Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Introduction
ACCOUNTING FOR LEASES
FASB ASC 840
Synopsis:
A lease that transfers substantially all of the benefits and risks of ownership should be accounted for
as the acquisition of an asset and the incurrence of an obligation by the lessee and as a sale or
financing by the lessor.
The chart below includes the BASIC criteria you must learn to classify leases. We will also do
more complicated examples that will require FARS research.
U.S. GAAP
CRITERIA FOR CAPITALIZATION:
FOR LESSEE AND LESSOR: (must meet at least one)
A1 - TITLE TRANSFERS. The lease transfers ownership of the property to the lessee by the end
of the lease term.
A2 - BARGAIN PURCHASE OPTION. The lease contains an option to purchase the leased
property at a bargain price.
A3 – ECONOMIC LIFE. The lease term is equal to or greater than 75% of the estimated economic
life of the leased property.
A4 – RECOVERY OF INVESTMENT. The present value of the minimum lease payments equals
or exceeds 90% of the fair value of the leased property less any investment tax credit retained
by the lessor.
FOR LESSOR ONLY: (must meet both)
B1 - COLLECTIBILITY. Collectibility of the minimum lease payments is reasonably predictable.
B2 - NO UNCERTAINTIES. No important uncertainties surround the amount of unreimburseable
costs yet to be incurred by the lessor under the lease.
We will work through a variety of examples. In some cases, we will classify the lease and do
journal entries. Those examples are contained in this file. In other cases, we will just classify the
lease. These classification examples are generally in the PowerPoint lecture slides and not included
in this file. We will not necessarily work examples in numeric order but you can find all the
solutions on the course web page.
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Introductory Examples – Lease 1A – Operating Lease
To illustrate accounting for lease transactions, we will use a simple case involving three parties:
1. Farview Farms needs a small tractor (Model SX). These tractors have an expected useful life of six years with
no salvage value.
2. Idaho First Bank & Trust which is currently charging 12% interest on long-term equipment loans.
3. Troy Tractors, Inc., which manufactures the Model SX tractor at a cost of $40,000 and then sells them for
$50,000. It also has a few units for trial use which rent for $500 per week.
If Farview Farms rents a tractor for one week from Troy Tractors, the journal entries would follow
the usual pattern for a rental:
Farview Farms Debit Credit
Rent expense
Cash
Troy Tractors Debit Credit
Cash
Rental Income
Depreciation expense
Accumulated depreciation
Comments --An operating lease is, in essence, a rental agreement. The lessor retains the risks and
benefits of ownership.
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Installment Purchase Arrangement
SITUATION 1B: PURCHASE WITH LONG-TERM BANK FINANCING
Assume Farview Farms decides to purchase the tractor and borrows the full purchase price of
$50,000 from Idaho First Bank & Trust at 12% interest on the unpaid balance of the loan. The
borrower agrees to make annual payments of $10,000 for five years. Again, the journal entries
follow the normal pattern:
Farview Farms Debit Credit
Cash
Note Payable to Bank
Equipment
Cash (to Troy Tractors)
At year end:
Depreciation expense
Accumulated depreciation
Interest expense
Interest payable
Troy Tractors Debit Credit
Cash
Sales
Cost of goods sold
Inventory
Idaho First Bank & Trust Debit Credit
Note Receivable
Cash
At year end
Interest receivable
Interest revenue
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
SITUATION 1C - DIRECT FINANCING LEASE
For various reasons either (or both) Farview Farms and Idaho First Bank & Trust might prefer a lease
arrangement to an outright purchase/long-term loan. Assume that the bank agrees to purchase the tractor from Troy
Tractors for $50,000. It then computes the payment on the lease required for it to earn its desired rate of 12% interest if
the lease is written for five years with the first payment coming at the end of the first year (after harvest). [PVA =
50,000, n = 5, i = 12%, pymt = 13,871]. The lease agreement specifies that Farview Farms gets to keep the tractor at the
end of the lease.
-----------------------------------------------------------------
DATE LEASE INTEREST REDUCTION LEASE
PAYMENT LEASE RECBL/LIAB
50,001.85 RECBL/LIAB BALANCE
-----------------------------------------------------------------
0 01/01/12 0.00 0.00 0.00 50,000.00
1 12/31/12 13,871.00 6,000.00 7,871.00 42,129.00
2 12/31/13 13,871.00 5,055.48 8,815.52 33,313.48
3 12/31/14 13,871.00 3,997.62 9,873.38 23,440.10
4 12/31/15 13,871.00 2,812.81 11,058.19 12,381.91
5 12/31/16 13,871.00 1,489.09 12,381.91 0.00
Farview Farms Debit Credit
Farm Equipment
Lease obligation
At year end:
Depreciation expense
Accumulated depreciation
Interest expense
Lease obligation
Cash
Troy Tractors Debit Credit
Cash
Sales
Cost of goods sold
Inventory
Idaho First Bank & Trust Debit Credit
Equipment held for lease
Cash
Net investment in lease
Equipment held for lease
Cash
Interest revenue
Net investment in lease
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
SITUATION 1D - SALES TYPE LEASE
Farview Farms may also be able to arrange a similar or better lease arrangement with the
manufacturer of the Model SX tractor. We will assume that the lease terms are the same for
purposes of illustration.
NOTE: The first step in doing lease accounting involves finding the present value of the
cash flows that are transferred between the lessee and lessor. This "present value of the minimum
lease payments" [PVMLP] will give you the SALES amount for the lessor (assuming a sales-type
lease) and the ASSET amount for the lessee.
COMPUTE PVMLP: [n = 5, i = 12%, pymt = 13,871]
Farview Farms Debit Credit
Farm Equipment
Lease obligation
At year end:
Depreciation expense
Accumulated depreciation
Interest expense
Lease obligation
Cash
Troy Tractors Debit Credit
Net investment in lease
Sales
Cost of goods sold
Inventory
At year end:
Cash
Interest revenue
Net investment in lease
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Introductory Example – Lease 1E - BARGAIN PURCHASE OPTION
1. Inception date: 1/1/12 7. First payment due on 12/31/12
2. Lessor: Troy Tractors Inc. 8. Lessee: Farview Farms
3. Fair value of tractor at 1/1/12: $50,000 9. Incremental borrowing rate (lessee): 12%
4. Cost to manufacture tractor: $40,000 10. Implicit interest rate (known to lessee): 12%
5. Estimated fair value at end of lease is $10,000 11. Option to buy at end of lease term for $5,000
6. Fixed non-cancelable lease term: 5 years. 12. Estimated useful life of tractor: 8 years
To earn its desired return of 12%, at what amount should Troy Tractors set the annual payments?
Construct an amortization table and prepare the journal entries for both parties:
Date Payment Interest "Principal" Balance
0
1
2
3
4
5
Farview Farms Debit Credit
At inception:
Farm Equipment
Lease liability
At year end:
Interest expense
Lease liability
Cash
Depreciation expense
Accumulated depreciation
Troy Tractors Debit Credit
At inception:
Lease Receivable
Sales
Cost of Goods Sold
Inventory
At year end:
Cash
Lease Receivable
Interest revenue
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Introductory Example – Lease 1F - ANNUITY DUE
Assume that Troy Tractors and Farview Farms sign a lease agreement on a SX Tractor with
the following terms:
1. Inception date: 1/1/12 6. Lessee: Farview Farms
2. Lessor: Troy Tractors Inc. 7. Fixed non-cancelable lease term: 6 years.
3. Fair value of tractor at 1/1/12: $50,000 8. Option to buy at end of lease term for $2,000
4. Estimated fair value at end of lease is $10,000 9. Estimated useful life of tractor: 8 years
5. First payment due on 1/1/12 10. Desired rate of return for lessor and incremental
borrowing rate for lessee: 12%
With these lease terms, how much should Troy Tractors ask for the annual payments?
Construct an amortization table and prepare the journal entries for both parties:
Date Payment Interest "Principal" Balance
0
1
2
3
4
5
6
Farview Farms Debit Credit
At inception:
Farm Equipment
Lease liability
Cash
At year end:
Interest expense
Lease liability
Depreciation expense
Accumulated depreciation
Troy Tractors Debit Credit
At inception:
Cash
Lease Receivable
Sales
Cost of Goods Sold
Inventory
At year end:
Lease Receivable
Interest revenue
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
International Financial Reporting Standards (IFRS)
Leases (IAS17)
A lease is classified as a finance lease if it transfers substantially all the risks and rewards
incidental to ownership. A lease is classified as an operating lease if it does not transfer
substantially all the risks and rewards incidental to ownership.
Classification depends on the substance of the transaction rather than the form of the contract.
Examples of situations that individually or in combination would normally lead to a lease being
classified as a finance lease are:
a) the lease transfers ownership of the asset to the lessee by the end of the lease term.
b) the lessee has the option to purchase the asset at a price that is expected to be sufficiently
lower than the fair value at the date the option becomes exercisable for it to be reasonably
certain, at the inception of the lease, that the option will be exercised.
c) the lease term is for the major part of the economic life of the asset even if title is not
transferred.
d) at the inception of the lease the present value of the minimum lease payments amounts to at
least substantially all of the fair value of the leased asset.
e) the leased assets are of such a specialized nature that only the lessee can use them without
major modifications.
Other indications that it is a finance lease include:
a) if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are
borne by the lessee.
b) gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for
example, in the form of a rent rebate equalling most of the sales proceeds at the end of the
lease)
c) the lessee has the ability to continue the lease for a secondary period at a rent that is
substantially lower than market rent.
The examples and indicators (above) are not always conclusive. If it is clear from other features that
the lease does not transfer substantially all risks and rewards incidental to ownership, the lease is
classified as an operating lease.
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lease Example #3
On January 1, 2012, Andrewson Consulting and Sun Computers sign a lease with the following terms:
1. Term: 3 years 2. Payments of $47,523
3. Implicit interest rate (known to lessee) 10% 4. Lessor retains ownership of asset at end of lease
5. Fair value of asset $130,000 6. Cost of asset $100,000
7. Incremental borrowing rate: 15% 8. First payment due 1/1/12
9. Estimated useful life of asset: 4 years 10. No collection or cost uncertainties for lessor
FIND PRESENT VALUE OF MINIMUM LEASE PAYMENTS:
Type of lease for
Lessor Lessee
US GAAP
IFRS
Date Lease Payment Interest Principal Balance
1/01/12 130,000
0 1/01/12 47,523 0 47,523 82,477
1 1/01/13 47,523 8,248 39,275 43,202
2 1/01/14 47,523 4,320 43,203 0
142,569 12,568 130,001 0
Lessee Debit Credit Lessor Debit Credit
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lease Example #5
On March 30, 2012, Genessee Engineering, Inc. and Idaho First Bank sign a lease with the following terms:
1. Inception of lease: March 30, 2012 8. Payments of ______________
2. Term: 3 years 9. Est. fair value of asset at end of lease $5,000
3. Implicit interest rate (not known to lessee) 10% 10. Cost of asset $100,000
4. Fair value of asset $100,000 11. First payment due 3/30/12
5. Incremental borrowing rate: 12% 12. No collection or cost uncertainties for lessor
6. Estimated useful life of asset: 5 years 13. Both parties have calendar-year fiscal years.
7. Purchase option at end of lease: $2,500
FIND THE PAYMENT WHICH IDAHO FIRST BANK SHOULD ASK TO EARN THE IMPLICIT INTEREST
RATE LISTED ABOVE:
PVMLP for Lessee:
PVMLP for Lessor:
Type of lease for
Lessor Lessee
US GAAP
IFRS
Explain:
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Example 5 – Lessee Accounting (Capital Lease with BPO)
On March 30, 2012, Genessee Engineering, Inc. and Idaho First Bank sign a lease with the following terms:
1. Term: 3 years 2. Payments of 35,869
3. Implicit interest rate (not known to lessee) 10% 4. Est. fair value of asset at end of lease $5,000
5. Fair value of asset $100,000 6. Cost of asset $100,000
7. Incremental borrowing rate: 12% 8. First payment due 3/30/12
9. Estimated useful life of asset: 5 years 10. No collection or cost uncertainties for lessor
11. Purchase option at end of lease: $2,500 12. Both parties have calendar-year fiscal years.
Date Lease Interest Principal Balance
Payment
03/30/12 98,270
0 03/30/12 35,869 0 35,869 62,401
1 03/30/13 35,869 7,488 28,381 34,020
2 03/30/14 35,869 4,082 31,787 2,234
3 03/30/15 2,500 266 2,234 0
Genessee Engineering Inc. Debit Credit
3/30/12 Leased Asset
Lease obligation
Cash 35,869
12/31/12 Depreciation expense
Accumulated depreciation
Interest expense
Interest payable
3/30/13 Interest expense
Interest payable
Lease obligation
Cash 35,869
12/31/13 Depreciation expense
Accumulated depreciation
Interest expense
Interest payable
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lease #5 Genessee Engineering Inc. Debit Credit
3/30/14 Interest expense
Interest payable
Lease obligation
Cash 35,869
12/31/14 Depreciation expense
Accumulated depreciation
Interest expense
Interest payable
3/30/15 Interest expense
Interest payable
Lease obligation
Cash 2,500
12/31/15 Depreciation expense
Accumulated depreciation
12/31/15 Depreciation expense
Accumulated depreciation
3/30/17 Depreciation expense
Accumulated depreciation
Acc'd Depreciation Lease Liability
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Example 5 – Lessor Accounting (Direct Financing Lease with BPO)
Date Lease Interest Principal Balance
Payment
03/30/12 100,000
0 03/30/12 35,869 0 35,869 64,131
1 03/30/13 35,869 6,413 29,456 34,675
2 03/30/14 35,869 3,468 32,401 2,274
3 03/30/15 2,500 226 2,274 0
110,107 10,107 100,000
Idaho First Bank & Trust Debit Credit
03/30/12 Cash 35,869
Net investment in lease
Equipment purchased for lease
12/31/12 Interest receivable
Interest revenue
3/30/13 Cash 35,869
Interest receivable
Interest revenue
Net investment in lease
12/31/13 Interest receivable
Interest revenue
3/30/14 Cash 35,869
Interest receivable
Interest revenue
Net investment in lease
12/31/14 Interest receivable
Interest revenue
12/31/15 Cash 2,500
Interest receivable
Interest revenue
Net investment in lease
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Example 5 – FASB Style J E s - Lessor
Date Lease Interest Principal Balance
Payment
03/30/12 100,000
0 03/30/12 35,869 0 35,869 64,131
1 03/30/13 35,869 6,413 29,456 34,675
2 03/30/14 35,869 3,468 32,401 2,274
3 03/30/15 2,500 226 2,274 0
110,107 10,107 100,000
Idaho First Bank & Trust Debit Credit
3/30/12 Lease Payments Receivable
110,107
(or Gross investment in lease)
Equipment purchased for lease
Unearned interest revenue
Cash 35,869
Lease Payments Receivable
(or Gross investment in lease)
12/31/12 Unearned interest revenue
Interest revenue
3/30/13 Cash 35,869
Unearned interest revenue
Interest revenue
Lease Payments Receivable
(or Gross investment in lease)
Continue as above for the following dates
12/31/13
3/30/14
12/31/14
3/30/15
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
COMMENTS ON APPLYING CRITERIA
LEASE TERM:
Always ends at a bargain purchase option (including ordinary renewal periods up to BPO).
Includes renewal periods
under bargain renewal options
if there is a penalty large enough to assure renewal
if renewal or extensions is at option of lessor
during which lessee guarantees lessor's debt related to property
during which there is a loan from lessee to the lessor
Lease must be cancelable only under remote contingency, with permission of lessor, or if
lessee enters into new lease with lessor, or with there is a large penalty for cancellation that
makes cancellation unlikely.
MINIMUM LEASE PAYMENTS:
Excludes contingent rentals
Excludes executory costs paid by lessor:
maintenance
property taxes
insurance
Excludes all rental payments past date of bargain purchase option
Includes all rental payments up to date of bargain purchase option
Includes bargain purchase option
Includes renewal penalties not large enough to assure continuation of lease
Includes rents during renewal periods covered by:
bargain renewal options
nonrenewal penalty large enough to assure continuation of lease
Includes guaranteed residual value of property -
If guaranteed by lessee
If guaranteed by third party, only lessor includes as part of minimum lease payments
Note:
Never record the leased asset at more than its fair value!
The asset should be recorded at the lower of the PVMLP or the FMV.
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lease Example #7
On January 1, 2012, Harris Manufacturing (lessee) and Accel Engines sign a lease with the following terms:
1. Term: 4 years 2. Payments of $84,079
3. Implicit interest rate (known to lessee) 10% 4. Lessor retains ownership of asset at end of lease
5. Fair value of asset $300,000 6. Cost of asset $250,000
7. Incremental borrowing rate: 12% 8. First payment due 1/1/12
9. Estimated useful life of asset: 6 years 10. No collection or cost uncertainties for lessor
10. Est. fair value of asset at end of lease: $10,000 11. The residual value is NOT guaranteed by lessee
PVMLP for Lessee: PVMLP for Lessor:
Type of lease for
Lessor Lessee
US GAAP
IFRS
Explain:
Lessee Lessor
Lease Lease
Date Interest Principal Balance Interest Principal Balance
Payment Payment
01/01/12 293,171 300,000
0 01/01/12 84,079 0 84,079 209,092 84,079 0 84,079 215,921
1 01/01/13 84,079 20,909 63,170 145,922 84,079 21,593 62,486 153,435
2 01/01/14 84,079 14,592 69,487 76,435 84,079 15,344 68,735 84,700
3 01/01/15 84,079 7,644 76,435 0 84,079 8,470 75,609 9,091
10,000 909 9,091 0
Lessee – Harris Manufacturing Debit Credit
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lease # 7 - Lessor Accounting for Sales-Type Lease when there is an
Unguaranteed Residual Value
Lease
Date Interest Principal Balance
Payment
01/01/12 300,000
0 01/01/12 84,079 0 84,079 215,921
1 01/01/13 84,079 21,593 62,486 153,435
2 01/01/14 84,079 15,344 68,735 84,700
3 01/01/15 84,079 8,470 75,609 9,091
4 01/01/16 10,000 909 9,091 0
Totals 346,316 46,316 300,000 0
Lessor – Accel Engines Debit Credit
1/1/12
Net Investment in Lease
(PVMLP + PV of Unguaranteed RV)
Cost of Sales
(Cost of asset - PV of Unguaranteed RV)
Inventory/Equipment
(Cost of asset)
Sales Revenue
(PVMLP)
Cash
Net Investment in Lease
12/31/12
Interest receivable
Interest Revenue
1/1/13
Cash
Interest Receivable
Net Investment in Lease
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
UNGUARANTEED RESIDUAL VALUES -
JOURNAL ENTRY FORMAT FOR LESSOR
(As illustrated by FASB -- use of Gross rather than Net investment in lease is optional.
Net investment in lease = GIIL - unearned income)
DIRECT FINANCING LEASE:
Gross Investment in Lease (MLP + Unguaranteed Residual Value + initial direct costs)
Equipment (Cost or carrying amount)
Unearned Income (GIIL - cost or carrying amount)
SALES TYPE LEASE:
Gross Investment in Lease (MLP + Unguaranteed Residual Value)
Cost of Sales (Cost of asset - PV of Unguaranteed Residual Value)
Inventory/Equipment (Cost of asset)
Unearned Income (GIIL -PVMLP)
Sales Revenue (PVMLP)
Where MLP = minimum lease payments exclusive of executory costs paid by the lessor
GIIL = gross investment in lease
PVMLP = present value of MLP
The “easier” method:
DIRECT FINANCING LEASE:
Net Investment in Lease (PVMLP + PV of Unguaranteed Residual Value + initial direct costs)
Equipment (Cost or carrying amount)
SALES TYPE LEASE:
Net Investment in Lease (PVMLP + PV of Unguaranteed Residual Value)
Cost of Sales (Cost of asset - PV of Unguaranteed Residual Value)
Inventory/Equipment (Cost of asset)
Sales Revenue (PVMLP)
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lease Example #9
On January 1, 2012, Hamford Ritz Inc. and Cisco Leasing sign a lease with the following terms:
1. Term: 4 years 2. Payments of $81,140
3. Implicit interest rate (not known to lessee) 10% 4. Lessor retains ownership of asset at end of lease
5. Fair value of asset $300,000 6. Cost of asset $300,000
7. Incremental borrowing rate: 12% 8. First payment due 1/1/12
9. Estimated useful life of asset: 5 years 10. No collection or cost uncertainties for lessor
11. Est. fair value of asset at end of lease: $25,000 12. The residual value is NOT guaranteed by lessee
13. The lessor incurred initial direct costs of $1,848
related to the lease
FIND PRESENT VALUE OF MINIMUM LEASE PAYMENTS:
Type of lease for
Lessor Lessee
US GAAP
IFRS
Explain:
Lessee
Date Lease Payment Interest Principal Balance
01/01/12 12% 276,026
0 01/01/12 81,140 0 81,140 194,886
1 01/01/13 81,140 23,386 57,754 137,131
2 01/01/14 81,140 16,456 64,685 72,447
3 01/01/15 81,140 8,694 72,447 0
Hamford Ritz Inc. (Lessee) Debit Credit
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lease Example #9 – Lessor Accounting for Initial Direct
Costs with a Direct Financing Lease
How to arrive at adjusted interest rate:
Date Lease Payment Interest Principal Balance
01/01/12 9.56% 301,848
0 01/01/12 81,140 0 81,140 220,708
1 01/01/13 81,140 21,100 60,040 160,667
2 01/01/14 81,140 15,360 65,780 94,887
3 01/01/15 81,140 9,072 72,069 22,818
4 01/01/16 25,000 2,182 22,818 0
Cisco Leasing Co. (Lessor) Debit Credit
1/1/12 Initial Direct Costs – Leases 1,848
Cash 1,848
Equipment held for lease 300,000
Cash 300,00
1/1/12 Net investment in lease
Equipment purchased for lease 300,000
Initial direct costs - leases 1,848
Cash 81,140
Net investment in lease
12/31/12 Net investment in lease
Interest revenue
1/1/13 Cash 81,140
Net investment in lease
12/31/15 Net investment in lease
Interest revenue
1/1/16 Used Equipment
Net investment in lease
Loss on Leased Asset
The last “payment” the lessor will receive is the returned equipment. It should be recorded at the lower of fair value or
original estimated residual value. In other words, it may be necessary to record a loss. Lessors are supposed to evaluate
the residual values at each balance sheet date and recognize any losses in anticipated value.
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lease Example #10
On May 1, 2012, SlumberJay, Inc. and Omaha Oscillators, Inc. sign a lease with the following terms:
1. Term: 4 years 2. Payments of $82,434
3. Implicit interest rate (NOT known to lessee) 10% 4. Lessor retains ownership of asset at end of lease
5. Fair value of asset $270,000 6. Cost of asset $250,000
7. Incremental borrowing rate: 12% 8. First payment due 5/1/12
9. Estimated useful life of asset: 4 years 10. There are collection uncertainties for lessor
10. Est. fair value of asset at end of lease: $0 11. The payments include $5,000 for insurance to be
12. Initial direct costs incurred by lessor $1,000 paid by the lessor
FIND PRESENT VALUE OF MINIMUM LEASE PAYMENTS:
Type of lease for
Lessor Lessee
US GAAP
IFRS
Date Lease Payment Interest Principal Balance
05/01/12 270,000
0 05/01/12 77,434 0 77,434 192,566
1 05/01/13 77,434 19,257 58,177 134,389
2 05/01/14 77,434 13,439 63,995 70,394
3 05/01/15 77,434 7,040 70,394 0
Lessor – Omaha Oscillators, Inc. Debit Credit
05/01/12Initial direct costs – deferred
Cash
05/01/12Cash 82,434
Unearned rental income
Prepaid Insurance
12/31/12Rental costs
Initial direct costs - deferred
Insurance expense
Prepaid insurance
Unearned rental income
Rental income
Depreciation expense
Accumulated Depreciation
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lessor – Omaha Oscillators, Inc. Debit Credit
05/01/13Cash 82,434
Unearned rental income
Prepaid Insurance
12/31/13Rental costs
Initial direct costs - deferred
Insurance expense
Prepaid insurance
Unearned rental income
Rental income
Depreciation expense
Accumulated Depreciation
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lease Example #10 - Lessee
Date Lease Payment Interest Principal Balance
05/01/12 263,417
0 05/01/12 77,434 0 77,434 185,983
1 05/01/13 77,434 22,318 55,116 130,867
2 05/01/14 77,434 15,704 61,730 69,137
3 05/01/15 77,434 8,296 69,138 0
SlumberJay, Inc. - Lessee debit credit
05/01/12Leased Asset
Prepaid Insurance
Lease Obligation
Cash 82,434
12/31/12Depreciation Expense
Accumulated Depreciation
Insurance expense
Prepaid insurance
Interest Expense
Interest Payable
05/01/13Lease Obligation
Interest Payable
Insurance expense
Cash 82,434
12/31/13Depreciation Expense
Accumulated Depreciation
Insurance expense
Prepaid insurance
Interest Expense
Interest Payable
01/01/14Lease Obligation
Interest Payable
Prepaid Insurance
Cash 82,434
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lease Example #11
On June 1, 2012, Fantasia Funnels, Inc. and Idaho First Bank sign a lease with the following terms:
1. Term: 4 years 2. Payments of $61,924
3. Interest rate used to compute payments = 12% 4. Cost of asset $200,000
5. Fair value of asset $200,000 6. First payment due 6/1/12
7. Incremental borrowing rate: 14% 8. The lessee can purchase asset for $10,000 at end
(Lessee does not know implicit interest rate) of lease, otherwise, asset is returned to lessor.
9. Estimated useful life of asset: 6 years 10. The payments include $5,000 for maintenance.
11. Est. fair value of asset at end of lease: $10,000 12. No collection or cost uncertainties for lessor
13. Initial direct costs to arrange lease: $3,000
FIND PRESENT VALUE OF MINIMUM LEASE PAYMENTS:
Type of lease for
Lessor Lessee
US GAAP
IFRS
Explain:
Lessee’s Amortization Schedule
Date Lease Payment Interest Principal Balance
06/01/12 14% 189,081
0 06/01/12 56,924 0 56,924 132,157
1 06/01/13 56,924 18,502 38,422 93,735
2 06/01/14 56,924 13,123 43,801 49,933
3 06/01/15 56,924 6,991 49,933 0
Fantasia Funnels Inc. (Lessee) Debit Credit
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lease Example #11
Lease
Date Interest Principal Balance
Payment
6/01/12 203,000
0 6/01/12 56,924
1 6/01/13 56,924
2 6/01/14 56,924
3 6/01/15 56,924
4 6/01/16 10,000
Note: This problem is similar to Lease #9. It requires you to compute a new interest rate for the lessor so
that the initial direct costs are amortized over the life of the lease. Note that the residual value MUST be
included because the asset’s value at the end of the lease is important to the lessor since there is no title
transfer or bargain purchase option.
Remember that the lessor’s amortization table includes residual values (whether or not they are guaranteed)
if the lessor expects the leased asset to be returned at end of lease (in other words, no title transfer and no
bargain purchase option).
Idaho First Bank. (Lessor) Debit Credit
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
LEASE Example #12
On August 1, 2012, Hells Gate Jet Boats and Washington Leasing Co. sign a lease with the following terms:
1. Term: 4 years with possible renewal (see #11) 2. Payments of $49,523
3. Implicit interest rate (NOT known to lessee) 10% 4. Lessor retains ownership of asset at end of lease
5. Fair value of asset $200,000 6. Cost of asset $200,000
7. Incremental borrowing rate: 14% 8. First payment due 8/1/12
9. Estimated useful life of asset: 6 years 10. No collection or cost uncertainties for lessor
11. At the end of the lease, HGJB can renew for one 12. The residual value is NOT guaranteed by lessee,
more year at same annual amount of $49,523. This is asset is expected to be worth $25,000 at end of 4
certainly no bargain. There is a $15,000 penalty for years, and $15,000 at end of 5 years.
non-renewal of the lease. However, this amount is
probably not large enough to assure that HGJB will
renew.
WHAT ARE THE MINIMUM LEASE PAYMENTS? FIND PRESENT VALUE:
LESSOR - Washington Leasing Co.
Date Payment Interest "Principal" Balance
0
1
2
3
4
5
Lessor - Washington Leasing Co. Debit Credit
Lease Example 12 (continued)
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
On August 1, 2012, Hells Gate Jet Boats and Washington Leasing Co. sign a lease with the following terms:
1. Term: 4 years with possible renewal (see #11) 2. Payments of $49,523
3. Implicit interest rate (NOT known to lessee) 10% 4. Lessor retains ownership of asset at end of lease
5. Fair value of asset $200,000 6. Cost of asset $200,000
7. Incremental borrowing rate: 14% 8. First payment due 8/1/12
9. Estimated useful life of asset: 6 years 10. No collection or cost uncertainties for lessor
11. At the end of the lease, HGJB can renew for one 12. The residual value is NOT guaranteed by lessee,
more year at same annual amount of $49,523. This is asset is expected to be worth $25,000 at end of 4
certainly no bargain. There is a $15,000 penalty for years, and $15,000 at end of 5 years.
non-renewal of the lease. However, this amount is
probably not large enough to assure that HGJB will
renew.
WHAT ARE THE MINIMUM LEASE PAYMENTS? FIND PRESENT VALUE:
LESSEE - Hells Gate Jet Boats
Date Payment Interest "Principal" Balance
0
1
2
3
4
5
Lessee - Hells Gate Jet Boats Debit Credit
Lease #12 – continued
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
What if the lessee decided that the penalty was large enough that they would renew the lease? How
would you classify the lease in this situation?
LESSEE - Hells Gate Jet Boats
Date Payment Interest "Principal" Balance
0
1
2
3
4
5
Lessee - Hells Gate Jet Boats Debit Credit
Note that the implicit interest rate for the lessor would also have to be re-computed if the lessor also decided that the
penalty was going to be large enough. A new table would be required. It would still be direct financing lease since
lease term would exceed 75% of economic life.
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
LEASE Example #13
On October 1, 2012, Knightco (lessee) and Jack Dear Corp. sign a lease with the following terms:
1. Term: 4 years, with possible renewal (see #11) 2. Payments of $68,565
3. Implicit interest rate (NOT known to lessee) 10% 4. Lessor retains title to the asset at end of lease
5. Fair value of asset $260,000 6. Cost of asset $200,000
7. Incremental borrowing rate: 12% 8. First payment due 10/1/12
9. Estimated useful life of asset: 6 years 10. No collection or cost uncertainties for lessor
11. Lease can be renewed for one more year at 12. Est. fair value of asset at end of original lease term is
$17,000. The actual value is probably $25,000. $35,000. It should be worth $15,000 at the end of 5
13. There are no guarantees of residual value years.
LESSOR AMORTIZATION TABLE
Date Payment Interest "Principal" Balance
0
1
2
3
4
5
LESSEE AMORTIZATION TABLE
Date Payment Interest "Principal" Balance
0
1
2
3
4
5
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Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon
Lease #13
Lessee – Knightco Inc. Debit Credit
Lessor – Jack Dear Corp. Debit Credit
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