L E A R N IN G O B J E C T IV E S

21 Accounting for Leases

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain the nature, economic substance, 5. Describe the lessor’s accounting for direct-
and advantages of lease transactions. financing leases.
2. Describe the accounting criteria and 6. Identify special features of lease
procedures for capitalizing leases by the arrangements that cause unique accounting
lessee. problems.
3. Contrast the operating and capitalization 7. Describe the effect of residual values,
methods of recording leases. guaranteed and unguaranteed, on lease
4. Explain the advantages and economics of accounting.
leasing to lessors and identify the 8. Describe the lessor’s accounting for sales-
classifications of leases for the lessor. type leases.
9. List the disclosure requirements for leases.
21-1
 Investment in Debt Securities

Different motivations for investing:

 To earn a high rate of return.
 To secure certain operating or financing arrangements
with another company.

21-2 LO 1
 The Leasing Environment

A lease is a contractual agreement between a lessor and a

lessee, that gives the lessee the right to use specific property,
owned by the lessor, for a specified period of time.

Largest group of leased equipment involves:

 Information technology equipment
 Transportation (trucks, aircraft, rail)
 Construction
 Agriculture

21-3 LO 1
 The Leasing Environment Illustration 21-2
What Do Companies
Lease?

21-4 LO 1
 The Leasing Environment

Who Are the Players? Captive

Leasing
Banks Independents Companies
► Wells Fargo ► International ► Caterpillar
► Chase Lease Finance Financial
Corp. Services Corp.
► Citigroup
► Ford Motor
► PNC
Credit (Ford)
► IBM Global
23%
Financing

47% Market Share 26%

21-5 LO 1
 The Leasing Environment

Advantages of Leasing
1. 100% financing at fixed rates.
2. Protection against obsolescence.
3. Flexibility.
4. Less costly financing.
5. Tax advantages.
6. Off-balance-sheet
financing.

21-6 LO 1
 The Leasing Environment

Conceptual Nature of a Lease

Capitalize a lease that transfers substantially all of the
benefits and risks of property ownership, provided the
lease is noncancelable.

Leases that do not transfer

substantially all the benefits
and risks of
ownership are operating leases.

21-7 LO 1
 L E A R N IN G O B J E C T IV E S
21 Accounting for Leases

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain the nature, economic substance, 5. Describe the lessor’s accounting for direct-
and advantages of lease transactions. financing leases.
2. Describe the accounting criteria and 6. Identify special features of lease
procedures for capitalizing leases by the arrangements that cause unique accounting
lessee. problems.
3. Contrast the operating and capitalization 7. Describe the effect of residual values,
methods of recording leases. guaranteed and unguaranteed, on lease
4. Explain the advantages and economics of accounting.
leasing to lessors and identify the 8. Describe the lessor’s accounting for sales-
classifications of leases for the lessor. type leases.
9. List the disclosure requirements for leases.
21-8
 Accounting by the Lessee

If the lessee capitalizes a lease, the lessee records an asset

and a liability generally equal to the present value of the rental
payments.
 Records depreciation on the leased asset.
 Treats the lease payments as consisting of interest and
principal.

Journal Entries for Capitalized Lease Illustration 21-2

21-9 LO 2
 Accounting by the Lessee

For a capital lease, the FASB has identified four criteria.

1. Lease transfers ownership of the property to the lessee.
2. Lease contains a bargain-purchase option.
3. Lease term is equal to 75 percent or more of the estimated
economic life of the leased property.

4. The present value of the minimum lease One or more

must be met
payments (excluding executory costs)
for capital
equals or exceeds 90 percent of the fair lease
value of the leased property. accounting.

21-10 LO 2
 Accounting by the Lessee

Lease Agreement Leases that DO NOT meet

any of the four criteria are
accounted for as Operating
Leases.
Illustration 21-4

21-11 LO 2
 Accounting by the Lessee

Capitalization Criteria
Transfer of Ownership Test
 If the lease transfers ownership of the asset to the
lessee, it is a capital lease.

Bargain-Purchase Option Test

 At the inception of the lease, the difference between
the option price and the expected fair market value
must be large enough to make exercise of the option
reasonably assured.

21-12 LO 2
 Accounting by the Lessee

Capitalization Criteria
Economic Life Test (75% Test)
 Lease term is generally considered to be the fixed,
noncancelable term of the lease.
 Bargain-renewal option can extend this period.
 At the inception of the lease, the difference between the
renewal rental and the expected fair rental must be
great enough to make exercise of the option to renew
reasonably assured.

21-13 LO 2
 Accounting by the Lessee

Illustration: Home Depot leases Dell PCs for two years

at a rental of $100 per month per computer and
subsequently can lease them for $10 per month per
computer for another two years. The lease clearly offers a
bargain-renewal option; the lease term is considered to be
four years.

Advance slide in presentation

21-14 mode to reveal answer. LO 2
 Accounting by the Lessee

Capitalization Criteria
Recovery of Investment Test (90% Test)
Minimum Lease Payments:
 Minimum rental payment
 Guaranteed residual value
 Penalty for failure to renew or extend the lease
 Bargain-purchase option
Executory Costs:
 Insurance Exclude from present value of
 Maintenance Minimum Lease Payment
 Taxes Calculation

21-15 LO 2
 Accounting by the Lessee

Capitalization Criteria
Discount Rate
Lessee computes the present value of the minimum lease
payments using its incremental borrowing rate, with one
exception.
► If the lessee knows the implicit interest rate computed
by the lessor and it is less than the lessee’s incremental
borrowing rate, then lessee must use the lessor’s rate.

21-16 LO 2
 Accounting by the Lessee

Asset and Liability Accounted for Differently

Asset and Liability Recorded at the lower of:
1. present value of the minimum lease payments
(excluding executory costs) or

2. fair-market value of the leased asset.

21-17 LO 2
 Accounting by the Lessee

Asset and Liability Accounted for Differently

Depreciation Period
 If lease transfers ownership, depreciate asset over the
economic life of the asset.
 If lease does not transfer ownership, depreciate over
the term of the lease.

21-18 LO 2
 Accounting by the Lessee

Asset and Liability Accounted for Differently

Effective-Interest Method
 Used to allocate each lease payment between principal
and interest.

Depreciation Concept

 Depreciation and the discharge of the obligation are

independent accounting processes.

21-19 LO 2
 Accounting by the Lessee
Illustration: Caterpillar Financial Services Corp. (a subsidiary of Caterpillar) and Sterling
Construction Corp. sign a lease agreement dated January 1, 2014, that calls for Caterpillar to
lease a front-end loader to Sterling beginning January 1, 2014. The terms and provisions of
the lease agreement, and other pertinent data, are as follows.
• The term of the lease is five years. The lease agreement is noncancelable, requiring
equal rental payments of $25,981.62 at the beginning of each year (annuity-due basis).
• The loader has a fair value at the inception of the lease of $100,000, an estimated
economic life of five years, and no residual value.
• Sterling pays all of the executory costs directly to third parties except for the property
taxes of $2,000 per year, which is included as part of its annual payments to Caterpillar.
• The lease contains no renewal options. The loader reverts to Caterpillar at the
termination of the lease.
• Sterling’s incremental borrowing rate is 11 percent per year.
• Sterling depreciates, on a straight-line basis, similar equipment that it owns.
• Caterpillar sets the annual rental to earn a rate of return on its investment of 10 percent
per year; Sterling knows this fact.

21-20 LO 2
 Accounting by the Lessee

What type of lease is this?

Capital Lease?
Capitalization Criteria:
1. Transfer of ownership NO
2. Bargain purchase option NO
3. Lease term = 75% of Lease term = 5 yrs.
economic life of leased Economic life = 5 yrs.
YES
property
4. Present value of minimum
lease payments => 90% of PV = $100,000 YES
FMV of property FMV = $100,000.

21-21 LO 2
 Accounting by the Lessee

Compute present value of the minimum lease payments.

Payment $ 25,981.62
Property taxes (executory cost) - 2,000.00
Minimum lease payment 23,981.62
Present value factor (i=10%,n=5) x 4.16986 *

PV of minimum lease payments $100.000.00

Sterling uses Caterpillar’s implicit interest rate of 10 percent instead of its

incremental borrowing rate of 11 percent because (1) it is lower and (2) it
knows about it.

* Present value of an annuity due of 1 for 5 periods at 10% (Table 6-5)

21-22 LO 2
 Accounting by the Lessee

Sterling records the capital lease on its books on January 1, 2014,

as:

Leased Equipment (under capital leases) 100,000

Lease Liability 100,000

Sterling records the first lease payment on January 1, 2014, as

follows.

Property Tax Expense 2,000.00

Lease Liability 23,981.62
Cash 25,981.62

21-23 LO 2
 Accounting by the Lessee Illustration 21-6
Lease Amortization
Schedule for Lessee—
Annuity-Due Basis

Sterling records accrued interest on December 31, 2014

21-24 LO 2
 Accounting by the Lessee Illustration 21-6
Lease Amortization
Schedule for Lessee—
Annuity-Due Basis

Prepare the entry to record accrued interest at Dec. 31, 2014.

Sterling records accrued interest on December 31, 2014
Interest Expense 7,601.84
Interest Payable 7,601.84
21-25 LO 2
 Accounting by the Lessee

Prepare the required on December 31, 2014, to record depreciation

for the year using the straight-line method ($100,000 ÷ 5 years).

Depreciation Expense (capital leases) 20,000

Accumulated Depreciation—Capital Leases 20,000

The liabilities section as it relates to lease transactions at

December 31, 2014.
Illustration 21-7

21-26 LO 2
 Accounting by the Lessee Illustration 21-6
Lease Amortization
Schedule for Lessee—
Annuity-Due Basis

Sterling
records the
lease
payment of
January 1,
2015, as
follows.

Property Tax Expense 2,000.00

Interest Payable 7,601.84
Lease Liability 16,379.78
Cash 25,981.62
21-27 LO 2
 Accounting by the Lessee

Operating Method (Lessee)

The lessee assigns rent to the periods benefiting from the use of
the asset and ignores, in the accounting, any commitments to
make future payments.

Illustration: Assume Sterling accounts for the lease as an

operating lease. Sterling records the payment on January 1,
2014, as follows.

Rent Expense 25,981.62

Cash 25,981.62

21-28 LO 2
 L E A R N IN G O B J E C T IV E S
21 Accounting for Leases

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain the nature, economic substance, 5. Describe the lessor’s accounting for direct-
and advantages of lease transactions. financing leases.
2. Describe the accounting criteria and 6. Identify special features of lease
procedures for capitalizing leases by the arrangements that cause unique accounting
lessee. problems.
3. Contrast the operating and capitalization 7. Describe the effect of residual values,
methods of recording leases. guaranteed and unguaranteed, on lease
4. Explain the advantages and economics of accounting.
leasing to lessors and identify the 8. Describe the lessor’s accounting for sales-
classifications of leases for the lessor. type leases.
9. List the disclosure requirements for leases.
21-29
 Accounting by the Lessee Illustration 21-8
Comparison of Charges
to Operations—Capital
vs. Operating Leases

Differences using a capital lease instead of an operating lease.

1. Increase in amount of reported debt.
2. Increase in amount of total assets (specifically long-lived assets).
3. Lower income early in the life of the lease.
21-30 LO 3
 L E A R N IN G O B J E C T IV E S
21 Accounting for Leases

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain the nature, economic substance, 5. Describe the lessor’s accounting for direct-
and advantages of lease transactions. financing leases.
2. Describe the accounting criteria and 6. Identify special features of lease
procedures for capitalizing leases by the arrangements that cause unique accounting
lessee. problems.
3. Contrast the operating and capitalization 7. Describe the effect of residual values,
methods of recording leases. guaranteed and unguaranteed, on lease
4. Explain the advantages and economics of accounting.
leasing to lessors and identify the 8. Describe the lessor’s accounting for sales-
classifications of leases for the lessor. type leases.
9. List the disclosure requirements for leases.
21-31
 Accounting by the Lessor

Benefits to the Lessor

1. Interest revenue.
2. Tax incentives.
3. High residual value.

21-32 LO 4
 Accounting by the Lessor

Economics of Leasing
A lessor determines the amount of the rental, basing it on the rate
of return—the implicit rate—needed to justify leasing the asset.

If a residual value is involved (whether guaranteed or not), the

company would not have to recover as much from the lease
payments.

21-33 LO 4
 Accounting by the Lessor
E21-10 (Computation of Rental): Morgan Leasing Company signs an
agreement on January 1, 2014, to lease equipment to Cole Company. The
following information relates to this agreement.
1. The term of the non-cancelable lease is 6 years with no renewal option.
The equipment has an estimated economic life of 6 years.
2. The cost and fair value of the asset at January 1, 2014, is $245,000.
3. The asset will revert to the lessor at the end of the lease term, at which
time the asset is expected to have a residual value of $43,622, none of
which is guaranteed.
4. Cole Company assumes direct responsibility for all executory costs.
5. The agreement requires equal annual rental payments, beginning on
January 1, 2014.
6. Collectability of the lease payments is reasonably predictable. There are
no important uncertainties surrounding the amount of costs yet to be
incurred by the lessor.
21-34 LO 4
 Accounting by the Lessor
E21-10 (Computation of Rental): Assuming the lessor desires a 10% rate
of return on its investment, calculate the amount of the annual rental
payment required.

Fair market value of leased equipment $ 245,000

Present value of residual value (calculation below) (24,623)
Amount to be recovered through lease payment 220,377
PV factor of annunity due (i=10%, n=6) ÷ 4.79079
Annual payment required $ 46,000

Residual value $ 43,622

PV of single sum (i=10%, n=6) x 0.56447
PV of residual value $ 24,623

21-35 LO 4
 Accounting by the Lessor

Classification of Leases by the Lessor

a. Operating leases.

b. Direct-financing leases.

c. Sales-type leases.

21-36 LO 4
 Accounting by the Lessor

Classification of Leases by the Lessor

Illustration 21-10

A sales-type lease involves a manufacturer’s or dealer’s profit, and a

direct-financing lease does not.
21-37 LO 4
 Accounting by the Lessor

Classification of Leases by the Lessor

Illustration 21-11

A lessor may classify a lease as an operating lease but the lessee may
classify the same lease as a capital lease.
21-38 LO 4
 L E A R N IN G O B J E C T IV E S
21 Accounting for Leases

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain the nature, economic substance, 5. Describe the lessor’s accounting for direct-
and advantages of lease transactions. financing leases.
2. Describe the accounting criteria and 6. Identify special features of lease
procedures for capitalizing leases by the arrangements that cause unique accounting
lessee. problems.
3. Contrast the operating and capitalization 7. Describe the effect of residual values,
methods of recording leases. guaranteed and unguaranteed, on lease
4. Explain the advantages and economics of accounting.
leasing to lessors and identify the 8. Describe the lessor’s accounting for sales-
classifications of leases for the lessor. type leases.
9. List the disclosure requirements for leases.
21-39
 Accounting by the Lessor

Direct-Financing Method (Lessor)

In substance the financing of an asset purchase by the
lessee.
Lessor records:
 A lease receivable instead of a leased asset.
 Receivable is the present value of the minimum lease
payments.

21-40 LO 5
 Accounting by the Lessor

E21-10: Amortization schedule for the lessor.

21-41 LO 5
 Accounting by the Lessor

E21-10:
Prepare all of the
journal entries for
the lessor for 2014
and 2015.

1/1/14 Lease Receivable 245,000

Equipment 245,000
Cash 46,000
Lease Receivable 46,000

21-42 LO 5
 Accounting by the Lessor

E21-10:
Prepare all of the
journal entries for
the lessor for 2014
and 2015.

12/31/14 Interest Receivable 19,900

Interest Revenue 19,900
1/1/15 Cash 46,000
Lease Receivable 26,100

21-43 Interest Receivable 19,900

 Accounting by the Lessor

E21-10:
Prepare all of the
journal entries for
the lessor for 2014
and 2015.

12/31/15 Interest Receivable 17,290

Interest Revenue 17,290

21-44 LO 5
 Accounting by the Lessor

Operating Method (Lessor)

 Records each rental receipt as rental revenue.
 Depreciates leased asset in the normal manner.

21-45 LO 5
 Accounting by the Lessor

Illustration: Assume Morgan accounts for the lease as an

operating lease. It records the cash rental receipt as follows:

Cash 46,000
Rental Revenue 46,000

Depreciation is recorded as follows:

($245,000 – 46,622) ÷ 6 years = $33,063

Depreciation Expense 33,063

Accumulated Depreciation 33,063

21-46 LO 5
 L E A R N IN G O B J E C T IV E S
21 Accounting for Leases

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain the nature, economic substance, 5. Describe the lessor’s accounting for direct-
and advantages of lease transactions. financing leases.
2. Describe the accounting criteria and 6. Identify special features of lease
procedures for capitalizing leases by the arrangements that cause unique accounting
lessee. problems.
3. Contrast the operating and capitalization 7. Describe the effect of residual values,
methods of recording leases. guaranteed and unguaranteed, on lease
4. Explain the advantages and economics of accounting.
leasing to lessors and identify the 8. Describe the lessor’s accounting for sales-
classifications of leases for the lessor. type leases.
9. List the disclosure requirements for leases.
21-47
 Special Lease Accounting Problems

1. Residual values.
2. Sales-type leases (lessor).
3. Bargain-purchase options.
4. Initial direct costs.
5. Current versus noncurrent classification.
6. Disclosure.

21-48 LO 6
 L E A R N IN G O B J E C T IV E S
21 Accounting for Leases

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain the nature, economic substance, 5. Describe the lessor’s accounting for direct-
and advantages of lease transactions. financing leases.
2. Describe the accounting criteria and 6. Identify special features of lease
procedures for capitalizing leases by the arrangements that cause unique accounting
lessee. problems.
3. Contrast the operating and capitalization 7. Describe the effect of residual values,
methods of recording leases. guaranteed and unguaranteed, on lease
4. Explain the advantages and economics of accounting.
leasing to lessors and identify the 8. Describe the lessor’s accounting for sales-
classifications of leases for the lessor. type leases.
9. List the disclosure requirements for leases.
21-49
 Special Lease Accounting Problems

Residual Values
Meaning of Residual Value - Estimated fair value of the
leased asset at the end of the lease term.

Guaranteed versus Unguaranteed – Lessee agrees to

make up any deficiency below a stated amount that the
lessor realizes in residual value at the end of the lease
term.

21-50 LO 7
 Special Lease Accounting Problems

Residual Values
Lease Payments - Lessor may adjust lease payments
because of the increased certainty of recovery of a
guaranteed residual value.

Lessee Accounting for Residual Value - The minimum

lease payments, include the guaranteed residual value but
excludes the unguaranteed residual value.

21-51 LO 7
 Special Lease Accounting Problems
Illustration: Caterpillar Financial Services Corp. (a subsidiary of Caterpillar) and Sterling
Construction Corp. sign a lease agreement dated January 1, 2014, that calls for Caterpillar to
lease a front-end loader to Sterling beginning January 1, 2014. The terms and provisions of
the lease agreement, and other pertinent data, are as follows.
• The term of the lease is five years. The lease agreement is noncancelable, requiring
equal rental payments of $25,981.62 at the beginning of each year (annuity-due basis).
• The loader has a fair value at the inception of the lease of $100,000, an estimated
economic life of five years, and an estimated residual value of $5,000.
• Sterling pays all of the executory costs directly to third parties except for the property
taxes of $2,000 per year, which is included as part of its annual payments to Caterpillar.
• The lease contains no renewal options. The loader reverts to Caterpillar at the
termination of the lease.
• Sterling’s incremental borrowing rate is 11 percent per year.
• Sterling depreciates, on a straight-line basis, similar equipment that it owns.
• Caterpillar sets the annual rental to earn a rate of return on its investment of 10 percent
per year; Sterling knows this fact.

21-52 LO 7
 Special Lease Accounting Problems

Illustration: Caterpillar assumes a 10 percent return on investment

(ROI), whether the residual value is guaranteed or unguaranteed.
Caterpillar would compute the amount of the lease payments as
follows.
Illustration 21-16

Advance slide in presentation

21-53 mode to reveal answer. LO 7
 Special Lease Accounting Problems

Guaranteed Residual Value (Lessee Accounting)

Computation of Lessee’s capitalized amount assuming a guaranteed

residual value.
Illustration 21-17

21-54 LO 7
 Guaranteed Residual Value (Lessee)
Illustration 21-18

21-55 LO 7
 Guaranteed Residual Value (Lessee)

At the end of the lease term, before the lessee transfers the asset to
Caterpillar, the lease asset and liability accounts have the following
balances.
Illustration 21-19

Assume that Sterling depreciated the leased asset down to its residual
value of $5,000 but that the fair market value of the residual value at
December 31, 2018, was $3,000. Sterling would make the following
journal entry.

21-56 LO 7
 Guaranteed Residual Value (Lessee)
Illustration 21-19

Loss on Capital Lease 2,000.00

Interest Expense (or Interest Payable) 454.76
Lease Liability 4,545.24
Accumulated Depreciation—Capital Leases 95,000.00
Leased Equipment (under capital leases) 100,000.00
Cash 2,000.00

21-57 LO 7
 Special Lease Accounting Problems

Unguaranteed Residual Value (Lessee Accounting)

Assume the same facts as those above except that the $5,000
residual value is unguaranteed instead of guaranteed. Caterpillar will
recover the same amount through lease rentals—that is, $96,895.40.
Sterling would capitalize the amount as follows:
Illustration 21-20

21-58 LO 7
 Unguaranteed Residual Value (Lessee)
Illustration 21-21

21-59 LO 7
 Unguaranteed Residual Value (Lessee)

At the end of the lease term, before Sterling transfers the asset to
Caterpillar, the lease asset and liability accounts have the following
balances.
Illustration 21-22

21-60 LO 7
 Comparative Entries
Illustration 21-23

21-61 LO 7
 Special Lease Accounting Problems

Lessor Accounting for Residual Value

The lessor works on the assumption that it will realize the residual
value at the end of the lease term whether guaranteed or
unguaranteed.

Illustration: Assume a direct-financing lease with a residual value

(either guaranteed or unguaranteed) of $5,000. Caterpillar determines
the payments as follows.
Illustration 21-24

21-62 LO 7
 Lessor Accounting for Residual Value
Illustration 21-25

21-63 LO 7
 Lessor Accounting for Residual Value
Illustration 21-25

Caterpillar would
make the following
entries for this
direct-financing
lease in the first
year.

1/1/14 Lease Receivable 100,000

Equipment 100,000

21-64 LO 7
 Lessor Accounting for Residual Value
Illustration 21-25

Caterpillar would
make the following
entries for this
direct-financing
lease in the first
year.

1/1/14
Cash 25,237.09
Lease Receivable 23,237.09
Property Tax Expense/Property Taxes Payable
2,000.00
21-65 LO 7
 Lessor Accounting for Residual Value
Illustration 21-25

Caterpillar would
make the following
entries for this
direct-financing
lease in the first
year.

12/31/14 Lease Receivable 7,676.29

Interest Revenue 7,676.29

21-66 LO 7
 L E A R N IN G O B J E C T IV E S
21 Accounting for Leases

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain the nature, economic substance, 5. Describe the lessor’s accounting for direct-
and advantages of lease transactions. financing leases.
2. Describe the accounting criteria and 6. Identify special features of lease
procedures for capitalizing leases by the arrangements that cause unique accounting
lessee. problems.
3. Contrast the operating and capitalization 7. Describe the effect of residual values,
methods of recording leases. guaranteed and unguaranteed, on lease
4. Explain the advantages and economics of accounting.
leasing to lessors and identify the 8. Describe the lessor’s accounting for sales-
classifications of leases for the lessor. type leases.
9. List the disclosure requirements for leases.
21-67
 Special Lease Accounting Problems

Sales-Type Leases (Lessor)

 Primary difference between a direct-financing lease and
a sales-type lease is the manufacturer’s or dealer’s
gross profit (or loss).
 Lessor records the sale price of the asset, the cost of
goods sold and related inventory reduction, and the
lease receivable.
 There is a difference in accounting for guaranteed and
unguaranteed residual values.

21-68 LO 8
 Sales-Type Leases (Lessor)

Direct-Financing versus Sales-Type Leases

Illustration 21-27

21-69 LO 8
 Sales-Type Leases (Lessor)

21-70 LO 8
 Sales-Type Leases (Lessor)

Illustration: To illustrate a sales-type lease with a guaranteed

residual value and with an unguaranteed residual value, assume
the same facts as in the preceding direct-financing lease
situation. The estimated residual value is $5,000 (the present
value of which is $3,104.60), and the leased equipment has an
$85,000 cost to the dealer, Caterpillar. Assume that the fair
market value of the residual value is $3,000 at the end of the
lease term.

21-71 LO 8
 Sales-Type Leases (Lessor)

Computation of Lease Amounts by Caterpillar

Financial—Sales-Type Lease Illustration 21-28

21-72 LO 8
 Comparative
Sales-Type Leases (Lessor) Entries
Illustration 21-29

21-73 LO 8
 Special Lease Accounting Problems

Bargain Purchase Option (Lessee)

 Lessee must increase the present value of the minimum
lease payments must include the present value of the
option.
 Only difference between the accounting treatment for a
bargain-purchase option and a guaranteed residual value
of identical amounts is in the computation of the
annual depreciation.

21-74 LO 8
 Special Lease Accounting Problems

Initial Direct Costs (Lessor)

Accounting for initial direct costs:
 Operating leases, the lessor should defer initial direct
costs.
 Sales-type leases, the lessor expenses the initial direct
costs.
 Direct-financing lease, the lessor adds initial direct
costs to the net investment.

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 Special Lease Accounting Problems

Current versus Noncurrent

GAAP does not indicate how to measure the current and
noncurrent amounts.

Both the annuity-due and the ordinary-annuity situations report

the reduction of principal for the next period as a current
liability/current asset.

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 Current versus Noncurrent
Illustration 21-30

The current portion of the lease liability/receivable as of December

31, 2014, would be $18,017.70.

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 L E A R N IN G O B J E C T IV E S
21 Accounting for Leases

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Explain the nature, economic substance, 5. Describe the lessor’s accounting for direct-
and advantages of lease transactions. financing leases.
2. Describe the accounting criteria and 6. Identify special features of lease
procedures for capitalizing leases by the arrangements that cause unique accounting
lessee. problems.
3. Contrast the operating and capitalization 7. Describe the effect of residual values,
methods of recording leases. guaranteed and unguaranteed, on lease
4. Explain the advantages and economics of accounting.
leasing to lessors and identify the 8. Describe the lessor’s accounting for sales-
classifications of leases for the lessor. type leases.
9. List the disclosure requirements for leases.
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 Special Lease Accounting Problems

Disclosing Lease Data

 General description of the nature of leasing arrangements.

 The nature, timing, and amount of cash inflows and outflows

associated with leases, including payments to be paid or
received for each of the five succeeding years.

 The amount of lease revenues and expenses reported in the

income statement each period.

 Description and amounts of leased assets by major balance

sheet classification and related liabilities.

 Amounts receivable and unearned revenues under lease

agreements.
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 Unresolved Lease Accounting Problems

To avoid leased asset capitalization, companies design, write,

and interpret lease agreements to prevent satisfying any of the
four capitalized lease criteria.

The real challenge lies in disqualifying the lease as a capital

lease to the lessee, while having the same lease qualify as a
capital (sales or financing) lease to the lessor.

Unlike lessees, lessors try to avoid having lease arrangements

classified as operating leases.

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