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Journal Entry to Record Capital Equipment Lease

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					Acct. 414 – Journal Entry Examples: Leases                                Prof. Teresa Gordon




                                             Introduction
                                 ACCOUNTING FOR LEASES
                                   FASB 13 (as amended)
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.


9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                1
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.




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                             2
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


9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                           3
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                                 4
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                            5
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                         6
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



9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                        7
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.




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                 8
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                                   9
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:




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                                10
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                           11
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                          12
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                       13
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



9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                     14
Acct. 414 – Journal Entry Examples: Leases                                    Prof. Teresa Gordon




COMMENTS ON APPLYING CRITERIA (US GAAP)

         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.




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                15
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                                   16
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                   17
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)




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                         18
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                                       19
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

9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                           21
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                    22
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                       23
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                    25
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)


9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                     26
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.




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                                    28
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




9d87936f-6641-4c52-aa46-2afc4ce25620.doc                                                                            29
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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