Chapter 15 Leases - WordPress.com · Residual Value •The market value of the leased property at...

15-1

1. Why Leasing sometimes makes more sense

2. The accounting issues in recording a lease

transaction

3. The types of contractual provisions in lease

4. The lease classification: capital vs. operating

5. Lessee accounting: operating and capital

6. Lessor accounting: operating and capital

7. Leases disclosures

8. International accounting for leases

9. The sale-leaseback transaction

Chapter 15 Leases

15-2

Which Company Owns the Largest Number of

Commercial Aircraft in the World?

However, General Electric owns over 1,800 aircraft

that it leases to more than 225 customer airlines in

over 70 countries.

15-3

Introduction

• A lease is a contract specifying the terms under

which the owner of property, the lessor,

transfers the right to use the property to a

lessee.

• A major challenge for the accounting profession

has been to establish standards that prevent

companies from using the legal form of a lease

to avoid recognizing future payment obligations

as a liability.

15-4

Economic Advantages to Leasing Over

Purchasing

1. No down payment

2. Avoid risks of ownership

3. Flexibility

For the Lessee

1. Increased sales

2. Ongoing business relationship with lessee

3. Residual value retained

For the Lessor

1. Describe the circumstances in which leasing

makes more business sense than does

outright sale and purchase

15-5

Simple Example

• Owner Company owns a piece of equipment

with a market value of $10,000 and an estimated

useful life of five years.

• User Company wishes to acquire the equipment.

• User Company can borrow $10,000 from the

bank at 10% interest. Payments for principal and

interest would be five equal annual installments

of $2,638.

2. The accounting issues in recording a lease

transaction

15-6

• Alternatively, User Company can lease the

equipment from Owner Company for five years

and make five annual “rental” payments of

$2,638.

• User will still use the equipment for five years

and will still make payments of $2,638 per

year.

• The primary difference is that now Owner is

not just selling the equipment but is also

substituting for the bank in providing financing.

(continued)

Simple Example

15-7

• Has effective ownership of the equipment

been passed from Owner to User?

• Is the transaction complete, meaning does

Owner have any significant responsibilities

remaining in regard to the equipment?

• Is Owner Company reasonably certain the five

annual payments can be collected from User

Company?(continued)

On the date the lease is signed, should Owner

Company recognize an equipment sale?

The key accounting issues for the lessor are:

Simple Example

15-8

• Question: On the date the lease is signed, should

User recognize the lease equipment as an asset and

the obligation to make the lease payment as a

liability?

• Answer: The answer hinges on whether effective

ownership, as opposed to legal ownership, of the

equipment changes hands when Owner and User

sign the lease agreement.

• The economic substance of the lease is that the lease

signing is equivalent to the transfer of effective

ownership, and the fact that Owner retains legal title

of the equipment during the lease period is a mere

technicality.

Simple Example

15-9

Capital vs. Operating Lease

• Capital leases are accounted for as if the

lease agreement transfers ownership of the

asset from the lessor to lessee.

• Operating leases are accounted for as

rental agreements, with no transfer of

effective ownership associated with the

lease.

15-10

Why Leasing Over Purchasing?

• Keeping the asset off the balance sheet

improves financial ratio measures of efficiency.

• Keeping the liability off the balance sheet

improves measures of leverage.

• For companies that lease a large portion of the

assets they use, the accounting standards

associated with leasing are the most critical

standards that they apply.

15-11

Cancellation Provisions

• Some leases are noncancelable, meaning that

these lease contracts are cancelable only on the

outcome of some remote contingency or that the

cancellation provisions and penalties of these

leases are so costly to the lessee that

cancellation will not occur.

• All cancelable leases are accounting for as

operating leases.

• Some, but not all noncancelable leases are

accounted for as capital leases.

3. Outline the type of contractual provisions

typically included in lease agreements

15-12

Bargain Purchase Option

• If the specified purchase option price is

expected to be considerably less than the fair

value at the date the purchase option may be

exercised, the option is called a bargain

purchase option.

• By definition, a bargain purchase option is one

that is expected to be exercised.

• Noncancelable leases with BPO are

accounted for as capital leases.

15-13

Lease Term

• The lease term is the time period from the

beginning to the end of the lease.

• The beginning of the lease term occurs

when the leased property is transferred to

the lessee.

• The end of the lease term is more flexible

because many leases include provisions

allowing the lessee to extend the lease

period.

(continued)

15-14

Lease Term

• The end of the lease term is at the end of the

fixed noncancelable lease period plus all

renewal option periods that are likely to be

exercised.

• A bargain purchase option is one with such

an attractive lease rate, or other favorable

provision, that at the inception of the lease, it is

likely that the lease will be renewed beyond the

fixed lease period.

15-15

Residual Value

• The market value of the leased property at the

end of the lease term is referred to as its

residual value.

• Some lease contracts require the lessee to

guarantee a minimum residual value. If the

market value falls below the guaranteed

residual value, the lessee must pay the

difference.

(continued)

15-16

Residual Value

• If there is no bargain purchase option or

guarantee of the residual value, the lessor

reacquires the property.

• If the actual amount of the residual value is

unknown until the end of the lease term, it must

be estimated at the inception of the lease. The

residual value under these circumstances is

referred to as an unguaranteed residual

value.

15-17

Minimum Lease Payments

• The rental payments required over the lease

term plus any amount to be paid for the

residual value are referred to as the minimum

lease payments.

• Lease payments sometimes include charges

for items such as insurance, maintenance, and

taxes on the leased property. These are

referred to as executory costs and they are

not included as part of the minimum lease

payment.

(continued)

15-18

Dorney Leasing Co. owns and leases road

equipment for three years at $3,000 per month.

Included in the lease payment is $500 per month

for executory costs to insure and maintain the

equipment. At the end of the 3-year period,

Dorney is guaranteed a residual value of $10,000

by the lessee.

(continued)


15-19

Minimum lease payments:

Rental payments exclusive of executory

costs ($2,500 × 36) $ 90,000

Guaranteed residual value 10,000

Total minimum lease payments $100,000

How did Dorney decide that a $2,500 monthly lease payment

would be sufficient if 12% is the interest rate?


15-20

Nature of Leases

• The implicit interest rate is the rate used by the

lessor in calculating the desired lease payment.

• For purposes of computing the present value of

the minimum lease payments, the lessee uses the

lower of the implicit interest rate used by the

lessor and the lessee’s own incremental

borrowing rate.

• The lessee’s incremental borrowing rate is the

rate at which the lessee could borrow the amount

of money necessary to purchase the leased asset,

taking into consideration the lessee’s financial

situation and current conditions in the marketplace.

15-2115-21

4. Apply the lease classification criteria in order

to distinguish between capital and operating

leases

15-22

General Classification Criteria—

Lessee and Lessor

1. The lease transfers ownership of the leased asset

to the lessee by the end of the lease term.

2. The lease contains a bargain purchase option

making it reasonably assured that the property will be

purchased by the lessee at a future date.

3. The lease term is equal to 75% or more of the estimated

economic life of the leased property.

4. The present value of the minimum lease payments at the

beginning of the lease equals or exceeds 90% or more of

the fair market value of the leased asset.

The four general criteria that apply to all leases for both

the lessee and lessor relate to transfer of ownership,

bargain purchase option, economic life, and fair value.

15-23

IASB Approach

• IAS 17, “Accounting for Leases,” states

simply:

A lease is classified as a finance

(i.e., capital) lease if it transfers

substantially all the risks and

rewards incident to ownership.

• This type of standard places the responsibility

of distinguishing the type of lease on the

accountant.

(continued)

15-24

IAS 17 gives the following examples of

situations that “would normally lead to a lease

being classified as a finance lease”:

IASB Approach

a) The lease transfers ownership of the asset to

the lessee at 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.

(continued)

15-25

IASB Approach

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 amount to at

least substantially all of the fair value of the

leased asset.

Note the similarity between the IAS

17 guidelines and those of the FASB.

They are the same in spirit.

15-26

Revenue Recognition Criteria—Lessor

In addition to meeting one of the four general

criteria, a lease must meet two additional

revenue recognition criteria to be classified by

the lessor as a capital lease:

1. Collection of the minimum lease payments

must be reasonably predictable.

2. Any unreimbursable costs yet to be incurred

by the lessor under the terms of the lease

are known or can be reasonably estimated

at the lease inception date.

15-28

Accounting for Leases—Lessee

• All leases as viewed by the lessee may be

divided into two types: operating leases and

capital leases.

• If the lease meets any one of the four, it is

treated as a capital lease. Otherwise, it is an

operating lease.

• Accounting for operating leases involves the

recognition of rent expense over the term of the

lease.

5. Properly account for both capital and

operating leases from the standpoint of the

lessee (asset user)

15-29

Accounting for Leases—Lessee

• Accounting for a capital lease essentially

requires the lessee to report on the balance

sheet the present value of the future lease

payments, both as an asset and a liability.

• The asset is amortized as though it had been

purchased by the lessee.

15-30

Accounting for Operating Lease—Lessee

The lease terms for manufacturing equipment

are $40,000 a year on a

year-to-year basis. The entry to record the lease

payment for the year would be as follows:

Rent Expense 40,000

Cash 40,000

15-31

• The terms of the lease for an aircraft by

International Airlines provide for payments of

$150,000 a year for the first two years of the

lease and $250,000 for each of the next three

years.

• The total lease payments would be

$1,050,000, or $210,000 a year on a straight-

line basis. The required entries in the five

years are shown on Slide 15-32.

(continued)

Operating Leases with Varying Lease

Payments

15-32

The required entries in the first two years

would be as follows:

Rent Expense 210,000

Cash 150,000

Rent Payable 60,000current liability

The entries for each of the last three years

are as follows:

Rent Expense 210,000

Rent Payable 40,000

Cash 250,000

Operating Leases with Varying Lease

Payments

15-33

• Lease period: 5 years, beginning January 1,

2013. Noncancelable.

• Rental amount: $65,000 per year payable

annually in advance; includes $5,000 to cover

executory costs.

• Estimated economic life of equipment: 5 years.

• Expected residual value of equipment at end of

lease period: None.

Marshall Corporation—Lessee

(continued)

Accounting for Capital Leases—Lessee

15-34

Leased Equipment 250,192

Obligations under Capital Leases 250,192

To record the lease.

Marshall Corp. Entries on January 1, 2013

Lease Expense 5,000


Cash 65,000

To record the first lease

payment (including executory

costs of $5,000).

PMT =

$60,000; N = 5;

I = 10%


15-35

• The term lease expense is used to record the

executory costs related to the leased

equipment, such as insurance and taxes.

• When a lease is capitalized, the asset is

included on the balance sheet and written off

over time. The word amortization, instead of

depreciation, is typically used when

describing the systematic expensing of the

cost of a leased asset.


(continued)

15-36

Marshall Corp. Entries on December 31, 2013

Amortization Expense on Leased

Equipment 50,038

Accumulated Amortization on


$250,192/5

If normal company depreciation policy for this

type of equipment is used, the amortization entry

for 2013 is shown below:

(continued)


15-37

(continued)

15-37

15-38

Prepaid Executory Costs 5,000

Obligations under Capital

Leases 40,981

Interest Expense 19,019

Cash 65,000

Entries on December 31, 2013

($250,192 –

$60,000) ×0.10


(continued)

15-39

The December 31, 2013, balance sheet of

Marshall Corporation would include information

concerning the leased equipment and related

obligations.


15-40


• As the amount of interest expense declines

each period, the total expense will be reduced

and, for the last two years, will be less than the

$65,000 payments (See Slide 15-37).

• The total amount debited to expense over the

life of the lease will be the same regardless of

whether the lease is accounted for as an

operating lease or a capital lease.

(continued)

15-4115-41

15-42

Accounting for Leases with a Bargain

Purchase Option

• Frequently, the lessee is given the option of

purchasing the property in the future at what

appears to be a bargain price.

• The present value of the bargain purchase

option is part of the minimum lease payments

and should be included in the capitalized value

of the lease.

(continued)

15-43

Lessee

• Lease period: 5 years, beginning January 1,

2013, noncancelable.

• Rental amount: $65,000 per year payable

annually in advance; includes $5,000 to cover

executory costs.

• Estimated economic life of equipment: 5 years.

• Expected residual value of equipment at end of

lease period: None.


Purchase Option

15-44

• These are the same facts as the previous

illustration. However, we’ve added a bargain

purchase option of $75,000 exercisable after

five years. The economic life of the equipment

is expected to be ten years.

• Notice in Slide 15-45 that the present value of

the bargain purchase amount of $75,000, or

$46,569, increases the present value of the

minimum lease payments.


Purchase Option

15-45


Present value of five payments at the

beginning of each year for five years:

PMT = $60,000, N = 5, I = 10% $250,192

Present value of the bargain purchase

option of $75,000 at the end of 5 years:

FV = $75,000, N = 5, I = 10% 46,569

Present value of minimum lease payments $296,761


Purchase Option

(continued)

15-46(continued)

15-46

15-47

Entries on December 31, 2017



Cash 75,000

To record exercise of bargain

purchase option.

Equipment 148,381




To transfer remaining balance in

leased asset account to equipment.


Purchase Option

15-48

If the equipment is not purchased and the lease

is permitted to lapse, the following entry is

required on December 31, 2017:

Loss from Failure to Exercise

Bargain Purchase Option 73,381

Obligation under Capital Leases 68,182






Purchase Option

15-49

Accounting for Purchase of Asset

During Lease Term

• On December 31, 2015, rather than making

the lease payment due, the lessee purchased

the leased property in the Marshall

Corporation example for $120,000.

• At that date, the remaining liability recorded

on the lessee’s books is $114,545 and the

net book value of the recorded leased asset

is $100,078 [capitalized value of $250,192

less $150,114 amortization ($50,038 × 3)].

(Slides 15-37)(continued)

15-50

Given the facts in Slide 15-49, the entry to record

the purchase on the lessee’s books would be as

follows:


Obligation under Capital Leases 104,132

Equipment 105,533




Cash 120,000

[$100,078 + ($120,000 – $114,545)]

Accounting for Purchase of Asset

During Lease Term

15-51

Treatment of Leases on Lessee’s

Statement of Cash Flows

• Operating leases present no special problems

to the lessee in preparing a statement of cash

flows.

• For capital leases by the lessee the

amortization of leased assets would be treated

the same as depreciation.

• The portion of the cash payment allocated to

interest expense would require no adjustment

under the indirect method and would be

reported as part of the cash payment for interest

expense under the direct method.

(continued)

15-52



• The portion of the cash payment allocated to

the lease liability would be reported as a

financing outflow under either method.

• The impact of a capital lease on the lessee’s

statement of cash flows is summarized in

Exhibit 15-6 on Slide 15-53.

(continued)

15-5315-53

15-54

In 2013, Marshall Corporation’s income before

any lease-related expenses is $200,000. Net

income for the year is computed as follows:

Income before lease-related expenses $200,000

Lease-related interest expense (19,019)

Lease-related amortization expense (50,038)

Net income $130,943



(continued)

15-55

The statement of cash flows for Marshall Corporation

for 2013, displaying only the lease-related items and

using the indirect method to report cash flow from

operating activities, would appear as follows:



15-56

In addition, the supplemental disclosure to the

statement of cash flows would include the

following two lease-related items:

• Significant noncash transaction: During 2013

the company leased equipment under a

capital lease arrangement. The present value

of the minimum future payments under the

lease was $250,192 on the lease-signing

date.

• Cash paid for interest was $19,019.



15-57

Accounting for Leases—Lessor

• Direct financing leases involve a lessor who

is primarily engaged in financing activities,

such as a bank or finance company. The lessor

views the lease as an investment.

• Sales-type leases involve manufacturers or

dealers who use leases as a means of

facilitating the marketing of their products.

6. Properly account for both capital and

operating leases from the standpoint of the

lessor (asset owner)

15-58

A sales-type lease generates two different types

of revenue:

1) An immediate profit or loss, which is the

difference between the cost of the property

being leased and its sales price, or fair value,

at the inception of the lease.

2) Interest revenue earned over time as the

lessee makes the lease payments that pay

off the lease obligation plus interest.

Accounting for Leases—Lessor

15-59

• For either an operating, direct financing, or

sales-type lease, a lessor may incur certain

costs, referred to as initial direct costs, in

connection with obtaining the lease.

• These costs include the costs to negotiate the

lease, perform the credit check on the lessee,

and prepare the lease documents.

Initial Direct Costs

(continued)

15-6015-60

15-61

Accounting for Operating Leases—Lessor

Minimum payment (in advance) including

$5,000 executory cost $65,000/year

Lease period (beginning Jan. 1, 2013) 5 years

Economic life of asset 10 years

Estimated residual value at end of lease $0

Implicit rate 10%

Incremental borrowing rate 10%

Cost to lessor $400,000

Initial direct costs $15,000

(continued)

Universal Leasing Co. (Lessor)

15-62


The entries to record the payment of the initial

direct costs and the receipt of the lease payment

on January 1, 2013 would be as follows:

Deferred Initial Direct Costs 15,000

Cash 15,000

Cash 65,000

Rent Revenue 60,000

Executory Costs 5,000

(continued)


15-63

To record the amortization of direct costs over five

years and the depreciation of equipment over ten

years using the straight-line basis:

Amortization of Initial Direct Costs 3,000


Depreciation Expense on Leased

Equipment 40,000

Accumulated Depreciation on




15-64

Accounting for Direct Financing Leases

Refer to Slides 15-33 for details concerning

Marshall Corporation’s leasing arrangement with

Universal Leasing Company. The cost of the

equipment to Universal was the same as the fair

value, $250,192 and Equipment Purchased for

Lease was charged when the equipment was

acquired.

(continued)

15-65

To record initial lease on January 1, 2013:

Lease Payments Receivable 300,000

Equipment Purchased for Lease 250,192

Unearned Interest Revenue 49,808

(continued)

Receivable Recorded at Gross Amount

To record first payment on January 1, 2013:

Cash 65,000

Lease Payment Receivable 60,000



15-66(continued)

15-66

15-67

To record receipt of the second payment:

Cash 65,000


Deferred Executory Costs (a liability) 5,000

Unearned Interest Revenue 19,019

Interest Revenue 19,019


15-68

The asset portion of the balance sheet of the lessor at

December 31, 2013, will report the lease receivable

as follows:


15-69

• Assuming the same facts as the last

illustration, except that the asset has a residual

value at the end of the 5-year lease of $75,000.

The cost to Universal Leasing Company was

again the same as its fair value, $296,761.

• The fair value in this example is different from

the fair value in the previous example because,

in the previous example, the asset was

assumed to be worthless at the end of the

lease term.

(continued)

Lessor Accounting for Direct

Financing Leases with Residual Value

15-70

To record initial lease on January 1, 2013:


Equipment Purchased for Lease 296,761

(continued)

Receivable Recorded at Net Amount

To record first payment on January 1, 2013:

Cash 65,000





15-71

To record payment on December 31, 2013:

Cash 65,000


Deferred Executory Cost 5,000


To record recovery of the leased asset at the end

of the lease term on December 31, 2017:

Equipment 75,000





15-72

Accounting for Sales-Type Leases—Lessor

• In a sales-type lease, an immediate profit or

loss arises from the difference between the

sales price of the leased property and the

lessor’s cost to manufacture or purchase the

asset.

• If there is no difference between the sales price

and the lessor’s cost, the lease is not a sales-

type lease.

• The lessor will also recognize interest revenue

over the lease term for the difference between

the sales price and the gross amount of the

minimum lease payments.

15-73

(3) Cost or carrying value of

leased asset to lessor

Manufacturer’s

or Dealer’s

Profit (Loss)

(1) Minimum lease payments

(2) Fair value of leased asset

Financial

Revenue

(Interest)


(continued)

15-74

Fair value of equipment $250,192

Lease period (beginning Jan. 1, 2013) 5 years

Economic life of asset 10 years

Estimated residual value at end of lease $0

Implicit rate 10%

PV of future lease payments $250,192

Cost to lessor $160,000

Direct costs incurred $15,000

American Manufacturing Co. (Lessor)


(continued)

15-75

(1) Minimum lease payments:

($65,000 – $5,000) × 5 $300,000

(2) Fair value of equipment $250,192

$49,808

(Interest

Revenue)

(3) Cost of leased equipment

to lessor, plus initial direct

costs $175,000

$75,192

(Mfr.’s

Profit)


(continued)

15-76



Sales 250,192

Cost of Goods Sold 175,000

Finished Goods Inventory 160,000


Cash 65,000



To record entries on January 1, 2013:


15-77

• The minimum lease payments will include

the following if they are part of the

agreement:

a lump sum (from a bargain purchase

option) at the end of the lease term OR

a guaranteed residual value.

• The receivable is increased by the present

value of the future payment, and sales are

increased by the present value of the

additional amount.

Accounting for Sales-Type Leases—BPO or

Guaranteed R/V

(continued)

15-78

Using the data from Exhibit 15-5, American

Manufacturing offers a bargain purchase option

of $75,000 at the end of five years.


Guaranteed R/V

15-79


Sales 296,761

Cost of Goods Sold 175,000



Cash 65,000






Guaranteed R/V

15-80

Accounting for Sales-Type Leases—

Unguaranteed Residual Value

When a sales-type lease does not contain a

bargain purchase option or a guaranteed

residual value, but the economic life of the

leased asset exceeds the lease term, the

residual value will remain with the lessor. This

is called an unguaranteed residual value.

(continued)

15-81


Sales 250,192

Cost of Goods Sold ($175,000 –

$46,569) 128,431

Finished Goods Inventory

($160,000 – $46,569) 113,431







15-82

Gross profit on the transaction is the same

regardless of whether the residual value is

guaranteed or unguaranteed.



15-83

Third-Party Guarantees of Residual Value

• When a lease is used to increase sales, the

seller wants to account for the lease as a

sales-type lease.

• On the other hand, the buyer would prefer to

account for the lease as an operating lease to

keep the obligation off the balance sheet.

• A third-party guarantee of residual value is a

clever trick that companies have devised to

get around accounting rules.

(continued)

How do they do it?

15-84

Third-Party Guarantees of Residual Value

• The lessor includes a guaranteed residual value

with the calculation so that present value of the

minimum lease payments meet the 90% of fair

value criterion. This allows the lessor to treat the

lease as a sales-type lease.

• The lessee pays an insurance company or

investment firm to guarantee the residual value.

This allows the lessee to remove the guaranteed

residual value from the calculation, dropping the

amount below 90%. This allows the lessee to

account for the lease as an operating lease.

15-85

Sale of Asset During Lease Term

If the leased asset in Exhibit 15-8 below is sold on

December 31, 2015, for $140,000 before the

$60,000 rental payment is made (the Lease

Payments Receivable balance is $104,132)…

15-86

…a gain of $25,455 would be reported. The

following journal entry would be recorded on

December 31, 2015, to record the sale:

Cash 140,000



Gain on Sale of Leased Asset 25,455

Sale of Asset During Lease Term

15-87

Treatment of Leases on Lessor’s


In 2013, American Manufacturing’s income

before any lease-related items is $200,000. Net

income for the year can be computed as follows:

Income before lease-related items $200,000

Lease-related sales 250,192

Lease-related cost of goods sold (175,000)

Leased-related interest revenue 19,019

Net income $294,211

(continued)

15-8815-88

15-89

Treatment of Leases on Lessor’s


For 2013, American Manufacturing’s cash flow

from operations, using the indirect method,

would appear as follows:

Net income $294,211

Less: Increase in lease payments

receivable ($250,192 – $60,000 – $40,981) (149,211)

Plus: Decrease in finished goods inventory 175,000

Net cash flow from operating activities $320,000

Operating activities:

15-90

Disclosure Requirements for Leases

• The required information supplements the

amounts recognized in the financial

statements and usually is included in a single

note to the financial statements.

• The information listed on Slides 15-91 and

15-92 is required for all leases that have initial

or remaining noncancelable lease terms in

excess of one year.

7. Prepare and interpret the lease disclosure

required of both lessors and lessees

15-91

1. Gross amount of assets recorded as capital leases,

along with related accumulated amortization.

2. Future minimum rental payments required as of the

date of the latest balance sheet presented in aggregate

and for each of the five succeeding fiscal years.

3. Rental expense for each period for which an income

statement is presented.

4. A general description of the lease contracts, including

information about restrictions on such items as

dividends, additional debt, and further leasing.

5. For capital leases, the amount of imputed interest

necessary to reduce the lease payments to present

value.

Disclosure Requirements for Leases

Lessee

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• IAS 17 relies on the exercise of accounting

judgment to distinguish between operating and

capital leases.

• A proposal, titled “Accounting for Leases: A New

Approach,” notes that current lease accounting

standards fail in their objective of requiring

companies to recognize significant rights and

obligations as assets and liabilities in the balance

sheet.

International Accounting of Leases

8. Compare the treatment of accounting for

leases in the United States with the

requirements of international accounting

standards

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International Accounting of Leases

• This proposal suggests that the lease

accounting rule be simplified as follows: All

lease contracts are to be accounted for as

capital leases.

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Sale-Leaseback Transactions (Sale at a Gain)

On January 1, 2013, Hopkins Inc. sells equipment

having a carrying value of $750,000 to Ashcroft

Co. for $950,000 and immediately leases back the

equipment. Terms of the lease are:

1. The term of the lease is 10 years,

noncancelable. A down payment of $200,000

is required plus equal lease payments of

$107,107 at the beginning of each year. The

implicit rate is 10%.

9. Record a sales-leaseback transaction for

both a seller-lessee and a purchaser-

lessor

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2. The equipment has a fair value of $950,000

and an expected life of 20 years. Straight-

line depreciation is used.

3. Hopkins has an option to renew the lease

for $10,000 per year for 10 years, the rest

of its economic life. Title passes at the end

of the lease.

(continued)


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