Intermediate Accounting

IFRS Edition
Kieso, Weygandt, Warfield
Fourth Edition

Chapter 21
Accounting for Leases
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College

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Subsequent Lease Accounting
To illustrate the accounting for a lease using the finance lease
method, assume that CNH Capital (NLD) (a subsidiary of CNH
Global) and Ivanhoe Mines Ltd. (CAN) sign a lease agreement
dated January 1, 2022, that calls for CNH to lease a backhoe
to Ivanhoe beginning January 1, 2022.
The terms and provisions of the lease agreement and other
pertinent data are shown on the next slide.

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Lessee Accounting: Example 1
Terms and provisions of the lease agreement:
• The term of the lease is five years. The lease agreement is non-cancelable,
requiring equal rental payments of €20,711.11 at the beginning of each year
(annuity-due basis).
• The backhoe has a fair value at the commencement of the lease of
€100,000, an estimated economic life of five years, and a guaranteed
residual value of €5,000. (Ivanhoe expects that it is probable that the
expected value of the residual value at the end of the lease will be greater
than the guaranteed amount of €5,000.)
• The lease contains no renewal options. The backhoe reverts to CNH Capital
at the termination of the lease.
• Ivanhoe’s incremental borrowing rate is 5 percent per year.
• Ivanhoe depreciates its equipment on a straight-line basis.
• CNH sets the annual rental rate to earn a rate of return of 4 percent per
year; Ivanhoe is aware of this rate.
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Present Value of Lease Payments
Ivanhoe computes the lease liability and the amount capitalized as
a right-of-use asset as follows:

Capitalized Value = PV of annual rental payments

Where:
• PMT: Annual Rental Payment
• N: lease term
• R: discount rate

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Present Value of Lease Payments

Ivanhoe uses CNH's implicit interest rate of 4 % instead of its

incremental borrowing rate of 5 % because it is known to
Ivanhoe.

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Lessee Journal Entries at Lease Inception
Ivanhoe records the finance lease on its books on January 1, 2022,
as:
Right-of-Use Asset 95,890.35
Lease Liability 95,890.35

• Ivanhoe records the first lease payment on January 1, 2022,

as follows.

Lease Liability 20,711.11

Cash 20,711.11

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Lease Amortization Schedule— Lessee

ILLU STRATIO N 21.7

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Journal Entries at End of 2022
On December 31, 2022, Ivanhoe records interest expense for the
first year of the lease as follows.
Interest Expense 3,007.17
Lease Liability 3,007.14

Depreciation of the right-of-use asset over the five-year lease term,

applying Ivanhoe’s normal depreciation policy (straight-line
method), results in the following entry at December 31, 2022.

Depreciation Expense 19,178.07

Right-of-Use Asset (€95,890.35 ÷ 5 years) 19,178.07

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 Financial Statements Presentation
The statement of financial position as it relates to lease transactions at December 31,
2022.

ILLU STRATIO N 21.8

On its December 31, 2022, income statement, Ivanhoe reports,

ILLU STRATIO N 21.9

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Second Lease Payment

ILLU STRATIO N 21.7

On January 1, 2023, Ivanhoe records the second lease payment as follows.

Lease Liability (€3,007.17 + €17,703.95) 20,711.11
Cash 20,711.11

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Purchase of Equipment at Termination
of Lease

ILLU STRATIO N 21.7

If Ivanhoe purchases the equipment from CNH at the termination of the lease
at a price of €5,000 and the estimated remaining life of the equipment is two
years, it makes the following entry on January 1, 2027.
Equipment 5,000
Cash 5,000

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Lessee Accounting: Example 2
To illustrate a situation where the expected residual value is below
the guaranteed residual value, assume in the earlier CNH/Ivanhoe
example that it is probable that the residual value will be €3,000
instead of the guaranteed amount of €5,000. If Ivanhoe estimates
the residual value of the backhoe at the end of the lease to be
€3,000, Ivanhoe includes €2,000 (€5,000 − €3,000) as an additional
lease payment in determining the lease liability and right-of-use
asset.

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Computation of Lessee’s Capitalized
Amount— Guaranteed Residual Value
Ivanhoe computes the lease liability and the amount capitalized as
a right-of-use asset as follows:

Note : PV of a single cash flow = FCF/ (1+r)n

ILLU STRATIO N 21.10

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Lessee Accounting: Example 2
Journal Entries at Lease Inception
Ivanhoe makes the following entries to record the lease and the
first payment on January 1, 2022, as:

Right-of-Use Asset 97,534.21

Lease Liability 97,534.21
Lease Liability 20,711.11
Cash 20,711.11

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Lessee Accounting: Example 2
Lease Amortization Schedule— Lessee

ILLU STRATIO N 21.11

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Journal Entries— Guaranteed Residual
Value

ILLU STRATIO N 21.12

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Lessee Accounting: Example 2
Residual Value Loss
Assume that due to poor maintenance of the backhoe, Ivanhoe and CNH
agree that the fair value of the asset is zero upon returning the backhoe
to CNH on January 1, 2027. In this case, Ivanhoe reports a loss of €3,000.
Under the expected payment scenario, Ivanhoe makes the following
entry.
Loss on Lease (€5,000 − €2,000) 3,000
Cash 3,000

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Lessee Accounting: Example 3
U nguaranteed Residual Value: Assume that Hathaway Disposal
(lessor) and Marks and Spencer plc (M& S)(G BR) (the lessee) sign a
lease agreement dated January 1, 2022. The lease agreement
specifies that Hathaway will grant right-of-use of one of its
standard cardboard compactors for use at one of M&S’s stores.
Information relevant to the lease is as follows.
• Lease term is three years, non-cancelable, requires rental
payments of £17,620.08 at the beginning of each year.
• Compactor has a cost and fair value at commencement of the
lease of £60,000, an estimated economic life of seven years,
and an expected residual value of £12,000, which is
unguaranteed.

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Lessee Accounting: Example 3
More D ata
• Lease contains no renewal options, the compactor reverts to
Hathaway at the termination of the lease.
• Implicit rate of the lessor is not known by M&S. M&S’s
incremental borrowing rate is 6 percent.

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Lessee Accounting: Example 3
Journal Entries at Inception of Lease
The present value of the lease payments for M&S in this
situation is £49,924.56 (£17,620.08 × 2.83339 (PVF = AD 3,6% )).
The lease liability of £49,924.56 does not include any
payments related to the unguaranteed residual value.
M&S makes the following entries.
January 1, 2022
Right-of-Use Asset 49,924.56
Lease Liability 49,924.56
Lease Liability 17,620.08
Cash 17,620.08

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Lessee Accounting: Example 3
Lease Amortization Schedule— Lessee

ILLU STRATIO N 21.14

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Lessee Accounting: Example 3
Journal Entries by Lessee

ILLU STRATIO N 21.15

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