Accounting 306

1:30-3:00
Case 11-6

Brian Barrett
Lin Ding
Brandon Malab
Monica Padilla
Iris Zhou

This lease should not be classified as an operating lease. The junior accountant did not
consider applying the other criteria in classifying the lease. Since we need to only pass one of the
criteria, the junior accountant should have been able to determine that by using the economic life
test. Based on the case the lease term is three years and the useful life is four years, which
amounts at 75%. Although IAS 17 does not provide specific percentages, it is the majority of the
estimated economic life of the leased equipment. It should be considered as a finance lease
because paragraph 10 section C under IAS 17 states it depends on the substance of the
transaction. Leases can be classified as finance if the lease term is for the major part of the
economic life of the asset even if title is not transferred.
The junior accountant analysis for the journal entries during the three years are
inaccurate. There was no calculation of the lease liability. In order to calculate the present value
of minimum lease payments, it includes four possible items. The four items that are included are:
Minimum rental payment
Guaranteed residual value
Penalty for failure to renew or extend the lease
Bargain-purchase option
Out of the four items, only guaranteed residual value and rental payments are included in
the case. The junior accountant should have calculated the minimum lease payments by using an
interest rate of 10% and a period of 3 years. The 10% was used because under IFRS, it requires
to use the implicit rate unless it cannot be determined. The period should be three because that is
how long our lease term is.
Since he recognizes the lease as an operating lease, he is using the wrong accounts in the
journal entries. The accounts should be in accordance to finance leases. There were many entries

ignored by both accountants which include: depreciation, executory costs, and interest expense.
The correct journal entries for both the junior and senior accountant would be as follows:

Date

Account

1/1/2013 Leased Equipment

Dr.

Cr.
$263,711

Lease Liability
12/31/2013 Lease Liability
Interest Expense

$263,711
$73,629
$26,371

Cash
12/31/2013 Depreciation Expense

$100,000
$81,237

Accumulated Depr.
Lease
12/31/2013 Executory Expense

$81,237
$2,000

Cash
12/31/2014 Lease Liability
Interest Expense

2000
$80,992
$19,008

Cash
12/31/2014 Depreciation Expense

$100,000
$81,237

Accumulated Depr.
Lease
12/31/2014 Executory Expense

$81,237
$2,000

Cash
12/31/2015 Lease Liability
Interest Expense

2000
$89,091
$10,909

Cash
12/31/2015 Depreciation Expense

$100,000
$81,237

Accumulated Depr.
Lease
12/31/2015 Executory Expense
Cash

$81,237
$2,000
2000

The senior accountant was also partially incorrect in his calculations in multiple steps of
the process. On his first step, the senior accountant is correct in that the lease should be treated as

a financing lease. However, the senior accountant should consider making multiple corrections
further on from step one. In correcting his mistakes, his improvements will correctly align his
amortization table. Having the correct amortization table will make it easier to record the proper
journal entries for the first year.
In the senior accountants computation of the lease asset and obligation, he failed to use
the correct amortization rate. Additionally, he failed to include the guaranteed residual value in
his computation of present value of minimum lease payments. If he had included the guaranteed
residual value and used the correct rate, then he would have achieved a starting lease liability of
$263,711. With that being, he would have had an amortization table in Step 3, which would
appear as the following:

Date

PMT

10% Interest

Reduction

1/1/2013

Lease Liability
$263,711

12/31/2013

$100,000

$26,371

$73,629

$190,083

12/31/2014

$100,000

$19,008

$80,992

$109,091

12/31/2015

$100,000

$10,909

$89,091

$20,000

12/31/2015

$20,000

$2,000

$18,000

$2,000

Since we are the Lessee, there are no major differences in this situation between IFRS
and GAAP. The only notable difference is that this lease, under IFRS, is considered a finance
lease. Had this lease been held to GAAP standards, it would have been referred to as a capital
lease. The tests about which way to treat a lease under GAAP are far more specific, but in this
case, the lease passed the same test under both GAAP and IFRS. Additionally, IFRS uses the
implicit interest rate on a consistent basis, whereas GAAP will use the incremental borrowing
rate unless the implicit rate is known and is less than the incremental borrowing rate. In this case,

only the terminology is changed between GAAP and IFRS; no major changes in calculation are
required.

Reference List
Case 11-6. Lesse Ltd. 2010. Deloitte Development LLC.
International Financial Reporting Standards 17. (2009). Retrieved from CICA: International
Financial Reporting Standards database. Paragraph 10.