Unformatted text preview: Leases
Part 1 15-2 Accounting by the Lessor and Lessee
A lease is an agreement in which the
lessor conveys the right to use property,
plant, or equipment, usually for a stated
period of time, to the lessee.
Lessee == Renter
Lessor == Owner
property 15-3 Capital Leases vs. Installment Notes Matrix, Inc. acquires equipment from Apex, Inc. by paying
$193,878 every 6 months for the next 3 years. The interest rate associated with the agreement is 9%. 15-4 Inception of the Agreement
At inception January 1
1) What is the initial entry if this was an installment note? 2) What is the initial entry if recorded as a capital lease? (lessee) 15-5 Classification Criteria
Lease A capital lease must meet one of four criteria: Ownership transfers to
or .. .. ..
A bargain purchase option (BPO)
or .. ..
or more of
or more of the fair value of
asset. 15-6 Classification Criteria
A bargain purchase option (BPO) gives the lessee the
right to purchase the leased asset at a price
significantly lower than the expected fair value and the
exercise of the option appears reasonably assured.
The lease term is normally considered to be the noncancelable term of the lease plus any periods covered by
bargain renewal options. If the inception of the lease
occurs during the last 25% of an asset’s economic life,
this criterion does not apply.
For the lessee, a capital lease is treated as the purchase
of an asset – the lessee records both an asset and
liability at inception of the lease. 15-7 Additional Lessor Conditions
The four conditions discussed apply to both the lessee
and lessor. However, the lessor must meet two
additional conditions for the lease to be classified as
either a direct financing or sales-type lease:
1. The collectibility of the lease payments must be
2. If any costs to the lessor have yet to be incurred, they
are reasonably predictable. Performance by the lessor
is substantially complete. Lessor = Owner of the property subject to the lease. 15-8 U. S. GAAP vs. IFRS Operating Leases
under aa 44year
specified 44 annual
January 11 through
paid aa $112,000
at aa cost
Prepare journal entries for Winn Heat Transfer from the inception of the lease
through the end of 2016. Winn uses straight-line depreciation. 15-9 15-10 Leasehold Improvements Sometimes a lessee will make improvements
to leased property that reverts back to the
lessor at the end of the lease.
Like other assets, leasehold improvement
costs are allocated as depreciation expense
over its useful life to the lessee, which is to be
the shorter of the physical life of the asset or
the lease term. 15-11 Operating Lease: Scheduled Rent Increases
On January 1, 2016, HP Corporation signed a 5-year
operating lease agreement to lease office space with
payments due at December 31 of each year.
Year Amount Frequency 2016 $6,000 Annual
payment 2017 $10,000 Annual
payment 2018 $17,000 Annual
1)What is the lease expense for 2018?
2)What is the
balance in Deferred
Rent Expense Payable
at the end of
3)What is the balance in Deferred Rent Expense Payable at the end of
2018? 15-12 Capital Leases – Lessee and Lessor
The amount recorded (capitalized) is the
present value of the minimum lease payments.
However, the amount recorded cannot exceed
the fair value of the leased asset.
In calculating the present value of the minimum
lease payments, the interest rate used by the
lessee is the lower of:
1. Its incremental borrowing rate, or
2. The implicit interest rate used by the lessor. 15-13 Capital Leases – Lessee and Lessor
If the lessor is not a manufacturer or
dealer, the fair value of the leased
asset typically is the lessor’s cost.
When the lessor is a manufacturer or
dealer, the fair value of the property at the
inception of the lease is likely to be its
normal selling price. 15-14 Capital Leases – Lessee and Lessor
Depreciation Period • The lessee normally should depreciate a
leased asset over the term of the lease. • If ownership transfers or a bargain
purchase option is present (i.e., either of
the first two classification criteria), the
asset should be depreciated over its useful
life. Direct Financing Leases
Edison Leasing leased high-tech electronic equipment to Manufacturers
Southern on January 1, 2016.
Edison purchased the equipment from International Machines at a cost of
1)Prepare a lease amortization schedule
2)Prepare entries for Edison Leasing (lessor) from the inception of the lease
through January 1, 2017.
3)Prepare entries for Manufacturers Southern (lessee) from the inception of
the lease through April 1, 2016 and annual depreciation 15-15 15-16 Sales-Type Leases
If the lessor is a manufacturer or dealer, the
fair value of the leased asset generally is
higher than the cost of the asset. At
payments). In addition to interest revenue earned over the
lease term, the lessor receives a manufacturer’s
or dealer’s profit on the “sale” of the asset. 15-17 Sales-Type Leases
Manufacturers Southern leased high-tech electronic equipment from
International Machines on January 1, 2016.
International Machines manufactured the equipment at a cost of
1) Prepare appropriate entries for International Machines from January 1,
2016 through July 1, 2016 (lessor)
2) Prepare appropriate entries for Manufacturers Southern from January
1, 2016 through July 1, 2016 (lessee) 15-18 Bargain Purchase Options
and Residual Value
A bargain purchase option (BPO) is a provision of some
lease contracts that gives the lessee the option of
purchasing the leased property at a bargain price. The
expectation that the option price will be paid effectively
adds an additional cash flow to the lease for both the
lessee and the lessor. As a result:
and aa lease
payments. Bargain Purchase Option (BPO)
Universal Leasing leases electronic equipment under long-term direct
Universal earns interest under these arrangements at a 12% annual rate. The company leased an electronic typesetting machine it purchased for
$44,900 to a local publisher, Desktop Inc., on December 31, 2015.
The lease contract specified annual payments of $9,626 beginning January 1,
2016, the inception of the lease, and each December 31 through 2017 (3-year
The publisher had the option to purchase the machine on December 30, 2018,
the end of the lease term, for $26,700 when it was expected to have a residual
value of $30,700.
Prepare the appropriate entries for Universal Leasing from the inception of the
lease through the end of the lease term. 15-19 15-20 Group Work: Capital Leases
Manufacturers Southern leased high-tech electronic equipment from
Edison Leasing on January 1, 2016.
Edison purchased the equipment from International Machines at a cost
of $127,024. Required:
1)Prepare full amortization table (until end of lease)
2)Record journal entries for Manufacturers Southern (lessee) from
January 1, 2016 through July 1, 2016
3)Prepare the entry for depreciation on December 31, 2016 ...
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