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Chapter 15

Leases

EXERCISE
S

(a) Gothic Corporation


(Lessee)
June 30, 2011

Rent expense...................
Exercise
40,000
Cash ............................
......................................... 40,000

December 31, 2011


Rent expense...................................
Cash ............................................

15-1

40,000
40,000

(b) HardWhere (Lessor)


June 30, 2011
Cash................................................
Rent revenue...............................

40,000

December 31, 2011


Cash................................................
Rent revenue...............................

40,000

40,000

40,000

Depreciation expense ($350,000 5 years) 70,000


Accumulated depreciation..........
70,000

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011


15-1

Exercise 15-2

PresentValueofMinimumLeasePayments:
($10,000 x 10.78685*) = $107,866
lease
present
payments
value
* present value of an annuity due of $1: n=12, i=2%
[i = 2% (8% 4) because the lease
calls for quarterly payments]

LeaseAmortizationSchedule
Lease
Payments

1 10,000
2 10,000
3 10,000
4 10,000
5 10,000
6 10,000
7 10,000
8 10,000
9 10,000
1010,000
1110,000
1210,000

Effective
Interest
2% x Outstanding Balance

.02 (97,886) = 1,957


.02 (89,823) = 1,796
.02 (81,619) = 1,632
.02 (73,251) = 1,465
.02 (64,716) = 1,294
.02 (56,010) = 1,120
.02 (47,130) =
.02 (38,073) =
.02 (28,834) =
.02 (19,411) =
.02 (9,799) =

120,000

The McGraw-Hill Companies, Inc., 2011


15-2

943
761
577
388
201*
12,134

Decrease
in Balance

10,000
8,043
8,204
8,368
8,535
8,706
8,880
9,057
9,239
9,423
9,612
9,799

Outstanding
Balance

107,866
97,886
89,823
81,619
73,251
64,716
56,010
47,130
38,073
28,834
19,411
9,799
0

107,866

Intermediate Accounting, 6e

* adjusted for rounding of other numbers in the schedule

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011


15-3

Exercise 15-2 (concluded)


January 1, 2011
Leased equipment (calculated above).....................
Lease payable (calculated above)........................
Lease payable .....................................................
Cash (lease payment)..........................................

107,866
107,866
10,000
10,000

April 1, 2011
Interest expense (2% x [$107,866 10,000])..............
Lease payable (difference).....................................
Cash (lease payment)..........................................

1,957
8,043

July 1, 2011
Interest expense (2% x $89,823: from schedule).........
Lease payable (difference).....................................
Cash (lease payment)..........................................

1,796
8,204

October 1, 2011
Interest expense (2% x $81,619: from schedule).........
Lease payable (difference).....................................
Cash (lease payment)..........................................

1,632
8368

December 31, 2011


Interest expense (2% x $73,251: from schedule).........
Interest payable ..............................................

1,465

Depreciation expense ($107,866 3 years)...............


Accumulated depreciation...............................

10,000

10,000

10,000

1,465
35,955
35,955

January 1, 2012

The McGraw-Hill Companies, Inc., 2011


15-4

Intermediate Accounting, 6e

Interest payable (from adjusting entry).......................


Lease payable (difference).....................................
Cash (lease payment)..........................................

Exercise 15-3
Lease
Payments

1 10,000
2 10,000
3 10,000
4 10,000
5 10,000
6 10,000
7 10,000
8 10,000
9 10,000
1010,000
1110,000
1210,000

1,465
8,535
10,000

LeaseAmortizationSchedule
Effective
Interest
2% x Outstanding Balance

.02 (97,886) = 1,957


.02 (89,823) = 1,796
.02 (81,619) = 1,632
.02 (73,251) = 1,465
.02 (64,716) = 1,294
.02 (56,010) = 1,120
.02 (47,130) =
.02 (38,073) =
.02 (28,834) =
.02 (19,411) =
.02 (9,799) =

120,000

943
761
577
388
201*
12,134

Decrease
in Balance

10,000
8,043
8,204
8,368
8,535
8,706
8,880
9,057
9,239
9,423
9,612
9,799

Outstanding
Balance

107,866
97,886
89,823
81,619
73,251
64,716
56,010
47,130
38,073
28,834
19,411
9,799
0

107,866

* adjusted for rounding of other numbers in the schedule

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011


15-5

Exercise 15-3 (concluded)


January 1, 2011
Lease receivable (present value of lease payments)...
Inventory of equipment (lessors cost)...............
Cash (lease payment)..............................................
Lease receivable .............................................
April 1, 2011
Cash (lease payment)..............................................
Lease receivable (to balance) ............................
Interest revenue (2% x [$107,866 10,000]).........
July 1, 2011
Cash (lease payment)..............................................
Lease receivable (to balance).............................
Interest revenue (2% x $89,826: from schedule)....
October 1, 2011
Cash (lease payment)..............................................
Lease receivable (to balance).............................
Interest revenue (2% x $81,619: from schedule)....
December 31, 2011
Interest receivable ..............................................
Interest revenue (2% x $73,251: from schedule)....
January 1, 2012
Cash (lease payment)..............................................
Lease receivable (to balance).............................
Interest receivable (from adjusting entry)............

107,866
107,866
10,000
10,000

10,000
8,043
1,957

10,000
8,204
1,796

10,000
8,368
1,632

1,465
1,465

10,000
8,535
1,465

Exercise 15-4Requirement 1
The McGraw-Hill Companies, Inc., 2011
15-6

Intermediate Accounting, 6e

LessorsCalculationofLeasePayments
Amount to be recovered (fair value)
Lease payments at the beginning
of each of eight quarters:

$107,866
__________________

($107,866 10.7866**)

$10,000

** present value of an annuity due of $1: n=12, i=2%

Requirement 2
January 1, 2011
Lease receivable (fair value)..................................
Cost of goods sold (lessors cost)...........................
Sales revenue (fair value)..................................
Inventory of equipment (lessors cost)...............
Cash (lease payment)..............................................
Lease receivable .............................................
April 1, 2011
Cash (lease payment)..............................................
Lease receivable .............................................
Interest revenue (2% x [$107,866 10,000])........

Exercise 15-5

107,866
90,000
107,866
90,000
10,000
10,000

10,000
8,043
1,957

Present value of periodic lease payments*


($205,542

7.49236**)

$1,540,000
** present value of an annuity due of $1: n=13, i=11%

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011


15-7

The lease meets at least one (actually 3 of 4 in this case) criteria for classification
as a capital lease.
January 1, 2011
Cash (given)......................................................................
Helicopter (carrying value).............................................
Deferred gain on sale-leaseback (difference)................

1,540,000

Leased helicopter (present value of lease payments)................


Lease payable (present value of lease payments)...............

1,540,000

Lease payable .................................................................


Cash............................................................................

205,542

1,240,000
300,000

1,540,000

205,542

December 31, 2011


Interest expense (11% x [$1,540,000 205,542])....................
Interest payable ..........................................................

146,790

Depreciation expense ($1,540,000 15 years*)..................


Accumulated depreciation..........................................

102,267

Deferred gain on sale-leaseback ($300,000 20 years).......


Depreciation expense .................................................

15,000

146,790

102,267

15,000

* The helicopter is depreciated over its remaining useful life rather than the lease term
because title transfers to the lessee.

The McGraw-Hill Companies, Inc., 2011


15-8

Intermediate Accounting, 6e

PROBLEM
S

Requirement 1
Capital lease to lessee;
lessor.

Direct financing lease to

Since the present value of minimum lease payments (same


for both the lessor and the lessee) is equal to (>90%) the
fair value of the asset, the 90% recovery criterion is met.

Problem 15-1

CalculationofthePresentValueofMinimumLeasePayments
Present value of periodic lease payments
$32,629 x 15.32380**

$500,000
(rounded)

** present value of an annuity due of $1: n=20, i=3%

The 75% of useful life criterion is met also. Both additional lessor conditions are
met for a capital lease. There is no dealers profit because the fair value equals the
lessors cost.
Requirement 2
Pal Learning Systems (Lessee)
January 1, 2011
Leased equipment (calculated above).................................
Lease payable (calculated above)....................................

500,000

Lease payable .................................................................


Cash (lease payment)......................................................

32,629

Alternate Exercise and Problem Solutions

500,000

32,629

The McGraw-Hill Companies, Inc., 2011


15-9

April 1, 2011
Interest expense (3% x [$500,000 32,629])...........................
Lease payable (difference).................................................
Cash (lease payment)......................................................

Problem 15-1 (concluded)

14,021
18,609
32,629

Star Leasing (Lessor)


January 1, 2011

Lease receivable (present value)........................................


Inventory of equipment (lessors cost)...........................

652,580

Cash (lease payment)..........................................................


Lease receivable .........................................................

32,629

500,000

32,629

April 1, 2011
Cash (lease payment)..........................................................
Lease receivable .........................................................
Interest revenue (3% x [$500,000 32,629]).......................

The McGraw-Hill Companies, Inc., 2011


15-10

32,629
18,608
14,021

Intermediate Accounting, 6e

Requirement 3
Star Leasing (Lessor)
January 1, 2011
Lease receivable (present value)........................................
Cost of goods sold (lessors cost)......................................
Sales revenue (fair value)..............................................
Inventory of equipment (lessors cost)...........................

500,000
450,000

Cash (lease payment)..........................................................


Lease receivable .........................................................

32,629

500,000
450,000

32,629

April 1, 2011
Cash (lease payment)..........................................................
Lease receivable .........................................................
Interest revenue (3% x [$500,000 32,629]).......................

Alternate Exercise and Problem Solutions

32,629
18,608
14,021

The McGraw-Hill Companies, Inc., 2011


15-11

Problem 15-2Requirement 1
Lessors Calculation of Lease Payments
Amount to be recovered (fair value)

$1,097,280

Less: Present value of the guaranteed


residual value ($75,000 x .68301*)

(51,225)

Amount to be recovered through periodic lease payments


$1,046,055
_____________________
Lease payments at the beginning

of each of four years:


*

($1,046,055 3.48685**)

$300,000

present value of $1: n=4, i=10%

** present value of an annuity due of $1: n=4, i=10%

Requirement 2
The lessees incremental borrowing rate (12%) is more than the lessors implicit
rate (10%). So, both parties calculations should be made using a 10% discount rate:

The McGraw-Hill Companies, Inc., 2011


15-12

Intermediate Accounting, 6e

Problem 15-2 (continued)

Application of Classification Criteria

Does the agreement specify that

ownership of the asset transfers


to the lessee?

NO

Does the agreement contain a

bargain purchase option?

NO

Is the lease term equal to 75%

or more of the expected


economic life of the asset?

NO
{4 yrs < 75% of 6 yrs}

Is the present value of the

minimum lease payments equal


to or greater than 90% of the
fair value of the asset?

YES
{$1,046,055b > 90% of $1,046,055}

b See calculation below.

Present Value of Minimum Lease Payments


Present value of periodic lease payments
($300,000 x 3.48685**)

$1,046,055

Plus: Present value of the lessee-guaranteed


residual value ($75,000 x .68301*)
Present value of minimum lease payments
*

51,225
$1,097,280

present value of $1: n=4, i=10%

Alternate Exercise and Problem Solutions

The McGraw-Hill Companies, Inc., 2011


15-13

** present value of an annuity due of $1: n=4, i=10%

Problem 15-2 (continued)

(a) By Blair Co. (the lessee)

Since at least one criterion is met, this is a capital lease to the lessee. Blair
records the present value of minimum lease payments as a leased asset and a lease
liability.

(b) By HHH (the lessor)


Since the fair value equals the lessors carrying value, there is no dealers profit,
making this a direct financing lease.

Requirement 3
December 31, 2011

Blair Co. (Lessee)


Leased equipment (calculated above).................................
Lease payable (calculated above)....................................
Lease payable..................................................................
Cash (lease payment)......................................................
HHH (Lessor)
Lease receivable (calculated above)....................................

The McGraw-Hill Companies, Inc., 2011


15-14

1,097,280
1,097,280
300,000
300,000

1,097,280

Intermediate Accounting, 6e

Inventory of equipment (lessors cost)...........................


Cash (lease payment)..........................................................
Lease receivable..........................................................

Alternate Exercise and Problem Solutions

1,097,280
300,000
300,000

The McGraw-Hill Companies, Inc., 2011


15-15

Requirement 4
Problem 15-2 (continued)
Since both use the same discount rate and since the residual value is lesseeguaranteed, the same amortization schedule applies to both the lessee and lessor:

LeaseAmortizationSchedule
Dec. Payments
31

2011
2011300,000
2012300,000
2011300,000
2012300,000
2013 75,000
1,275,000

Effective
Interest
10% x Outstanding Balance

.10 (797,280) = 79,728


.10 (577,008) = 57,701
.10 (334,709) = 33,471
.10 (68,180) =

6,820*
177,720

Decrease
in Balance

300,000
220,272
242,299
266,529
68,180
1,097,280

Outstanding
Balance

1,097,280
797,280
577,008
334,709
68,180
0

Requirement 5
December 31, 2012

The McGraw-Hill Companies, Inc., 2011


15-16

Intermediate Accounting, 6e

Blair Co. (Lessee)


Interest expense (10% x [$1,097,280 - 300,000]).....................
Lease payable (difference).................................................
Cash (lease payment)......................................................
Depreciation expense ([$1,097,280 - 75,000] 4 years).........
Accumulated depreciation..........................................

HHH (Lessor)
Cash (lease payment)..........................................................
Lease receivable..........................................................
Interest revenue (10% x [$1,097,280 - 300,000]).................

Alternate Exercise and Problem Solutions

79,728
220,272
300,000
255,570
255,570

300,000
220,272
79,728

The McGraw-Hill Companies, Inc., 2011


15-17

Problem 15-2 (concluded)

Requirement 6

December 31, 2013


Blair Co. (Lessee)
Depreciation expense ([$1,097,280 - 75,000] 4 years).........
Accumulated depreciation..........................................
Interest expense (10% x 68,180: from schedule as rounded)....
Lease payable (difference : from schedule)..........................
Accumulated depreciation ($1,097,280 - 75,000)...............
Loss on residual value guarantee ($75,000 - 4,500).............
Leased equipment (account balance)..............................
Cash ($75,000 - 4,500)............................................................

HHH (Lessor)
Inventory of equipment (actual residual value)...................
Cash ($75,000 - 4,500).................................................................
Lease receivable (account balance)................................
Interest revenue (10% x 68,180: from schedule as rounded)

The McGraw-Hill Companies, Inc., 2011


15-18

255,570
255,570
6,820
68,180
1,022,280
71,500
1,097,280
71,500

4,500
71,500
69,180
6,820

Intermediate Accounting, 6e