Asset 91,000.00
...............................................Lease Liability
91,000.00
......................Lease Liability 20,471.94
............................................... Cash
20,471.94
............................................... 12/31/19
..................Interest Expense 3,761.49
...............................................Lease Liability
3,761.49
............................................... (¥5,642.24 X 8/12 = ¥3,761.49)
12/31/19
.........Depreciation Expense 6,066.67
...............................................Right-of-Use Asset
6,066.67
............................................... ($91,000.00 ÷ 10 =
............................................... ($9,100.00; $9,100.00 X
............................................... (8/12 = $6,066.67)
1/1/20
......................Lease Liability 3,761.49
...............................................Interest Expense
3,761.49
5/1/20
..................Interest Expense 5,642.24
......................Lease Liability 14,829.70
............................................... Cash
20,471.94
12/31/20
...............................................Lease Liability
2,970.58
............................................... ($4,455.87 X 8/12)
12/31/20
...............................................Right-of-Use Asset
9,100.00
............................................... ($91,000.00 ÷ 10 years =
............................................... ($9,100.00)
(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.)
(a) The lease agreement has a bargain-purchase option. The collectibility of the
lease payments by Mooney is probable. The lease, therefore, qualifies as a sales-
type lease from the viewpoint of the lessor.
The 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.
The lease receivable is computed as follows:
¥20,471.94 Annual rental payment

X 4.31213 PV of an annuity-due of 1 for n = 5, i = 8%
¥ 4,000.00 Bargain purchase option

X .68058 PV of 1 for n = 5, i = 8%
¥ 2,722.32 PV of bargain-purchase option

+ 2,722.32 PV of bargain-purchase option
¥91,000.00 Lease receivable at commencement (rounded)
(b) MOONEY LEASING (Lessor)

Annual Lease Interest (8%) Recovery

Payment Plus on Lease of Lease Lease
Date BPO Receivable Receivable Receivable
5/1/19 ¥91,000.00
5/1/19 ¥ 20,471.94 ¥20,471.94 70,528.06
5/1/20 20,471.94 ¥ 5,642.24 14,829.70 55,698.36
5/1/21 20,471.94 4,455.87 16,016.07 39,682.29
5/1/22 20,471.94 3,174.58 17,297.36 22,384.93
5/1/23 20,471.94 1,790.79 18,681.15 3,703.78
4/30/24 4,000.00 296.22* 3,703.78 0
¥106,359.70 ¥15,359.70 ¥91,000.00
*Rounding error is 8 Yen.
5/1/19
(c) ...............Lease Receivable 91,000.00

............Cost of Goods Sold 65,000.00
.............................................Sales Revenue
91,000.00
............................................. Inventory
65,000.00
....................................Cash 20,471.94
20,471.94
12/31/19
...............Lease Receivable 3,761.49

3,761.49
............................................. (¥5,642.24 X 8/12 =
............................................. ¥3,761.49)
5/1/20
....................................Cash 20,471.94
18,591.19
1,880.75
................................................. (¥5,642.24 – ¥3,761.49)
12/31/20
...............Lease Receivable 2,970.58

2,970.58
............................................. (¥4,455.87 X 8/12 =
............................................. (¥2,970.58)
(d) If the collectibility of lease payments is not probable for the

the lease. Instead, Mooney would recognize any cash receipts as a deposit
liability.
5/1/19
Cash................................................................................. 20,471.94
........................................................................ 20,471.94
(a) This is a finance (sales-type) lease to Benson since the lease term is 75%
(6 ÷ 8) of the asset’s economic life. In addition, although the lease payments
are not provided in the problem facts, the lease will also meet the present
value test, as shown in part (b). There is a bargain-purchase option in the
lease, as Flynn has the option to purchase the asset at the end of the lease
term for a price $4,000 below the expected residual value of the asset, and
thus exercise of the option is reasonably certain. Last, collectibility of the
lease payments is probable.
(b) Computation of annual rental payment (by the lessor):
Fair value of leased asset................................................................ $150,000

Less: Present value of bargain-purchase option
............................................................................................................ ($1,000 X .
74622*)............................................................................................... 746
PV of lease payments....................................................................... $149,254
Six annual lease payments: $149,254 ÷ 5.32948**........................ $28,005
*Present value of $1 at 5% for 6 periods.

**Present value of an annuity-due at 5% for 6 periods.
1/1/19
(c) .....................Lease Receivable 150,000*

..................Cost of Goods Sold 120,000
...................................................Sales Revenue
150,000**
................................................... Inventory
120,000
*($28,005 X 5.32948) + ($1,000 X .74622), rounded

**Sales revenue would also include both the present values
of
the rental payments and the bargain-purchase option.
...........................................Cash 28,005
...................................................Lease Receivable
28,005
................................................... 12/31/19
.....................Lease Receivable 6,100

...................................................Interest Revenue
6,100
................................................... [($150,000 – $28,005) X .05]
(d) If the collectibility of lease payments is not probable for the

the lease. Instead, Bensen would recognize any cash receipts as a deposit
liability.
1/1/19
Cash................................................................................. 28,005
............................................................................. 28,005
1/1/19
(e) ........................Right-of-Use Asset 146,677
........................................................Lease Liability
146,677
........................................................ [($28,005 X 5.21236*) +
($1,000 X .70496**)]
...............................Lease Liability 28,005

........................................................ Cash
28,005
*Present value of an annuity-due at 6% for 6 periods.

**Present value of $1 at 6% for 6 periods.
12/31/19
..................Depreciation Expense 18,335
........................................................Right-of-Use Asset
18,335
........................................................ ($146,677 ÷ 8* years)
*The lessee uses the economic life of an asset instead of the

lease term for amortization purposes when ownership
transfers or there is a bargain purchase option.
...........................Interest Expense 7,120

........................................................Lease Liability
7,120
........................................................ ($146,677 – $28,005) X .
06
(f) The value of the lease liability for the lessee is unaffected by any initial
direct costs incurred. However, the initial measurement of the right-of-use
asset must be adjusted for initial direct costs incurred. Thus, the initial
right-of-use asset should be measured at $148,677 ($146,677 + $2,000)

..................................................... Cash
2,000
.....................................................Lease Liability
146,677
(a) The lease will be classified as a sales-type lease for Phelps. While ownership
does not transfer at the end of the lease, there is no bargain purchase option, the
asset is not specialized, and the present value test is not met (see calculation of
lease liability for PV of lease payments), the lease term is greater than 75% of the
useful life of the asset (5 ÷ 6 = 83%).
The calculation of the lease receivable for Phelps is done as follows:
Annual rental payments.................................................. £4,703

Present value of an annuity-due
for 5 periods at 8% ...................................................... x 4.31213
Present value of rental payments (rounded)................ £20,280*
*This value should be used in performing the present value test. The lease fails
the present value test because £20,280 ÷ £23,000 = 88.2%, which is less than
90%.
Expected residual value £4,000

Present value of $1 for 5 periods at 8% .68058
Present value of residual value (rounded) £2,722
Present value of expected residual value £2,722

Present value of annual rental payments 20,280
Lease Receivable £23,000*
*Rounded by £2.
The initial lease liability and right-of-use asset, from Walsh’s (lessee’s) point of
view is the present value of the rental payments (£20,280), and excludes the
residual value. This is because Walsh does not guarantee any part of the
residual value.
(b)
Phelps’ Journal Entries

1/1/19
.......................Lease Receivable 23,000*
Cost of Goods Sold.................. 13,280**
.....................................................Sales Revenue
20,280***
..................................................... Inventory
16,000
*(₤4,703 X 4.31213) + (₤4,000 X .68058), rounded

**₤16,000 – (₤4,000 X .68058), rounded
***₤4,703 X 4.31213, rounded
...........................................Cash 4,703
...................................................Lease Receivable
4,703
12/31/19
.....................Lease Receivable 1,464
...................................................Interest Revenue
................................................... [(₤23,000 – ₤4,703) x .08]
................................................... 1,464
Walsh’s Journal Entries

1/1/19
...................Right-of-Use Asset 20,280
...................................................Lease Liability
20,280
...........................Lease Liability 4,703

................................................... Cash
4,703
12/31/19
.......................Interest Expense 1,246
...................................................Lease Liability
................................................... [(£20,280 – £4,703) x .08]
................................................... 1,246
..............Depreciation Expense 4,056
Right-of-Use Asset (£20,280 ÷ 5)….. 4,056
(c)If the residual value is guaranteed, Walsh may need to consider this guarantee
in measuring the lease liability.
With respect to the initial measurement of the lease receivable, the lessor always
includes the residual value in the lease receivable, whether it is guaranteed or
not. Therefore, Phelps’ measurement of the lease receivable (£23,000) does not
change as a result of the guarantee.
For the lessee, only the amount that is probable to be owed under the guaranteed
residual value should be included in the initial measurement of the lease liability
and right-of-use asset. In this case, because Walsh expects the residual value to
be equal to the residual value guarantee, Walsh will not include any amount of the
residual value in the calculation of the lease liability and right-of-use asset, and
the initial measurements will remain £20,280. In order for the answer to change,
the expected residual value would have to be lower than the guarantee.
(d)Walsh would need to include the present value of the amount probable to be
owed under the residual value guarantee in its initial measurement of the lease
liability. Because the expected residual value is less than the guaranteed
residual value, Walsh must include the present value of the difference, or the
amount it expects to pay Phelps at the end of the lease term. Thus, the initial
measurement of the lease liability and right-of-use asset would instead be:
Present value of rental payments (rounded)................ £20,280

Present value of amount probable to be owed
[(£4,000 – £3,000) X .68058*...................................... 681
Lease liability................................................................... £20,961
*Present value of £1 for 5 periods at 8%.

If the lessee is unaware of the rate implicit in the lease, it should use its
incremental borrowing rate to calculate the present value of the lease payments
and initially measure the lease liability and right-of-use asset. Thus, the
calculation of the present value of the lease payments and therefore the lease
liability and right-of-use asset would be:
Annual rental payments.................................................. £4,703

Present value of an annuity-due
for 5 periods at 9% ...................................................... 4.23972
Lease Liability/Right-of-Use Asset................................ £19,939
The lessor is not impacted in any way if the lessee does not know the rate
implicit in the lease.
The lessee determines the lease liability and right-of-use asset as follows:
€25,562.96 Annual rental payment
€73,094.98 PV of minimum lease payments
(a) PLOTE AG (Lessee)

Reduction
Annual Lease Interest (5%) on of Lease Lease
Date Payment Liability Liability Liability
1/1/19 €73,094.98
1/1/19 €25,562.96 € –0– €25,562.96 47,532.02
1/1/20 25,562.96 2,376.60 23,186.36 24,345.66
1/1/21 25,562.96 1,217.30* 24,345.66 –0–
€76,688.88 €3,593.90 €73,094.98
*Rounding is €.02.
1/1/19
(b) ...............Right-of-Use Asset 73,094.98

...............................................Lease Liability
73,094.98
1/1/19
.......................Lease Liability 25,562.96
............................................... Cash
25,562.96
12/31/19
.......................Interest Expense 2,376.60

....................................................Lease Liability
2,376.60
..............Depreciation Expense 24,364.99

....................................................Right-of-Use Asset
24,364.99
.................................................... (€73,094.98 ÷ 3)
1/1/20
...........................Lease Liability 2,376.60

....................................................Interest Expense
2,376.60
.......................Interest Expense 2,376.60

...........................Lease Liability 23,186.36
.................................................... Cash
25,562.96
12/31/20
Interest Expense....................... 1,217.30

....................................................Lease Liability
1,217.30
..............Depreciation Expense 24,364.99

....................................................Right-of-Use Asset
24,364.99
Note to instructor:
1. The lessor sets the annual rental payment as follows:
Fair value of leased asset to lessor €80,000.00
residual value €7,000 X .88900
(present value of 1 at 4% for 3 periods) 6,223.00
Amount to be recovered through lease payments €73,777.00
Five periodic lease payments
€73,777.00 ÷ 2.88609* €25,562.96
*Present value of annuity-due of 1 for 3 periods at 4%.
(a) The calculation for the present value of lease payments is as follows:
€4,892 Annual rental payment

€18,214 PV of periodic rental payments
The lessee applies the finance lease method, based on the following
amortization schedule.
DONAHUE SA
Annuity-Due Basis
Reduction
1/1/19 €18,214
1/1/19 €4,892 € 0 €4,892 13,322
1/1/20 4,892 666 4,226 9,096
1/1/21 4,892 455 4,437 4,659
1/1/22 4,892 233 4,659 -0-
(b) 1/1/19

.....................................................Lease Liability
18,214
Lease Liability............................ 4,892

..................................................... Cash
4,892
12/31/19
Interest Expense........................ 666
.....................................................Lease Liability
666
Depreciation Expense (€18,214 ÷ 4) 4,554
4,554
12/31/20
.....................................................Lease Liability
455
Depreciation Expense (€18,214 ÷ 4) 4,554
4,554
1/1/20
Lease Liability............................ 4,892
..................................................... Cash
4,892
(c) Initial direct costs do not affect the value of the lease liability, but they
do change the value of the right-of-use asset. The initial measurement of the
right-of-use asset will be increased for any initial direct costs. As a result, the
calculation of the right-of-use asset is as follows:
€18,214 Initial measurement of lease liability
(Calculated in part a)
+ 750 Initial direct costs
€18,964 Right-of-use asset
To demonstrate how this impacts the amortization of the right-of-use asset,
below are the tables associated with the lease in this situation:
DONAHUE SA
Annuity-Due Basis
Reduction
1/1/19 €18,214
1/1/19 €4,892 € 0 €4,892 13,322
1/1/20 4,892 666 4,226 9,096
1/1/21 4,892 455 4,437 4,659
1/1/22 4,892 233 4,659 -0-
1/1/19

..................................................... Cash
750
.....................................................Lease Liability
18,214
Lease Liability............................ 4,892

..................................................... Cash
4,892
12/31/19
.....................................................Lease Liability
666
Depreciation Expense (€18,964 ÷ 4)….. 4,741
4,741
(d) With fully guaranteed residual value by Donahue the initial

measurement of the right-of-use asset and lease liability would not change, as
the company expects the residual value to be equal to the guaranteed residual
value. Therefore, no amount is probable to be owed under the guarantee, and no
amount needs to be accounted for in the initial lease liability by Donahue.
(e) A bargain renewal option would cause Donahue to take the additional
year (and payment) into account when determining how to classify the lease and
the initial measurement of the lease liability and right-of-use asset. However, for
purposes of the classification, Donahue need not know the value of the bargain
renewal option, as the additional year of lease term causes the lease term to be 5
years, which is greater than 75% of the useful life of the asset. (5 ÷ 6 = 83%).
Thus, Donahue classifies the lease as a finance lease and accounts for it in the
same way as described in part (b). The only difference is the present value of the
bargain renewal option must be included in the initial measurement of the lease
liability, as it is probable that it will be paid.
LO: 2, 4, Bloom: AP, Difficulty: Simple, Time: 10-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
(a) Fair value of leased asset to lessor €25,000

residual value €8,250 X .82270
(Present value of 1 at 5% for 4 periods) 6,787
Amount to be recovered through lease payments €18,213
Four periodic lease payments
€18,213 ÷ 3.72325* €4,892
*Present value of annuity-due of 1 for 4 periods at 5%.
(b) 1/1/19
....................................................Cash 4,892
.....................................................Unearned Lease Revenue
4,892
12/31/19
Unearned Lease Revenue......... 4,892
.....................................................Lease Revenue
4,892

.....................................................Accumulated Depreciation –
..................................................... Equipment (€20,000 ÷ 6)
3,333
(c) Even though the expected residual value declined, the fact that Donahue
has guaranteed a residual value of €8,250 leads Rauch to calculate rental
payments based on the same amount as if a residual value of $8,250 were
unguaranteed. That is, Rauch will look to recover through the lease payments
whatever portion of the fair value of the asset it does not recover through the
receipt of a residual value at the end of the lease term. Thus, all else being equal,
Rauch would demand the same amount in lease payments from Donahue as it
would under the original facts of the question.
Note to Instructor: The explanation above assumes all else being equal.
However, because Donahue guarantees the residual value, it is possible that
Rauch would compensate this reduction in risk with a lower interest rate used in
computing the payments, and the payments would therefore be lower in value.
In addition, the guarantee of the entire residual value of the asset would make
the lease a sales-type lease for Rauch.
(d) A fully guaranteed residual value by Donahue would cause the lease
to be classified as a sales-type lease by Rauch. As a result, Rauch would
recognize sales revenue and a lease receivable at the commencement of the
lease for the entire fair value of the asset, as well as derecognize the asset and
recognize cost of goods sold. Rauch would then recognize lease revenue for any
interest accrued on the lease receivable over the lease term, and amortize the
lease receivable over the term as well. Upon receipt of the asset again at the end
of the lease term, Rauch would derecognize the remaining lease receivable, and
record the asset as inventory at its fair value, along with any cash payment
required to be collected if the fair value is less than the guaranteed residual
value.
(e) A bargain renewal option also would cause the lease to be classified
as a sales-type lease by Rauch, as it would cause the lease term to be 83% (5 ÷ 6
= 83%) of the economic life of the asset. Thus, the accounting for the lease by
Rauch would be essentially the same as explained in part (d). However, as sales
revenue, Rauch would only recognize the present value of the lease payments
and bargain renewal option. That is, it would need to find the amount of residual
value expected at the end of the lease term, and reduce both sales revenue and
cost of goods sold by the present value of the residual value. In addition, at the
end of the lease term, Rauch could potentially recognize a gain or loss on the
lease, as the value of the residual value it receives could potentially be higher or
lower than the lease receivable it needs to remove upon the return of the asset.
*EXERCISE 21.18 (20–30 minutes)
Humphrey’s Restaurants (Seller-Lessee)

1/1/19
..............................................Cash 680,000
...................................................... Equipment
600,000
......................................................Gain on Sale of Equipment
80,000
......................Right-of-Use Asset 322,775

......................................................Lease Liability
322,775
...................................................... (€115,970 X 2.78326)
..............................Lease Liability 115,970

...................................................... Cash
115,970
HUMPHREY’S RESTAURANTS NV
Annuity-Due Basis
Reduction
1/1/19 €322,775
1/1/19 €115,970 €0 115,970 206,805
1/1/20 115,970 16,544 99,426 107,379
1/1/21 115,970 8,591* 107,379 0
*Rounded by €1.
12/31/19
..........................Interest Expense 16,544
......................................................Lease Liability
16,544
Depreciation Expense (€322,775 ÷ 3)….107,592
......................................................Right-of-Use Asset
107,592
Liquidity Finance (Buyer-Lessor)*
1/1/19
Equipment.......................... 680,000
....................................Cash
680,000
....................................................................... Cash
115,970
.Unearned Lease Revenue
115,970
12/31/19
.......................................................................Unearned Lease Revenue
115,970
..................Lease Revenue
115,970

.....................................................Accumulated Depreciation –
..................................................... Equipment (€680,000 ÷ 10)
68,000
*Lease should be treated as an operating lease because the lease does not
meet any of the sales-type classification tests.
*EXERCISE 21.19 (20–30 minutes)
(a) The situation described is a simple sale of equipment. Only one entry for
the sale of the equipment is required:
1/1/19
....................................................................... Cash
520,000
..........................Equipment
400,000
Gain on Disposal of Equipment 120,000
(b) The situation described is known as a failed sale. That is, the terms of the
lease meet the criteria to be classified as a finance lease to the lessee
(lease term > 75% of economic life, present value of lease payments > 90%
of fair value of the asset). Under a finance lease, the lessee is deemed to
have taken control of the asset. However, since the sale and the lease
occur on the same day, the seller/lessee is deemed to never have given up
control in the first place, and the lease is viewed simply as a financing
arrangement. The present value of the lease payments is $520,000
[$67,342.42 x 7.72173*], which is 100% of the fair value of the asset.
*Present value of an ordinary annuity for 10 years at 5%.

1/1/19
....................................................................... Cash
520,000.00
......................Note Payable
520,000.00
12/31/19
Interest Expense ($520,000 X 5%) 26,000.00
Note Payable...................... 41,342.42
....................................Cash
67,342.42
(c) The situation described is considered a sale-leaseback agreement for

financial reporting purposes. That is, the terms of the lease meet the criteria
to be classified as an operating lease to the lessee (lease term < 75% of
economic life, present value of lease payments < 90% of fair value of the
asset). Under an operating lease, the lessee is not deemed to take control of
the asset. However, upon the sale of the asset, the seller-lessee does
relinquish control of the asset, and thus can recognize any gain on the sale.
The lease is accounted for as a normal operating lease.
1/1/19
....................................................................... Cash
520,000
..........................Equipment
400,000
Gain on Disposal of Equipment 120,000
Right-of-Use Asset............ 192,559.59

....................Lease Liability
. . . ($67,342.42 X 2.85941*)
192,559.59
*Present value of an annuity-due for 3 periods at 5%.
Lease Liability.................... 67,342.42

....................................Cash
67,342.42
ZARLE INC.
Annuity-Due Basis
Reduction
1/1/19 $192,559.59
1/1/19 $67,342.42 $0 $67,342.42 125,217.17
1/1/20 67,342.42 6,260.86 61,081.56 64,135.61
1/1/21 67,342.42 3,206.81* 64,135.61 0
*Rounded $.03
12/31/19
Interest Expense................ 6,260.86
....................Lease Liability
6,260.86
Depreciation Expense ($192,559.59 ÷ 3)..64,186.53
............Right-of-Use Asset
64,186.53
TIME AND PURPOSE OF PROBLEMS
Problem 21.1 (Time 25–35 minutes)

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 by the lessee for a 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 commencement, 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.

Purpose—to develop an understanding of the accounting for a 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 for 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 principles used in a lease with a bargain purchase
option for the lessee. The student is required to discuss the nature of the lease and make journal entries for the
lessee.

Purpose—to develop an understanding of the accounting principles used in a finance (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 a sales-type lease with a guaranteed residual value. The student
discusses the classification of the lease and computes the lease receivable at commencement of lease, sales
price, and cost of goods sold. 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 lease with a guaranteed residual value. The student computes the
amount of the initial liability and right-of-use asset (with initial direct costs). 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 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 goods sold. 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 lessee accounting for a finance lease with an unguaranteed residual
value. The student computes the amount of the initial liability. 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 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
possible classification by the lessor as a finance lease.

Purpose—to develop an understanding of the accounting procedures involved in a finance (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 (including initial direct costs) 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— 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.

Purpose— 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.
SOLUTIONS TO PROBLEMS
PROBLEM 21.1
The lessee determines the lease liability as follows.
For purposes of measuring the initial lease liability, only amounts expected to be
owed under the residual value guarantee should be included. That is, only the
present value of the difference between the residual value guarantee and the
expected residual value at the end of the lease term should be included.
£ 113,864 Annual rental payment

£ 568,490 PV of periodic rental payments
£ 5,000 Amount expected to be owed under residual value

guarantee
($50,000 – $45,000)
X .63017 PV of 1 for n = 6, i = 8%
£ 3,151 PV of guaranteed residual value
$ 568,490 PV of periodic rental payments
+ 3,151 PV of guaranteed residual value
£ 571,641 PV of lease payments
(a) VANCE PLC (Lessee)

Annual
Lease Reduction
Payment Interest (8%) of Lease Lease
Date Plus GRV on Liability Liability Liability
1/1/19 £571,641
1/1/19 £113,864 £ –0– £113,864 457,777
1/1/20 113,864 36,622 77,242 380,535
1/1/21 113,864 30,443 83,421 297,114
1/1/22 113,864 23,769 90,095 207,019
1/1/23 113,864 16,562 97,302 109,717
1/1/24 113,864 8,777 105,087 4,630
12/31/24 5,000 370 4,630 0
£688,184 £116,543 £571,641
PROBLEM 21.1 (Continued)
(b) January 1, 2019

Right-of-Use Asset........................................... 571,641
..................................................Lease Liability
571,641
Lease Liability.................................................. 113,864

..................................................................Cash
113,864
December 31, 2019

Interest Expense.............................................. 36,622
..................................................Lease Liability
36,622
Depreciation Expense..................................... 95,274

..................Right-of-Use Asset (£571,641 ÷ 6)
95,274
January 1, 2020
Lease Liability.................................................. 36,622
..............................................Interest Expense
36,622

Lease Liability.................................................. 77,242
..................................................................Cash
113,864
December 31, 2020

..................................................Lease Liability
30,443

...........................................Right-of-Use Asset
95,274
Note to instructor: The guaranteed residual value is not subtracted from the
right-of-use asset for purposes of determining the amortizable base. This
reflects the intangible nature of the right-of-use asset. The lessee records as
a right-of-use asset only the amount of the fair value of the asset it intends
to use up throughout the course of the lease term. The return of the asset to
the lessor is not considered a benefit to the lessee, and thus should not be
included in the right-of-use asset. The right-of-use asset should be amortized to
zero, as all of its benefit is realized through the asset’s use.
(c) A lease incentive does not impact the measurement of the lease liability.
However, a reduction in the right-of-use asset must be made. Thus, the right-of-
use asset would be measured at £566,641 (£571,641 – £5,000).
The prepayment of rent by the lessee should be recorded as an asset in the form
of an increased right-of-use asset. Therefore, the right-of-use asset would
initially be measured at £576,641 (£571,641 + £5,000).
PROBLEM 21.2
(a) The $550,000 is the present value of the five annual lease payments of
$120,987 to be made at the beginning of each year discounted at 5% since
the lessee knows the implicit rate.
(b) Right-of-Use Asset........................................... 550,000

..................................................Lease Liability
550,000
($120,987 X Present value of annuity-due
........ factor for 5 years at 5% : $120,987 X
................................... 4.54595 = $550,000*)
*Rounded.
Lease Liability.................................................. 120,987

..................................................................Cash
120,987
(c) Depreciation Expense..................................... 220,000

220,000
....................... ($550,000 X 40% = $220,000)

..................................................Lease Liability
21,451
........................ (See amortization schedule)
(d) Lease Liability.................................................. 120,987

..................................................................Cash
120,987
CAGE COMPANY (Lessee)

Annual Reduction
Lease Interest (5%) of Lease Lease
Date Payment on Liability Liability Liability
1/1/19 $550,000
1/1/19 $120,987 $ –0– $120,987 429,013
1/1/20 120,987 21,451 99,536 329,477
1/1/21 120,987 16,474 104,513 224,964
(e) CAGE COMPANY

Statement of Financial Position (Partial)
December 31, 2019
Assets Liabilities
Non-current assets: Current:
*The
Right-of-use Asset $330,000 Lease liability $120,987*
current
portion
Noncurrent:
of the
Lease liability $329,477**
lease
liability will contain a component for the accrued interest expense to be paid on the lease
liability ($429,013 X 5% = $21,451) plus a component for the reduction of the original lease
liability ($120,987 – $21,451 = $99,536).
**See amortization schedule from part (d).
(f) Insurance payments are an executory cost. Assuming a gross lease, the
insurance payments must be included in the present value of the lease payments
when initially valuing the lease liability. Therefore, the initial liability would be
measured as follows:
Present value of rental payments (see part b) $550,000

Present value of insurance payments
($2,000 X 4.54595*)........................................ 9,092
Lease Liability.................................................. $559,092
* PV of an annuity-due of $1 for 5 periods at 5%.
PROBLEM 21.3
(a) December 31, 2019

..................................................Lease Liability
175,888*
........... (To record leased asset and related
.................. liability at the present value of
........ 5 future annual payments of €40,000
............ plus a bargain-purchase option of
........................................................................... €5,000 discounted at 8%)
*(€40,000 X 4.31213**) + (€5,000 X .68058***) = €175,888

**Present value of an annuity-due of 1 for 5 periods at 8%.
***Present value of 1 for 5 periods at 8%.
December 31, 2019

Lease Liability.................................................. 40,000
..................................................................Cash
40,000
............ (To record the first rental payment)
(b) LUDWICK STEEL SA (Lessee)

(Annuity-Due Basis)
Annual Reduction
Lease Interest (8%) of Lease Lease
Date Payment on Liability Liability Liability
12/31/19 — — — €175,888
12/31/19 €40,000 € 0 €40,000 135,888
12/31/20 40,000 10,871 29,129 106,759
12/31/21 40,000 8,541 31,459 75,300
12/31/22 40,000 6,024 33,976 41,324
12/31/23 40,000 3,306 36,694 4,630
12/31/24 5,000 370 4,630 0
December 31, 2020

25,127
(To record amortization of the right-of-use
........ asset based on a cost to Ludwick of
................... €175,888 and a life of 7 years)
December 31, 2020

Lease Liability.................................................. 29,129
..................................................................Cash
40,000
.......... (To record annual payment on lease
......... liability of which €10,871 represents
...... interest at 8% on the unpaid principal
................................................. of €135,888)
(c) December 31, 2021

Depreciation Expense........................................ 25,127
..............................................Right-of-Use Asset
25,127
... (To record annual amortization on leased
.............................................................................. assets)
Interest Expense................................................. 8,541

Lease Liability..................................................... 31,459
.....................................................................Cash
40,000
............. (To record annual payment on lease
.............. liability of which €8,541 represents
......... interest at 8% on the unpaid principal
.................................................... of €106,759)
(d) LUDWICK STEEL SA

Statement of Financial Positon (Partial)
December 31, 2021
Non-current assets: Current liabilities:

Right-of-Use asset €125,634* Lease liability €33,976**
Long-term liabilities:
Lease liability €41,324***
*€175,888 – (€25,127 X 2)
**Reduction of lease liability in 2022 (see schedule in part (b)).
***Lease liability as of 12/31/21 less the reduction of lease liability in 2022
(€75,300 – €33,976)
PROBLEM 21.4
Entries on August 1, 2019:
(1) Right-of-Use Asset...................................... 4,119,480

..............................................Lease Liability
4,119,480
The leased computer and the related liability are recorded at the present
value of the lease payments as follows: $40,000 X 102.987 = $4,119,480.
(2) Lease Liability............................................ 40,000

............................................................Cash
40,000
Explanation: This entry is to record the August 1, 2019, first payment under
the lease agreement. No interest is recognized on August 1 because the
agreement began on that date, and no time as elapsed.
Entries on August 31, 2019:
(1) Interest Expense........................................ 20,397

............................................Lease Liability
20,397
Explanation and computation: Interest accrued on the unpaid balance of the

lease liability from August 1 to August 31, 2019, is computed as follows:
($4,119,480 – $40,000) X .005 = $20,397.
(2) Depreciation Expense............................... 28,608

.....................................Right-of-Use Asset
28,608
Explanation and computation: Amortization is recorded for one month of the

use of computer using the lease term: ($4,119,480 ÷ 12) X 1/12 = $28,608.
PROBLEM 21.5
(a) GRISHELL TRUCKING

Schedule to Compute the Discounted Present Value
of Terminal Facilities and the Related Obligation
January 1, 2019
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, 2029 2,496,541
Discount to January 1, 2019
............................... ($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%.
*The calculation could also be done as a pure annuity-due of 1 for 10

periods as follows ($2 rounding difference):
First 10 annual payments ............................. $800,000

Present value of an annuity-due of 1 for
10 years at 6%............................................ X 7.80169 $6,241,352
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). The $1 bargain purchase option is not included in this
computation because it is immaterial.
(b) GRISHELL TRUCKING

Journal Entries
(1) 1/1/21
Lease Liability ($386,732 + $413,268)......... 800,000

..............................................................Cash
800,000
Partial Amortization Schedule

(Annuity-Due Basis)
Interest (6%)
on Lease Reduction of
Lease Liability Lease Lease
Date Payment Liability Liability
1/1/19 $7,635,410
1/1/19 $800,000 $ 0 $800,000 6,835,410
1/1/20 800,000 410,125 389,875 6,445,535
1/1/21 800,000 386,732 413,268 6,032,267
1/1/22 800,000 361,936 438,064 5,594,203
(2) 12/31/21

190,885
... (To record annual amortization expense
........... on leased assets) ($7,635,410 ÷ 40)
Note: The asset is depreciated over its economic life because a bargain-
purchase option is available at the end of the lease term.
(3)
12/31/21

..................................................Lease Liability
361,936
.......... (To record interest accrual at 6% on
. outstanding lease liability of $6,032,267)
PROBLEM 21.6
(a) This is a sales-type lease for Glaus (lessor), 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. In addition, the present value of the lease
payments is greater than 90% of the asset’s fair value, as shown in part (c).
(b) Calculation of annual rental payment
€700,000 – (€50,000 X .71068*)

= €109,365
6.07569**
*Present value of $1 at 5% for 7 periods.

**Present value of an annuity-due at 5% for 7 periods.
(c) Computation of lease liability, or present value of lease payments:
PV of annual payments: €109,365 X 5.91732* = €647,148
*Present value of an annuity-due at 6% for 7 periods.
Because the guaranteed residual value is equal to the expected residual

value, the lessee would not include any amount of the guaranteed residual value
in its calculation of the initial lease liability. Note that Jensen used its
incremental borrowing rate because Jensen does not know the implicit rate.
Note to the Instructor: The lease liability only includes the amount expected
to be owed under a residual value guarantee.
1/1/19
(d) ........................Right-of-Use Asset 647,148
........................................................Lease Liability
647,148
...............................Lease Liability 109,365

........................................................ Cash
109,365
12/31/19

........................................................ (€647,148 ÷ 7)
92,450

........................................................Lease Liability
........................................................ (€647,148 – €109,365) X .
06 .............................................32,267
1/1/20
...............................Lease Liability 109,365*

........................................................
Cash....................................................... 109,365
*The reduction in the liability is composed of two components.

One component is the payment of the accrued interest expense
from the prior period (€32,267) and the other component is the
reduction of the initial lease liability recorded (€77,098).
12/31/20

92,450

........................................................Lease Liability
27,641
......................................................... [(€647,148 – €109,365 –
......................................................... €77,098) X .06]
1/1/19
(e) ..........................Lease Receivable 700,000
......................Cost of Goods Sold 525,000
........................................................Sales Revenue
700,000
........................................................ Inventory
525,000
...............................................Cash 109,365
........................................................Lease Receivable
109,365
12/31/19
..........................Lease Receivable 29,532

........................................................Interest Revenue
........................................................ [(€700,000 – €109,365) X .
05] .............................................29,532
1/1/20
...............................................Cash 109,365
........................................................Lease Receivable
109,365
12/31/20
..........................Lease Receivable 25,540

........................................................Interest Revenue
........................................................... (€700,000 – €109,365 –
........................................................... €79,833) X .05
25,540
(f) PV of annual payments

(€109,365 X 5.91732*) €647,148
PV of amount probable to be owed
[(€50,000 – €40,000) X .66506**] €6,651
Lease Liability €653,799
*Present value of an annuity-due for 7 periods at 6%.

**Present value of $1 for 7 periods at 6%.
In this case, the guaranteed residual value is greater than the expected residual
value. Therefore, the lessee must include the present value of the amount
probable to be owed under the guaranteed residual value in its calculation of the
initial lease liability.
LO: 2, 3, Bloom: AN, Difficulty: Simple, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
PROBLEM 21.7
(a) The noncancelable lease is a sales-type lease because: (1) the lease term is
for 83% (10 ÷ 12) of the economic life of the leased asset, and
(2) the present value of the lease payments exceeds 90% of the fair value of
the leased property (see calculation below).
1. Lease Receivable:
Present value of annual payments of $60,000
made at the beginning of each period for 10 years,
R$60,000 X 8.10782 (PV of an annuity-due at 5%)
R$486,469
Present value of guaranteed residual value,
R$15,000 X .61391 (PV of $1 at 5% for 10 years)
9,209
........................Present value of lease payments
R$495,678
2. Sales price is the same as the present value of

lease payments................................................. R$495,678
3. Cost of sales is the cost of manufacturing the

x-ray machine................................................... R$300,000
(b) AMIRANTE SA (Lessor)

(Annuity-Due basis, guaranteed residual value)
Annual Lease Interest (5%) Recovery

Beginning Payment Plus on Lease of Lease Lease
of Year Residual Value Receivable Receivable Receivable
(a) (b) (c) (d)
Initial PV — — — R$495,678
1 R$ 60,000 — R$ 60,000 435,678
2 60,000 R$ 21,784 38,216 397,462
3 60,000 19,873 40,127 357,335
4 60,000 17,867 42,133 315,202
5 60,000 15,760 44,240 270,962
6 60,000 13,548 46,452 224,510
7 60,000 11,226 48,774 175,736
8 60,000 8,787 51,213 124,523
9 60,000 6,226 53,774 70,749
10 60,000 3,537 56,463 14,286
End of 10 15,000 714 14,286 0
R$615,000 R$119,322 R$495,678
(a) Annual lease payments and guaranteed residual value.

(b) Preceding balance of (d) X 5%, except beginning of first year of lease
term.
(c) (a) minus (b).
(d) Preceding balance minus (c).
(c) Lessor’s journal entries:
Beginning of the Year

Lease Receivable............................................. 495,678
Cost of Goods Sold......................................... 300,000
..................................................Sales Revenue
495,678
...........................................................Inventory
300,000
...............(To record lease receivable and sale)
Selling Expenses............................................. 14,000
..................................Accounts Payable/Cash
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

Lease Receivable................................................ 21,784
.................................................Interest Revenue
21,784
................ (To record interest during the first
............................................ year of the lease)
LO: 3, 4, Bloom: AP, Difficulty: Complex, Time: 30-40, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
PROBLEM 21.8
(a)
For purposes of measuring the initial lease liability, only probable amounts
expected to be owed under the residual value guarantee should be included.
That is, only the present value of the difference between
the residual value guarantee and the expected residual value at the end of
the lease term should be included. The calculation of the initial value of the
lease liability is as follows:
PV of Lease Liability:
PV of rental payments, R$60,000 X 8.10782............ R$486,469
PV of guaranteed residual expected to be owed
[(R$15,000 – R$10,000) X .61391].......................... 3,070
Initial lease liability.................................................... R$489,539
(b) CHAMBERS MEDICAL (Lessee)

(Annuity-Due Basis, GRV)
Annual Lease Interest (5%) Reduction

Beginning Payment Plus on Unpaid of Lease Lease
of Year GRV Liability Liability Liability
(a) (b) (c) (d)
Initial PV R$489,539
1 R$ 60,000 R$ 0 R$ 60,000 429,539
2 60,000 21,477 38,523 391,016
3 60,000 19,551 40,449 350,567
4 60,000 17,528 42,472 308,095
5 60,000 15,405 44,595 263,500
6 60,000 13,175 46,825 216,675
7 60,000 10,834 49,166 167,509
8 60,000 8,375 51,625 115,884
9 60,000 5,794 54,206 61,678
10 60,000 3,084 56,916 4,762
End of 10 5,000 238 4,762 0
R$605,000 R$115,461 R$489,539
(a) Annual lease payments and amount expected to be owed under residual value
guarantee.
(b) Preceding balance of (d) X 5%, except beginning of first year of lease term.
(c) (a) minus (b).
(c) Lessee’s journal entries:

..................................................Lease Liability
489,539
.... (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
.................................................... obligation)
End of the Year

..................................................Lease Liability
21,477
.... (To record accrual of annual interest on
..................................... lease obligation)
Amortization Expense..................................... 48,954

48,954
.......... (To record amortization expense for
............. year 1 using straight-line method
.............................. [R$489,539 ÷ 10 years])
Note to instructor: The guaranteed residual value is not subtracted from the
right-of-use asset for purposes of determining the amortizable base. This
reflects the intangible nature of the right-of-use asset. The lessee records as
a right-of-use asset only the amount of the fair value of the asset it intends
to use up throughout the course of the lease term. The return of the asset to
the lessor is not considered a benefit to the lessee, and thus should not be
included in the right-of-use asset. The right-of-use asset should be amortized to
zero, as all of its benefit is realized through the asset’s use.
(d) The document preparation costs are considered initial direct costs. As
such, they will impact the initial measurement of the right-of-use asset, but will
not affect the lease liability. The right-of-use asset must be increased as a result
of any initial direct costs incurred. Therefore, under the new circumstances, the
initial measurement of the right-of-use asset would be R$496,539 (R$489,539 +
R$7,000).
PROBLEM 21.9
(a) The lease is a sales-type lease because: (1) the lease term exceeds 75% of
the asset’s estimated economic life (10/12 = 83%), and (2) the present value of
the lease payments is greater than 90% of the fair value of the asset, as
calculated below:
¥ 40,000 Annual rental payment

¥ 289,876 PV of periodic rental payments
¥ 289,876 PV of periodic rental payments

÷ 299,140 Fair value of check-in kiosk
96.90% Rental payments percentage of fair value
1.
Present value of an annuity-due of $1 for
.......................................................................................................... 10 periods
discounted at 8%............................................................................ 7.24689
.......................................................................................................... Annual lease
payment........................................................................................... X ¥ 40,000
..........................................................................................................Present value of
the 10 rental payments................................................................... ¥289,876
.......................................................................................................... Add: Present
value of estimated residual
.......................................................................................................... value of
¥20,000 in 10 years at 8%
.......................................................................................................... (¥20,000 X .
46319) ............................................................................................. ¥ 9,264
..........................................................................................................Lease receivable
at commencement.......................................................................... ¥299,140
2. Sales revenue is ¥289,876 (the present value of the 10 annual lease

payments) or, the lease receivable of ¥299,140 minus the PV of the un-
guaranteed residual value of ¥9,264.
3. Cost of goods sold is ¥170,736 (the ¥180,000 cost of the asset less the
present value of the unguaranteed residual value of ¥9,264). The ¥4,000
in sales commissions are not included in the cost of goods sold, though
they would be expensed separately by the lessor.
(b) Kobayashi Group (Lessor)

Annuity-Due Basis, Unguaranteed Residual Value
Annual Lease Interest (8%) Lease

Beginning Payment Plus on Lease Receivable Lease
of Year Residual Value Receivable Recovery Receivable
(a) (b) (c) (d)
Initial PV ¥299,140
1 ¥ 40,000 ¥ 0 ¥ 40,000 259,140
2 40,000 20,731 19,269 239,871
3 40,000 19,190 20,810 219,061
4 40,000 17,525 22,475 196,586
5 40,000 15,727 24,273 172,313
6 40,000 13,785 26,215 146,098
7 40,000 11,688 28,312 117,786
8 40,000 9,423 30,577 87,209
9 40,000 6,977 33,023 54,186
10 40,000 4,335 35,665 18,521
End of 10 20,000 1,479* 18,521 0
¥420,000 ¥120,860 ¥299,140
*Rounding is ¥3.
(a) Annual lease payment (and return of expected residual value at end of
the lease).
(b) Preceding balance of (d) X 8%, except beginning of first year of lease
term.
(c) (a) minus (b).
(c) Beginning of the Year

..................................................Sales Revenue
289,876
...........................................................Inventory
180,000
. (To record the sale and the cost of goods
.................... sold in the lease transaction)
Selling Expenses............................................. 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 Revenue
20,731
........................ (To record interest during the
.................................... first year of the lease)
LO: 3, Bloom: AP, Difficulty: Complex, Time: 30-40, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
PROBLEM 21.10
(a) Initial Lease Liability:

Lease payments (¥40,000) X PV of an
................. annuity-due for 10 periods at 8% (7.24689)
¥289,876
(b) JAL (Lessee)

(Annuity-due basis and URV)
Interest (8%) Reduction

Beginning Annual Lease on Lease of Lease Lease
of Year Payment Liability Liability Liability
(a) (b) (c) (d)
Initial PV — — — ¥289,876
1 ¥ 40,000 — ¥ 40,000 249,876
2 40,000 ¥ 19,990 20,010 229,866
3 40,000 18,389 21,611 208,255
4 40,000 16,660 23,340 184,915
5 40,000 14,793 25,207 159,708
6 40,000 12,777 27,223 132,485
7 40,000 10,599 29,401 103,084
8 40,000 8,247 31,753 71,331
9 40,000 5,706 34,294 37,037
10 40,000 2,963 37,037 0
¥400,000 ¥110,124 ¥289,876
(a) Annual lease payment required by lease contract.

(b) Preceding balance of (d) X 8%, except beginning of first year of lease term.
(c) (a) minus (b).
(c) Lessee’s journal entries:

..................................................Lease Liability
289,876
............... (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

..................................................Lease Liability
19,990
.... (To record accrual of annual interest on
.............................................. lease liability)

28,988
.......... (To record amortization expense for
........................... first year [¥289,876 ÷ 10])
LO: 2, Bloom: AP, Difficulty: Complex, Time: 30-40, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
PROBLEM 21.11
(a) The lease agreement satisfies the 90% of fair value requirement (calculation
below).
PV of Lease Payments:
PV of rental payments, $30,300 X 7.24689*.............. $219,581
PV of guaranteed residual value, $50,000 X .46319**
23,160
PV of Lease Payments............................................... $242,741
Fair value of the asset............................................... ÷ 242,741
Percentage of fair value of the leased asset........... 100%
For the lessor, it is a sales-type lease.
Note to Instructor: For purposes of measuring the initial lease liability, only
amounts expected to be owed under the residual value guarantee should be
included. That is, only the present value of the difference between the
residual value guarantee and the expected residual value at the end of the
lease term should be included. The calculation of the initial value of the
lease liability is as follows:
PV of Lease Liability:
PV of rental payments, $30,300 X 7.24689*.............. $219,581
PV of guaranteed residual expected to be owed
[($50,000 – $45,000) X .46319**]............................ 2,316
Initial lease liability.................................................... $221,897

(b) January 1, 2019

Lessee:
..................................................Lease Liability
221,897
(see calculation in part a)
Lease Liability.................................................. 30,300

..................................................................Cash
30,300
January 1, 2019
Lessor:
..................................................Sales Revenue
242,741
...........................................................Inventory
180,000
Cash.................................................................. 30,300
30,300
December 31, 2019

Lessee:
..................................................Lease Liability
.......................... [($221,897– $30,300) X .08]
15,328

.............................................. ($221,897 ÷ 10)
22,190
December 31, 2019

Lessor:
....................................................Lease Revenue
............................. [($242,741 – $30,300) X .08]
16,995
(c) In both (1) and (2), the lessee is no longer obligated or expected to make any
payment at the end of the lease. As a result, there should be no amount of
the residual value included in the lessee’s initial measurement of the lease
liability or right-of-use asset. Thus, in both (1) and (2), the amount of the
initial lease liability is $219,581, or the present value of the annual rental
payments (see part a for calculation).
(d) While the lessor still includes even an unguaranteed residual value in the
calculation of a lease receivable under a finance (sales-type) lease, the lack
of a residual value guarantee in this case could lead the lease to be
classified as an operating lease, as present value of the lease payments may
be less than 90% of the fair value of the asset. As a result, the lessor might
not remove the asset from its books at all, but rather continue to depreciate
the asset as normal and book lease revenue as it receives and earns rental
payments. In this situation ($219,581 ÷ $242,741 = 90.5%) the present value
test is still met and the lease is classified as a sales-type lease.
PROBLEM 21.12
(a) The lease should be treated as a sales-type lease by Ewing. The lease
qualifies for 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. In addition, the engines are specially built for the lessee.
Present Value of Lease Payments

...................................................€384,532 X 7.80169*
€3,000,000
*Present value of an annuity-due at 6% for 10 years, rounded by $1.
Dealer Profit
....................Sales (present value of lease payments)
€3,000,000
...................................................Less: Cost of engines
2,600,000
.................................................................Profit on sale
€ 400,000
(b) Right-of-Use Asset..................................... 3,000,000

............................................Lease Liability
3,000,000
(c) Lease Receivable....................................... 3,000,000

Cost of Goods Sold................................... 2,600,000
...........................................Sales Revenue
3,000,000
.....................................................Inventory
2,600,000
(d) Lessee (January 1, 2019)

Lease Liability............................................ 384,532
............................................................Cash
384,532
Lessor (January 1, 2019)

Cash............................................................ 384,532
.......................................Lease Receivable
384,532
(e) WINSTON INDUSTRIES/EWING
Annual
Lease Interest on Reduction in Lease
Receipt/ Receivable/ Receivable/ Receivable/
Date Payment Liability at 6% Liability Liability
1/1/19 €3,000,000
1/1/19 €384,532 € –0– €384,532 2,615,468
1/1/20 384,532 156,928 227,604 2,387,864
1/1/21 384,532 143,272 241,260 2,146,604
Lessee
December 31, 2019
Interest Expense........................................ 156,928
............................................Lease Liability
156,928
Depreciation Expense............................... 300,000

.......Right-of-Use Asset (€3,000,000 ÷ 10)
300,000
Lessor December 31, 2017
Lease Receivable....................................... 156,928
........................................Interest Revenue
156,928
(f) WINSTON INDUSTRIES

December 31, 2019
Non-current assets: Current liabilities:
Right-of-Use €2,700,000* Lease liability €384,532**
asset
Lease liability €2,387,864***
(See amortization
schedule in part (e))
*€3,000,000 – (€3,000,000 ÷ 10)

**Lease payments in 2020 (on January 1) will be the following:
Lease Liability............................................ 384,532

............................................................Cash
384,532
Part of the reduction in the lease liability will be attributable to the

previously accrued interest expense, and part will be a reduction of the
initial lease liability recorded. Nonetheless, the full payment will be a
reduction in lease liability in the following year, and should be classified as
current.
***€3,000,000 – €384,532 + €156,928 – €384,532
EWING SA
December 31, 2019
Assets
Current assets:
.........................................................Lease receivable €
384,532*
Noncurrent assets:
.........................................................Lease receivable
€2,387,864**
Note: The title Net Investment in leases is sometimes shown instead of

Lease receivable.
*Lease receivable is composed of accrued interest revenue (€156,928) as
well as the planned reduction of the initial lease receivable (€227,604).
**€2,615,468 – €227,604
(g) Legal fees incurred in connection with a lease are considered initial
direct costs of the lease, and should be capitalized as part of the right-of-use
asset. In contrast, lease incentives reduce the initial value of the right-of-use
asset. However, neither initial direct costs nor lease incentives affect the value of
the lease liability. Thus, the entry to initially record the lease is as follows:
Right-of-Use Asset..................................... 2,980,000

Cash (€50,000 – €30,000)........................... 20,000
............................................Lease Liability
3,000,000
LO: 2, 3, 4, Bloom: AP, Difficulty: Moderate, Time: 35-45, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
PROBLEM 21.13
(a) 1. £ 20,027 Interest expense (See amortization

schedule)
£ 52,174 Depreciation expense (£313,043 ÷ 6 =
£52,174)
2. Current liabilities:
£ 62,700 Lease liability
£207,670 Lease liability
Non-current assets:
£260,869 Right-of-Use asset (£313,043 –
£52,174)
3. £ 16,614 Interest expense (See amortization

schedule)
£52,174)
£161,584 Lease liability
Non-current Assets:
£208,695 Right-of-Use Asset
(b) 1. £ 5,007 Interest expense (£20,027 X 3/12 = £5,007)

£ 13,044 Depreciation expense
(£313,043 ÷ 6 = £52,174;
(£52,174 X 3/12 = £13,044)
£ 47,680 Lease liability (£42,673 + £5,007)
£207,670 Lease liability (£250,343 + £5,007 –
£47,680)
Non-current Assets:
£299,999 Right-of-Use Asset (£313,043 –
£13,044)
3. £ 19,174 Interest expense

[(£20,027 – £5,007) + (£16,614 X 3/12) =
[£15,020 + £4,154 = £19,174]
£52,174)
(£46,086 + [£16,614 X 3/12] =
[£46,086 + £4,154 = £50,240)
£161,584 Lease liability (£207,670 + £4,154 –
£50,240)
Property, plant, and equipment:

£247,825 Right-of-Use Asset (£313,043 –
£13,044 – £52,174)
PROBLEM 21.14
(a) The lease will be classified as an operating lease for the lessor. The lease
does not transfer ownership at the end of the lease term, does not have a
bargain purchase option, and the asset is not specialized. In addition,
neither the 75% test (3 ÷ 8 = 37.5%) nor the 90% test (calculation below) are
met.
PV of Lease Payments:
PV of rental payments, R$10,521 X 2.83339*........... R$29,810
Fair value of the asset............................................... ÷ 55,000
Percentage of fair value of the leased asset........... 54.20%
(b)
GARCIA SA
Annuity-Due Basis
Reduction
1/1/19 R$29,810
1/1/19 R$10,521 R$ 0 R$10,521 19,289
1/1/20 10,521 1,157 9,364 9,925
1/1/21 10,521 596 9,925 0
(c)
January 1, 2019
..................................................Lease Liability
29,810
(see calculation in part a)
Lease Liability.................................................. 10,521

..................................................................Cash
10,521
December 31, 2019

..............................................................Interest Expense 1,157
..........................................................................................Lease Liability
.................................................................................1,157
......Depreciation Expense (R$29,810 ÷ 3)……………… 9,937
..........................................................................................Right-of-Use Asset
.................................................................................9,937
(d)
January 1, 2019
Cash.................................................................. 10,521
...............................Unearned Lease Revenue
10,521
December 31, 2019

Unearned Lease Revenue.................................. 10,521
....................................................Lease Revenue
10,521

.............................Accumulated Depreciation –
.................. Leased Machinery (R$40,000 ÷ 8)
5,000
(e)When a lessee elects to use the short-term lease option, the company need not
recognize a lease liability or right-of-use asset on its books. Instead, the lessee
expenses payments as they are made.
As a result, if the lease were only 1 year, Garcia’s only entry for the lease would be
the following:
January 1, 2019
Lease Expense................................................. 10,521
..................................................................Cash
10,521
PROBLEM 21.15
(a) The lease is an operating lease to the lessor because:
1. it does not transfer ownership,

2. it does not contain a bargain purchase option,
3. it does not cover at least 75% of the estimated economic life (5/7 =
71%) of the crane, and
4. the present value of the lease payments is not at least 90% of the fair
value of the leased crane.
R$48,555 annual lease payments X PV of an annuity-due at 8% for 5 years

R$48,555 X 4.31213 = R$209,375, which is less than R$216,000 (90% X
R$240,000).
5. it does not meet the specialized asset test.
At least one of the five tests would have had to be satisfied for the lease to
be classified as other than an operating lease.
(b) Lessee’s Entries

1/1/19
Right-of-Use Asset.............................................. 209,375
.....................................................Lease Liability
209,375
Lease Liability..................................................... 48,555

.....................................................................Cash
48,555
ABRIENDO CONSTRUCTION
Annuity-Due Basis
Reduction
1/1/19 R$209,375
1/1/19 R$48,555 R$ 0 R$48,555 160,820
12/31/19 48,555 12,866 35,689 125,131
12/31/20 48,555 10,010 38,545 86,586
12/31/21 48,555 6,927 41,628 44,958
12/31/19
Interest Expense................................................. 12,866
.....................................................Lease Liability
12,866
Depreciation Expense (R$209,375 ÷ 5)..................... 41,875

.............................................Right-of-Use Asset
41,875
Lessor’s Entries
1/1/19
Cash..................................................................... 48,555
..................................Unearned Lease Revenue
48,555
12/31/19
Accumulated Depreciation—Leased Equipment
......................... [(R$240,000 – R$15,000) ÷ 7]
32,143
Unearned Lease Revenue.................................. 48,555

....................................................Lease Revenue
48,555
(c) Abriendo as lessee must record both a lease liability, as well as a right-of-use
asset. The first cash payment is a total reduction of the lease liability (as no
time has passed, and thus no interest has accrued). At the end of the year,
Abriendo must make an accrual for the annual lease expense. In this case,
since the payment does not occur until the first day of the following year,
Abriendo must accrue a lease liability equal to the amount of interest for
2019. In addition, Abriendo depreciates the asset similar to other fixed assets.
In the statement of financial position, Abriendo will present a right-of-use
asset of R$167,500 (R$209,375 – R$41,875) and a lease liability of R$173,686
(R$209,375 – R$48,555 + R$12,866). In the income statement, Abriendo will
show Interest Expense of R$12,866 and Depreciation Expense of R$41,875.
Cleveland as lessor must disclose in the statement of financial position or in

the notes the cost of the leased crane (R$240,000) and the accumulated
depreciation of R$32,143 separately from assets not leased. Additionally,
Cleveland must disclose in the notes the minimum future rentals as a total of
R$194,220, and for each of the succeeding four years: 2020—R$48,555; 2021
—R$48,555; 2022—R$48,555; 2023—R$48,555.
The income statement for the lessor reports lease revenue of R$48,555. While
this amount was initially unearned, Cleveland earned that revenue through the
passing of time that the crane was leased. As a result, at the end of the year,
Cleveland makes an adjusting entry to recognize that revenue.
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 leases to be
capitalized by the lessee and how a lease is recorded at its commencement 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 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 classification 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 three leases. The student determines how the
amount to be recorded as a liability at the commencement of each lease, and how the lessee should record
each lease payment for each lease.

Purpose—to provide the student with a lease arrangement with a bargain-purchase option in order to examine
the ethical issues of lease accounting.

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.
*CA 21.6 (Time 15–25 minutes)

Purpose— The student is required to discuss the accounting issues related to a sale-leaseback.
SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 21.1
(a) The IASB believes that the reporting of an asset and liability for a lease arrangement is
consistent with the conceptual framework definition of assets and liabilities. That is, assets are
probable future economic benefits obtained or controlled by a particular entity as a result of past
transactions or events. Liabilities are probable future sacrifices of economic benefits arising
from present obligations of a particular entity to transfer assets or provide services to other
entities in the future as a result of past transactions or events. All leases are capitalized since
the right-to-use is an asset and a liability is incurred.
(b) Evans should account for this lease at its commencement as an asset and an obligation at an
amount equal to the present value at the beginning of the lease term of lease payments during
the lease term. From the information provided, this lease represents transfer of ownership.
(c) Evans will incur interest expense equal to the interest rate used to capitalize the lease at its
commencement multiplied by the appropriate net carrying value of the lease liability at the
beginning of the period.
In addition, Evans will incur an expense relating to depreciation of the cost of the right-of-use
asset. This depreciation should be based on the lease term and depreciated in a manner
consistent with Evans’ normal depreciation policy for owned assets.
(d) The right-of-use asset recorded under the finance lease should be classified on Evans’
December 31, 2019, statement of financial position as noncurrent and should be separately
identified by Evans in its statement of financial position or footnotes thereto. The related
obligation recorded under the finance lease should be reported on Evans’ December 31, 2019,
statement of financial position appropriately classified into current and noncurrent liabilities
categories and should be separately identified by Evans in its statement of financial position.
LO: 2, Bloom: AN, Difficulty: Moderate, Time: 15-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
CA 21.2
(a) (1) 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 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).
(2) The amount recorded as an asset on Sylvan’s books should be shown in the non-current
asset section of the statement of financial position as “Right-of-Use Asset” or another
similar title. At the same time as the asset is recorded, a corresponding liability (“Lease
Liability” or similar title) is recognized in the same amount. This liability is classified as both
current and noncurrent, 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 recognized through
depreciation taken on the asset 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 commencement, the
term of the lease is the appropriate life for depreciation purposes. The lease payments
represent a payment of principal and interest at each payment date. Interest expense is
computed at the rate at which the lease payments were discounted and 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.
(3) The lessee should make the following qualitative disclosures:
 Nature of its leases, including general description of those leases.

 How variable lease payments are determined.
 Existence and terms and conditions for options to extend or terminate the lease and
for residual value guarantees.
 Information about significant assumptions and judgments (e.g., discount rates).
In addition the quantitative information that should be disclosed by the lessee is as follows:
 Total lease cost.

 Finance lease cost, segregated between the depreciation of the right-of-use assets
and interest on the lease liabilities.
 Low-value and short-term lease cost.
 Weighted-average remaining lease term and weighted-average discount rate.
 Maturity analysis of lease liabilities, on an annual basis for a minimum of each of the
next five years, the sum of the undiscounted cash flows for all years thereafter.
CA 21.2 (Continued)
(b) (1) Based on the given facts, Breton has entered into a sales-type lease. The discounted
present value of the lease payments is in excess of 90 percent of the fair value of the asset
at commencement of the lease arrangement and collectibility of lease payments is
probable.
(2) Breton should record a Lease Receivable for the present value of the lease payments and
the present value of the residual value. It might be noted that since the residual value is
unguaranteed that Breton may choose to record the residual value in a separate account
and not include the residual value in the lease receivable amount. 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 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 income 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:
 Lease-related income, including profit and loss recognized at lease commencement
for sales-type leases, and Interest Income.
 Income from variable lease payments not included in the lease receivable.
 The components of the net investment in finance leases, including the carrying
amount of the lease receivable, the unguaranteed residual asset.
 A maturity analysis for lease payments and a separate maturity analysis for the lease
receivable.
 Management approaches for risk associated with residual value of leased assets (e.g.,
buyback agreements or third party insurance).
LO: 2, 4, Bloom: AN, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
CA 21.3
(a) For Lease L, Santiago SA should record as a liability at the commencement of the lease an
amount equal to the present value of the lease payments during the lease term.
For Lease M, Santiago SA should record as a liability at commencement of the lease an amount
determined in the same manner as for Lease L plus the bargain purchase option should be
included in the lease payments at its present value.
For Lease N, Santiago SA should record as a liability at the commencement of the lease the
present value of the lease payments.
CA 21.3 (Continued)
(b) For Lease L, M, and N, Santiago Company should apply the finance lease method and allocate
each lease payment between a reduction of the liability and interest expense so as to produce a
constant periodic rate of interest on the remaining balance of the liability. Thus, the interest
expense and depreciation of the right-of-use asset will not equal the lease payment.
LO: 2, 4, Bloom: AN, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
CA 21.4
(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 recorded at the lower amount. On the other hand, if
Buchanan cannot or will not provide substantiation, she would appear to be trying to manipulate
the financial statements to reduce the recorded lease liability and to increase net income in the
earlier years of the lease term.
(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 higher 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.
LO: 2, 4, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, Reflective Thinking, AICPA BB: Professional Demeanor, Problem Solving, AICPA FC: Reporting,
AICPA PC: None
*CA 21.5
Memorandum Prepared by: (Your Initials)

Date:
HOCKNEY PLC
December 31, 2019
Reclassification of Leased Auto
While performing a routine inspection of the client’s garage, I found a used 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 it was only being leased, it was not listed
along with other company assets. Having elected to account for this agreement as a short-term lease,
Hockney, Inc. had charged £3,240 to 2019 rent expense.
CA 21.5 (Continued)
Examining the noncancelable lease agreement entered into with Crown New and Used Cars on
January 1, 2019, I determined that the automobile should be capitalized as a finance lease because
its lease term is greater than 1 year.
I advised the client to capitalize this lease at the present value of its rental payments: £5,778 (the present
value of the monthly payments). After inquiring of management about the residual value expected at the
end of the lease agreement, and ensuring management’s significant judgments and assumptions were
reasonable, I determined that the expected residual value of the lease equals the guaranteed residual
value, and thus none of the residual value guarantee should be included in the initial measurement of the
lease liability or right-of-use asset (as no amount is expected to be owed under the residual value
guarantee). The following journal entry to record the initial lease liability and related right-of-use asset
was suggested to management:
Right-of-Use Asset................................................................... 5,778

...........................................................................Lease Liability
5,778
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........................................................................... 2,778

Interest Expense (8% X £5,778).............................................. 462
...........................................................................Rent Expense
3,240
Finally, this vehicle must be amortized over its lease term, using the straight-line method. I computed
annual amortization of £2,889 (the initial right-of-use asset, £5,778, divided by the 2-year lease term).
The client was advised to make the following entry to record 2019 amortization:
Depreciation Expense.............................................................. 2,889

...................................................................Right-of-Use Asset
2,889
LO: 2, 4, Bloom: AP, Difficulty: Moderate, Time: 30-40, AACSB: Analytic, AICPA BB: Professional Demeanor, AICPA FC: Reporting, AICPA PC: None
*CA 21.6
(a) The major accounting issue is whether the transaction is a sale or a financing. To determine
whether it is a sale, the revenue recognition guidelines are used. That is, if control has passed
from seller to buyer then a sale has occurred. Conversely, if control has not passed from seller
to buyer the transaction is recorded as a financing (often referred to as a failed sale).
(b) This transaction should be reported as a financing as control of the leased asset has not passed
from the seller to the buyer. In essence, Perriman is borrowing money from the purchaser-lessor
(often referred to as a financing or a failed sale). In a financing (failed sale), Perriman:
 does not reduce the carrying value of the building;
 continues to depreciate the building as if it was the legal owner; and
 increases cash and records a note payable.
LO: 5, Bloom: AN, Difficulty: Moderate, Time: 15-25, AACSB: Analytic, AICPA BB: None, AICPA FC:
Reporting, AICPA PC: None
FINANCIAL REPORTING PROBLEM
(a) M&S uses both finance leases and operating leases.
(b) M&S reported finance leases of £48.6 million in total, and £0.4 million within
one year.
(c) M&S disclosed future minimum rentals (in millions) under non-cancelable
operating lease agreements as of 30 March 2016, of:
............................................Not later than one year £ 311.3

..........................................Later than one year and
........................................ not later than five years 1,108.4
.........................................Later than five years and
........................................ not later than ten years 1,099.4
.........................................Later than ten years and
.......................................... not later than 15 years 542.8
...........................................Later than 15 years and
...........................................Later than 20 years and
..................................................Later than 25 years 970.3
...........................................................................Total £4,609.9
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 characteristics
of the leases are the assets held under a finance lease are recognized 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 capital leases are set forth below (in
millions):
2015 2014
One year.............................................. € 583 € 655
Two years............................................ 640 539
Three years......................................... 576 548
Four years........................................... 573 513
Five years............................................ 418 508
Over 5 years........................................ 1,259 1,200
€4,049 €3,963
(d) At year-end 2015, the present value of minimum lease payments under
capital leases was €3,789 million. Imputed interest deducted from the future
minimum annual rental commitments was €260 million.
(e) The details of rental expense (in millions) are set forth below:
2015 2014
€1,027 €873
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 130 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 2015 for Delhaize is €555
million (the present value of the future lease payments).
(b) The total rental expense for Delhaize in 2015 was €352,000,000.
(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, 2015, is 44.61% or (€447,000/€1,002,000). The total payments
under operating leases are €1,563,000 and, therefore, the amount
representing interest might be estimated to be €697,254 or (€1,563,000 X
44.61%). Thus, the present value of the net operating payments might be
€865,746.
.........................................Total operating lease payments due

....................................................................................€1,563,000
..............................................................Less estimated interest
..................................................................................... 697,254
.................................Estimated present value of net operating
....................................................................... lease payments
....................................................................................€ 865,746
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
(a) The lease liability is computed as follows:
Present value of lease payments

= €3,057.25 X (PVF-AD3,12)
= (€3,057.25 X 2.69005)
= €8,224.16.
Therefore Salaur makes the following journal entries at the commencement date.
1/1/19
Right-of-Use Asset....................... 8,224.16

Lease Liability....................... 8,224.16
Lease Liability.............................. 3,057.25

Cash....................................... 3,057.25
SALAUR SpA
Annuity-Due Basis
Reduction
Annual Interest (12%) of Lease
Date Payment on Liability Liability Lease Liability
1/1/19 €8,224.16
1/1/19 €3,057.25 € 0 €3,057.25 5,166.91
1/1/20 3,057.25 620.03 2,437.22 2,729.69
1/1/21 3,057.25 327.56 2,729.69 0
ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued)
The entry to record lease expense in 2019 is as follows.
12/31/19
Interest Expense.......................... 620.03

Lease Liability....................... 620.03
Depreciation Expense (€8,224.16 ÷ 3)… 2,741.39
Right-of-Use Asset............... 2,741.39
(b) With the bargain purchase option, Salaur computes the lease liability and
right-of-use asset, as follows.
Present value of lease payments

= €3,057.25 X (PVF-AD3,12)
= (€3,057.25 X 2.69005)
= €8,224.16
Present value of bargain purchase option
= €100 X (PV3,12)
= (€100 X .7118) = 71.18
€8,295.34
Salaur makes the following entries at lease commencement.
1/1/19
Right-of-Use Asset...................... 8,295.34

Lease Liability...................... 8,295.34
Lease Liability.............................. 3,057.25

Cash...................................... 3,057.25
SALAUR SpA
Annual Lease Interest Reduction

Payment Plus (12%) on of Lease Lease
Date BPO Liability Liability Liability
1/1/19 €8,295.34
1/1/19 € 3,057.25 € 0 € 3,057.25 5,238.09
1/1/20 3,057.25 628.57 2,428.68 2,809.41
1/1/21 3,057.25 337.13 2,720.12 89.29
1/1//22 100.00 10.71 89.29 0
€9,271.75 €976.41 €8,295.34
12/31/19
Interest Expense.......................... 628.57

Lease Liability...................... 628.57
Depreciation Expense................. 1,659.07

Right-of-Use Asset
($8,295.34 ÷ 5).................. 1,659.07
Note that the right-of-use asset is amortized over the economic life (5 years) of
the asset, as Salaur is expected to purchase the computers at the end of the
lease.
Analysis
While all leases with terms longer than one year are capitalized (recorded on the
statement of financial position), the amounts differ depending on whether the
lease is classified as a finance or operating lease. As indicated in the entries
above, the right-of-use asset increases and the denominator of the return on
assets ratio (ROA = Net income ÷ Average assets) will increase, but by different
amounts (generally by more with a finance lease, and by higher amounts in the
early years of a finance lease). The classification tests are designed such that
leases that represent an in-substance purchase, will increase the denominator
more, which is more representative of the transaction. Similarly, the debt to
assets ratio (Total debt ÷ Total assets) will reflect the obligations, according the
non-cancellable payments required in the lease.
This reporting is in contrast to prior IFRS, under which many operating leases
were not capitalized, which gave the impression that companies with operating
leases looked more profitable and 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 is faithful representation. The lease criteria are

designed to report leases according to their economic substance. Thus, if
through a lease arrangement a company has control of the leased asset (whether
classified as finance or operating), 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 (completeness) if they report all assets and liabilities of the company.
Note to instructor: Under prior IFRS, companies could structure a lease to avoid
capitalization, which detracts from representational faithful reporting of the lease
arrangement, which may not be neutral.
RESEARCH CASE
(a) (1) According to IFRS 16, (paragraphs 26-28), a lessee shall measure the
lease liability at the present value of the lease payments that are not paid at
that date. The lease payments shall be discounted using the interest rate
implicit in the lease, if that rate can be readily determined. If that rate cannot
be readily determined, the lessee shall use the lessee’s incremental
borrowing rate.
The lease payments included in the measurement of the lease liability
comprise the following payments for the right to use the underlying asset
during the lease term that are not paid at the commencement date:
(a) fixed payments less any lease incentives receivable;
(b) variable lease payments that depend on an index or a rate, initially
measured using the index or rate as at the commencement date;
(c) amounts expected to be payable by the lessee under residual value
guarantees;
(d) the exercise price of a purchase option if the lessee is reasonably
certain to exercise that option; and
(e) payments of penalties for terminating the lease, if the lease term
reflects the lessee exercising an option to terminate the lease.
Variable lease payments that depend on an index or a rate described in

paragraph 27(b) include, for example, payments linked to a consumer price
index, payments linked to a benchmark interest rate (such as LIBOR) or
payments that vary to reflect changes in market rental rates.
(2) (paragraphs 23-24) Initial measurement of the right-of-use asset shall

comprise:
(a) the amount of the initial measurement of the lease liability;
(b) any lease payments made at or before the commencement date, less
any lease incentives received;
(c) any initial direct costs incurred by the lessee; and
(d) an estimate of costs to be incurred by the lessee in dismantling and
removing the underlying asset, restoring the site on which it is located
or restoring the underlying asset to the condition required by the terms
and conditions of the lease, unless those costs are incurred to produce
inventories. The lessee incurs the obligation for those costs either at
the commencement date or as a consequence of having used the
underlying asset during a particular period.
RESEARCH CASE (Continued)
(b) According to IFRS 16 (paragraphs 18-19), an entity shall determine the lease
term as the non-cancellable period of a lease, together with both:
1. periods covered by an option to extend the lease if the lessee is reasonably

certain to exercise that option; and
2. periods covered by an option to terminate the lease if the lessee is
reasonably certain not to exercise that option.
In assessing whether a lessee is reasonably certain to exercise an option to

extend a lease, or not to exercise an option to terminate a lease, an entity shall
consider all relevant facts and circumstances that create an economic incentive
for the lessee to exercise the option to extend the lease, or not to exercise the
option to terminate the lease.
(c) IFRS 16 (paragraph 44) indicates that a lessee shall account for a lease
modification as a separate lease if both:
(a) the modification increases the scope of the lease by adding the right to
use one or more underlying assets; and
(b) the consideration for the lease increases by an amount commensurate
with the stand-alone price for the increase in scope and any appropriate
adjustments to that stand-alone price to reflect the circumstances of the
particular contract.
GAAP CONCEPTS AND APPLICATION
GAAP21.1
The accounting for leases is found in Accounting Standards Codification section

842, which was updated in February 2016.
LO: 7, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Global, Communication, AICPA BB: Global, AICPA FC: Reporting, AICPA PC:
Communication
GAAP21.2
The following are similarities and differences between lease accounting under
IFRS and U.S. GAAP.
Similarities
• Both GAAP and IFRS share the same objective of recording leases by
lessees and lessors according to their economic substance—that is,
according to the definitions of assets and liabilities.
• Much of the terminology for lease accounting in IFRS and GAAP is the same.
• Both GAAP and IFRS require lessees to recognize a right-of-use asset and
related lease liability for leases with terms longer than one year.
• Under both IFRS and GAAP, lessors use the same general lease classification
criteria to determine if there is transfer of control of the underlying asset and
if lessors classify leases as sales-type or operating.
• GAAP and IFRS use the same lessor accounting model for leases classified
as sales-type or operating.
• GAAP and IFRS have similar qualitative and quantitative disclosure
requirements for lessees and lessors.
Differences
• There is no classification test for lessees under IFRS 16. Thus, lessees
account for all leases using the finance lease method; that is, leases
classified as operating leases under GAAP will be accounted for differently
compared to IFRS.
• IFRS allows alternative measurement bases for the right-of-use asset (e.g.,
the revaluation model, in accordance with IAS 16, Property, Plant and
Equipment).
GAAP CONCEPTS AND APPLICATION (Continued)
• In addition to the short term lease exception, IFRS has an additional lessee
recognition and measurement exemption for leases of assets of low value
(e.g., personal computers, small office furniture).
• IFRS includes less explicit guidance on collectibility of the lease payments by
lessors and amounts necessary to satisfy a residual value guarantee.
• IFRS does not distinguish between sales-type and direct financing leases for
lessors. Therefore, IFRS 16 permits recognition of selling profit on direct
financing leases at lease commencement.
LO: 7, Bloom: K, Difficulty: Simple, Time: 10-15, AACSB: Global, Communication, AICPA BB: Global, AICPA FC: Reporting, AICPA PC:
Communication
GAAP21.3
1/1/19
Right-of-Use Asset (2.83339* X $23,000)....................... 65,168
Lease Liability......................................................... 65,168
Lease Liability.................................................................. 23,000

Cash.......................................................................... 23,000
Schedule A
LEBRON JAMES CORPORATION
Annuity-Due Basis
Reduction
1/1/19 $65,168
1/1/19 $23,000 $ 0 $23,000 42,168
1/1/20 23,000 2,530 20,470 21,698
1/1/21 23,000 1,302 21,698 0
GAAP CONCEPTS AND APPLICATION (Continued)
Schedule B
Lease Expense Schedule
(C)
(A) (B) Amortization
Lease Expense Interest (6%) on of ROU Asset Carrying Value
Date (Straight-Line) Lease Liability (A-B) of ROU Asset
1/1/19 $65,168
12/31/19 $23,000 $2,530 $20,470 44,698
12/31/20 23,000 1,302 21,698 23,000
12/31/21 23,000 0 23,000 0
12/31/19
Lease Expense................................................................ 23,000
Lease Liability (Schedule A)............................ 2,530*
Right-of-Use Asset (Schedule B).................... 20,470
*The accrual of the lease liability is a result of the accrual of interest related to the
lease liability, as shown in schedule A. Note that this is expensed along with the
amortization of the right-of-use asset at the end of 2019.

CH 21

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CH 21

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CHAPTER 21

Accounting for Leases

1. Rationale for leasing. 1, 2, 3

2. Concepts, and 4, 5, 6, 7, 8, 1, 2, 3, 4, 1, 2, 3, 4, 7, 1, 2, 3, 4, 1, 2, 3, 4,5

3. Finance / Sales – 11, 15, 16, 7, 8, 9, 10, 5, 7, 8, 9, 11, 6, 7, 9, 11, 2, 5

4. Special Issues 26, 27 15, 16, 21, 9, 16, 17 6, 7, 8, 12, 3, 4, 5

*5. Sale-leaseback. 28, 29 26, 27 18, 19 6

*This material is dealt with in an Appendix to the chapter.

3. Explain the 11, 13, 6, 7, 8, 9, 5, 6, 7, 8, 9, 6, 7, 9, 2, 5

4. Discuss the 10, 21, 22, 23, 24, 6, 9, 10, 11, 1, 2, 7, 8, 3, 4, 5

*5. Describe the 28, 29 26, 27 18, 19 6

*This material is dealt with in an Appendix to the chapter.

2. (a) Possible advantages of leasing for the lessee:

3. Possible advantages of leasing for a lessor:

Questions Chapter 21 (Continued)

BRIEF EXERCISE 21.1

BRIEF EXERCISE 21.2

BRIEF EXERCISE 21.3

BRIEF EXERCISE 21.4

Lease Liability.................................................................. 41,933

BRIEF EXERCISE 21.4 (Continued)

*Present value of an annuity-due of 1 for 4 periods at 8%.

Depreciation Expense..................................................... 37,500

BRIEF EXERCISE 21.5

Depreciation Expense..................................................... 37,500

BRIEF EXERCISE 21.6

Lease Liability.................................................................. 5,300

BRIEF EXERCISE 21.6 (Continued)

Depreciation Expense..................................................... 3,398

BRIEF EXERCISE 21.7

Fair value of leased asset £70,000

BRIEF EXERCISE 21.8

**Present value of 1 for 4 periods at 6%.

BRIEF EXERCISE 21.9

Lease Receivable (4.99271* X £30,044)......................... 150,001

*Present value of an annuity-due of 1 for 6 periods at 8%.

BRIEF EXERCISE 21.10

BRIEF EXERCISE 21.11

BRIEF EXERCISE 21.12

BRIEF EXERCISE 21.13

Right-of-Use Asset (2.83339* X £35,000)....................... 99,169

Lease Liability.................................................................. 35,000

*Present value of an annuity-due of 1 for 3 periods at 6%.

Interest Expense.............................................................. 3,850

Depreciation Expense (£99,169 ÷ 3).............................. 33,056

BRIEF EXERCISE 21.15

Depreciation Expense..................................................... 25,000

Right-of-Use Asset (2.78326* X $12,000)....................... 33,399

*Present value of an annuity-due of 1 for 3 periods at 8%.

Lease Liability.................................................................. 12,000

Interest Expense.............................................................. 1,712

Depreciation Expense ($33,399 ÷ 3).............................. 11,133

BRIEF EXERCISE 21.17

Depreciation Expense..................................................... 6,000

BRIEF EXERCISE 21.18

£17,000 X 2.83339* = £48,168

*Present value of an annuity-due of 1 for 3 periods at 6%.

BRIEF EXERCISE 21.19

*Present value of an annuity-due of 1 for 3 periods at 6%.

BRIEF EXERCISE 21.19 (Continued)

Note to Instructor: The measurement of the lease liability/right-of-use asset

BRIEF EXERCISE 21.20

Right-of-Use Asset.......................................................... 215,544*

PV of rentals (€40,000 X 5.21236) €208,494