Chapter 15 - Leases

CHAPTER 15
LEASES
Overview
In the previous chapter, we saw how companies account for their long-term debt. The focus of that
discussion was bonds and notes. In this chapter we continue our discussion of debt, but we now turn our
attention to liabilities arising in connection with leases. Leases that produce such debtor/creditor relationships
are referred to as capital leases b the lessee and as either direct financing or sales-type leases b the lessor. !e
also will see that some leases do not produce debtor/creditor relationships, but instead are accounted for as lease
agreements. These are designated operating leases.
Learning Objectives
1. Identif and describe the operational, financial, and ta" ob#ectives that motivate leasing.
$. %"plain wh some leases constitute lease agreements and some represent purchases/sales accompanied b
debt financing.
&. %"plain the basis for each of the criteria and conditions used to classif leases.
'. (ecord all transactions associated with operating leases b both the lessor and lessee.
5. )escribe and demonstrate how both the lessee and lessor account for a capital lease.
*. )escribe and demonstrate how the lessor accounts for a sales-tpe lease.
+. %"plain how lease accounting is affected b the residual value of a leased asset.
,. )escribe the wa a bargain purchase option affects lease accounting.
-. %"plain the impact on lease accounting of e"ecutor costs, the discount rate, initial direct costs, and
contingent leases.
1.. %"plain sale-leasebac/ agreements and other special leasing arrangements and their accounting treatment.
11. )iscuss the primar differences between 0.1. 2334 and I5(1 with respect to leases.
Lecture Outline Lecture Outline
Part A: Accounting by te Lessor an! Lessee
"# A!vantages o$ Leasing
3. Leasing is used as a means of 6off-balance-sheet financing.7
1. Can avoid negativel affecting the debt-e8uit ratio and other mechanical indicators of ris/iness.
$. 3ssumes mar/et is naive, and is 6fooled7 b off-balance-sheet financing.
9. 3chieves operational ob#ectives b facilitating asset ac8uisition to overcome:
1. 0ncertaint or cash flow problems.
$. Time constraints and/or bureaucratic control sstems.
&. 5ear of obsolescence.
C. 3chieves ta" ob#ectives: 3 lessee often can negotiate lower lease paments if it allows the lessor to
retain ownership and thus benefit from depreciation deductions when:
1. The lessee has little or no ta"able income and will get little benefit from depreciation deductions.
$. The lessee has sufficient ta"able income to ta/e advantage of the depreciation deductions, but is in
lower ta" brac/ets than lessors.
15-1
Chapter 15 - Leases
""# "n %ee&ing wit te conce&t o$ 'substance over $or() a lease is accounte! $or as eiter:
3. 3 lease agreement or
9. 3 purchase/sale accompanied b debt financing ;T15-1<
"""# Lease Classi$ication ;T15-$<
3. 3 lessee should classif a lease transaction as a capital lease if it is noncancellable and if one or more
of four classification criteria are met: ;T15-$<
1. The agreement specifies that ownership of the asset transfers to the lessee.
$. The agreement contains a bargain purchase option.
&. The noncancellable lease term is e8ual to 75% or more of the e"pected economic life of the
asset.
'. The present value of the minimum lease paments is e8ual to or greater than 90% of the fair
value of the asset.
9. =therwise, it is an operating lease.
C. 3 lessor records a lease as a direct financing lease or a sales-tpe lease onl if two conditions relating to
revenue reali>ation are met in addition to one of the four classification criteria.
1. The collectibilit of the lease paments must be reasonabl predictable.
$. If an costs to the lessor have et to be incurred, the are reasonabl predictable.
;4erformance b the lessor is substantiall complete.<
"*# O&erating Leases ;T15-&<
3. !e assume that the fundamental rights and responsibilities of ownership are retained b the lessor and
that the lessee merel is using the asset temporaril.
9. 3 6sale7 is not recorded b the lessor?
C. 3 6purchase7 is not recorded b the lessee.
). Instead, the periodic lease paments are accounted for merel as rent: ;T15-'<
1. Rent revenue b the lessor,
$. Rent expense b the lessee.
%. 3dvance paments are considered prepayments of rent. The are deferred and allocated to rent over
the lease term. ;T15-5<
1. 3 refundable securit deposit is recorded as a long-term receivable ;b the lessee< and liability ;b
the lessor< unless it is not e"pected to be returned.
$. 3 prepament of the last period@s rent is recorded as prepaid rent and allocated to rent
e"pense/rent revenue during the last period of the lease term.
5. The cost of a leasehold improvement is depreciated over its useful life to the lessee. ;T15-5<
*# +on,O&erating Leases ;T15-*<
3. In a capital lease the lessee records a leased asset at the present value of the minimum lease paments.
9. 3 capital lease is recorded b the lessor as a sales-type lease or direct financing lease, depending on
whether the lease provides the lessor a dealer@s profit.
C. Interest accrues at the effective rate on the balance outstanding during the period. Lease paments
;e"cept the first< include interest on the outstanding balance as well as a residual portion that reduces
that outstanding balance. ;T15-+<
). 3n amorti>ation schedule is convenient to /eep up with changing amounts. ;T15-,<
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Chapter 15 - Leases
%. )epreciation is recorded for leased assets in a manner consistent with the lessee@s usual polic for
depreciating its operational assets ;T15--<
1. Aormall over the term of the lease.
$. =ver the assetBs useful life, if:
a. =wnership transfers or
b. 3 bargain purchase option is present.
5. 3 sales-tpe lease re8uires recording sales revenue and cost of goods sold b the lessor at the inception
of the lease. 3ll other entries are the same as in a direct financing lease. ;T15-1.<
1. The presence or absence of a manufacturer@s or dealer@s profit distinguishes between a sales-tpe
lease and a direct financing lease.
$. 3dditional profit e"ists when the fair value of the asset ;usuall the present value of the minimum
lease paments or Cselling priceC< e"ceeds the cost or carring value of the asset Csold.C ;T15-11<
Part -: -argain Purcase O&tions an! Resi!ual *alue
"# -argain Purcase O&tion
!hen a 94= is present, both the lessor and the lessee view the option price as an additional lease
pament. ;T15-1$<
3. The lease term effectivel ends when the 94= is e"ercisable.
9. Thus, if a 94= in a si"-ear lease could be e"ercised at the end of the fifth ear, the effect will be
to change the lease term to five ears, from si".
""# Resi!ual *alue ;T15-1&<
3 lessee-guaranteed residual value is included as a component of minimum lease paments for both the
lessor and the lessee. 3n unguaranteed residual value is not ;but is part of the lessor@s gross investment
in the lease<.
3. If the lessee obtains title, the lessor@s computation of lease paments is unaffected b an residual
value.
9. If the lessor retains title, the amount to be recovered through periodic lease paments is reduced b
the present value of the residual amount. ;T15-1'<
C. =n the other side of the transaction, the lessee considers the 6purchase7 price of the copier to
include:
1. 3t a minimum, the present value of the periodic lease paments.
$. 3n amount due to the residual value viewed as an additional 6pament7 if the lessee
guarantees the residual value to be a particular amount at the end of the lease term. ;T15-15,
T15-1*, T15-1+<
Part C: Oter Lease Accounting "ssues
3. %"ecutor costs are maintenance, insurance, ta"es, and an other costs usuall associated with
ownership. ;T15-1,<
1. 1ometimes, as an e"pedienc, a lease contract will specif that the lessor is to pa e"ecutor costs,
but that the lessee will reimburse the lessor through higher lease paments.
$. 3n portion of lease paments that represents e"ecutor costs is not considered part of minimum
lease paments.
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Chapter 15 - Leases
&. The lessee simpl e"penses e"ecutor costs as incurred.
9. The lessee uses the lower of the interest rate implicit in the lease or the lessee@s own incremental
borrowing rate. ;T15-1-<
C. Initial direct costs are the costs incurred b the lessor that are associated directl with originating a
lease and are essential to ac8uire that lease.
1. The include legal fees, commissions, evaluating the prospective lesseeBs financial condition, and
preparing and processing lease documents.
$. The method of accounting for initial direct costs depends on the nature of the lease:
a. 5or operating leases initial direct costs are recorded as assets and amorti>ed over the term of
the lease. 1ince the onl revenue an operating lease produces is lease revenue, and that
revenue is recogni>ed over the lease term, initial direct costs also are automaticall recogni>ed
over the lease term to match these costs with the rent revenues the help generate.
b. In direct financing leases interest revenue is earned over the lease term, so initial direct costs
are matched with the interest revenues the help generate. Therefore, initial direct costs are
not e"pensed at the outset, but are deferred and recogni>ed over the lease term. This can be
accomplished b increasing the lessor@s lease receivable b the total of initial direct costs.
Then, as interest revenue is recogni>ed over the lease term at a constant effective rate, the
initial direct costs are recogni>ed at the same rate ;that is, proportionall<.
c. 5or sales-type leases initial direct costs are e"pensed at the inception of the lease. 1ince the
usual reason for a sales-tpe lease is for a manufacturer or a dealer to sell its product, it@s
reasonable to recogni>e the costs of creating the transaction as a selling e"pense in the period
of the sale.
). Lease disclosure re8uirements include ;a< a 6general description7 of the leasing arrangement as well as
;b< minimum future paments, in the aggregate, and for each of the five succeeding fiscal ears.
%. )ecision-Da/ers@ 4erspective: 5inancial 1tatement Impact
1. 9alance 1heet and Income 1tatement
i. Lease liabilities affect the debt e8uit ratio and the rate of return on assets.
ii. =perating leases also represent long-term commitments that can become a problem if business
declines and cash inflows drop off.
iii. The net income difference between treating a lease as a capital lease versus an operating lease
generall is not significant.
iv. The impact on the balance sheet between capital leases and operating leases is significant.
$. 1tatement of Cash 5low Impact
i. 9oth the lessee and lessor report cash paments for operating leases in a statement of cash flows as cash
flows from operating activities.
ii. %ach lease pament in a capital lease includes both an amount that represents interest and an amount that
represents a reduction of principal. In a statement of cash flows, then, the lessee reports the interest
portion as cash flows from operating activities and the principal portion as cash flows from financing
activities. The lessor in a direct financing lease reports the interest portion as cash flows from operating
activities and the principal portion as cash flows from investing activities. 0nli/e for an operating lease,
both the lessee and lessor report the lease at its inception as a non-cash investing/financing activit.
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Chapter 15 - Leases
iii. Consistent with reporting sales of products under installment sales agreements rather than lease
agreements, the lessor reports cash receipts from a sales-tpe lease as cash flows from operating
activities.
Part .: S&ecial Leasing Arrange(ents
3. In a sale-leasebac/ transaction the owner of an asset sells it and immediatel leases it bac/ from the new
owner.
1. 3 gain on the sale of an asset in a sale leasebac/ arrangement is deferred and amorti>ed over the
lease term ;or asset life if title is e"pected to transfer to the lessee<.
$. The lease portion of the transaction is evaluated and accounted for li/e an lease.
9. (eal estate leases involve land E e"clusivel, or in part.
1. =nl the first ;title transfers< and second ;94=< classification criteria appl in a land lease.
$. !hen ;a< the leased propert includes both land and a building, ;b< neither of the first two criteria
is met, and ;c< the fair value of the land is $5F or more of the combined fair value, both the lessee
and the lessor treat the land as an operating lease and the building as an other lease.
&. 0sual lease accounting procedures appl to leases that involve onl part of a building although
e"tra effort ma be needed to arrive at reasonable estimates of cost and fair value.
C. 3 leveraged lease involves significant long-term, nonrecourse financing b a third part creditor.
1. 3 lessee accounts for a leveraged lease the same wa as a nonleveraged lease.
$. 3 lessor records its investment ;receivable< net of the nonrecourse debt and reports income from
the lease onl in those ears when the receivable e"ceeds the liabilit.
"nternational /inancial Re&orting Stan!ar!s
3. The I319 and 5319 are collaborating on a #oint pro#ect for a revision of leasing standards. The 9oards
have agreed that a 6right of use7 model ;where the lessee recogni>es an asset representing the right to
use the leased asset for the lease term and also recogni>es a corresponding liabilit for the lease rentals,
whatever the term of the lease< is the onl approach which recogni>es assets and liabilities that
corresponded to the conceptual framewor/ definitions. Dan people e"pect the new standard to result
in most, if not all, leases being recorded as an intangible asset for the right of use and a liabilit for the
present value of the lease paments. ;T15-$.<
9. 0nder I! "o. #7, land and buildings elements are considered separatel unless the land element is not
material. 0nder 0.1. 2334, land and building elements generall are accounted for as a single unit,
unless land represents more than $5F of the total fair value of the leased propert. ;T15-$1<
C. 0nder I! "o. #7, both parties to a lease generall use the rate implicit in the lease to discount
minimum lease paments. 0nder 0.1. 2334, lessors use the implicit rate and lessees use the
incremental borrowing rate unless the implicit rate is /nown and is the lower rate. ;T15-$$<
15-5
Chapter 15 - Leases
). !hen the leasebac/ is an operating lease, under I! "o. #7, the gain is recogni>ed immediatel but is
amorti>ed over the lease term under 0.1. 2334. !hen the leasebac/ is a finance ;capital< lease, under
I! "o. #7, the gain is recogni>ed over the lease term but is recogni>ed over the useful life of the asset
under 0.1. 2334. ;T15-$&<
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preferences.
15-*
Chapter 15 - Leases
-AS"C LEASE CLASS"/"CAT"O+S
3 lease is accounted for as either a lease agreement ;o&erating lease<
or a purchase/sale accompanied b debt financing. The choice of
accounting method hinges on the nature of the leasing arrangement.
Ca&ital leases are agreements that we identif as being formulated
outwardl as leases, but which are in realit installment purchases.
Lessee Lessor
1 =perating lease 1O&erating lease
1 Capital lease G Capital lease:
Direct financing lease
Sales-type lease
CLASS"/"CAT"O+ CR"TER"A
3 lessee should classif a lease transaction as a capital lease if it includes
a noncancelable lease term and one or more of the following four criteria
are met. =therwise, it is an operating lease.
1 The agreement specifies that ownership of the asset transfers to
the lessee.
2 The agreement contains a bargain &urcase o&tion.
3 The non-cancelable lease term is e8ual to 75% or more of the
e"pected economic life of the asset.
4 The present value of the minimum lease paments is e8ual to or
greater than 90% of the fair value of the asset.
15-+
Chapter 15 - Leases
A.."T"O+AL LESSOR CO+."T"O+S
The collectibilit of the lease paments must be reasonabl
predictable.
If an costs to the lessor have et to be incurred, the are
reasonabl predictable. ;4erformance b the lessor is
substantiall complete.<
2raphic 15-'
T15-$
15-,
Chapter 15 - Leases
OPERAT"+5 LEASES
=n Hanuar 1, $.11, 1ans 1erif 4ublishers, Inc., a computer services and printing firm, leased
a color copier from Compu)ec Corporation.
The lease agreement specifies four annual paments of I1..,... beginning Hanuar 1, $.11,
the inception of the lease, and at each Hanuar 1 through $.11. The useful life of the copier is
estimated to be si" ears.
9efore deciding to lease, 1ans 1erif considered purchasing the copier for its cash price of
I'+-,.+-. If funds were borrowed to bu the copier the interest rate would have been 1.F.
Jow should this lease be classifiedK !e appl the four classification criteria:
1 )oes the agreement specif that
ownership of the asset transfers
to the lesseeK A=
2 )oes the agreement contain a
bargain purchase optionK A=
3 Is the lease term e8ual to +5F
or more of the e"pected A=
economic life of the assetK L' rs M +5F of * rsN
4 Is the present value of the
minimum lease paments e8ual
to or greater than -.F of the A=
fair value of the assetK LI&',,*,5 M -.F of I'+-,.+-N
I1..,... " &.',*,5
OO
P I&',,*,5
lease present
paments value
OO
present value of an annuit due of I1: nP', iP1.F
1ince none of the four classification criteria is met, this is an operating lease.
Illustration 15-1
T15-&
15--
Chapter 15 - Leases
OPERAT"+5 LEASES
At Each of the Four Payment Dates
Sans Seri$ Publisers6 "nc# 7Lessee8
4repaid rent........................................................ 1..,...
Cash ............................................................ 1..,...
Co(&u.ec Cor&oration 7Lessor8
Cash.................................................................... 1..,...
0nearned rent revenue................................ 1..,...
At the End of Each Year
Sans Seri$ Publisers6 "nc# 7Lessee8
(ent e"pense...................................................... 1..,...
4repaid rent................................................. 1..,...
Co(&u.ec Cor&oration 7Lessor8
0nearned rent revenue....................................... 1..,...
(ent revenue............................................... 1..,...
)epreciation e"pense......................................... ","""
3ccumulated depreciation.......................... ","""
Illustration 15-1a
T15-'
15-1.
Chapter 15 - Leases
A.*A+CE PA90E+TS
3dvance paments are considered prepaments of rent. The are
deferred and allocated to rent over the lease term.
LEASEHOL. "0PRO*E0E+TS
1ometimes a lessee will ma/e improvements to leased propert that
reverts bac/ to the lessor at the end of the lease.
If a lessee constructs a new building on or ma/es modifications to
e"isting structures, that cost represents an asset #ust li/e an other
capital e"penditure. Li/e other assets, its cost is allocated as
depreciation e"pense over its useful life to the lessee, which will be
the shorter of the phsical life of the asset or the lease term.
T15-5
15-11
Chapter 15 - Leases
."RECT /"+A+C"+5 LEASES :
LESSEE A+. LESSOR CALC;LAT"O+S
=n Hanuar 1, $.11, 1ans 1erif 4ublishers, Inc. leased a copier from
5irst LeaseCorp. 5irst LeaseCorp purchased the e8uipment from
Compu)ec Corporation at a cost of I'+-,.+-.
The lease agreement specifies annual paments beginning Hanuar 1,
$.11, the inception of the lease, and at each )ecember &1 through
$.1*. Te si<,year lease ter( is e=ual to te esti(ate! use$ul li$e o$
te co&ier. The interest rate is 1.F.
Calculations:
Lessor:
I'+-,.+- Q '.+-.+-
OO
P I1..,...
lessor@s lease
cost paments
OO
present value of an annuit due of I1: nP*, iP1.F
Lessee:
I1..,... " '.+-.+-
OO
P I'+-,.+-
lease lessee@s
paments cost
OO
present value of an annuit due of I1: nP*, iP1.F
Illustration 15-$
T15-*
15-1$
Chapter 15 - Leases
."RECT /"+A+C"+5 LEASES :
LESSEE A+. LESSOR E+TR"ES
Direct Financing Lease [January 1 !"11#
Sans Seri$ Publisers6 "nc# 7Lessee8
Leased e8uipment ;present value of paments<........... '+-,.+-
Lease paable ;present value of paments<........... '+-,.+-
/irst LeaseCor& 7Lessor8
Lease receivable
O
;present value of paments<............ '+-,.+-
Inventor of e8uipment ;lessor@s cost<............ '+-,.+-
First Lease Payment [January 1 !"11#
Sans Seri$ Publisers6 "nc# 7Lessee8
Lease paable .................................................... 1..,...
Cash............................................................ 1..,...
/irst LeaseCor& 7Lessor8
Cash.................................................................... 1..,...
Lease receivable ......................................... 1..,...
Illustration 15-$ ;continued<
T15-* ;continued<
15-1&
Chapter 15 - Leases
15-1'
Chapter 15 - Leases
."RECT /"+A+C"+5 LEASES :
SECO+. LEASE PA90E+T
Second Lease Payment [Decem$er %1 !"11#
Sans Seri$ Publisers6 "nc# 7Lessee8
Interest e"pense ;1.F " RI'+-,.+- E 1..,...S<............... &+,-.,
Lease paable ;difference<...................................... *$,.-$
Cash ;lease pament<........................................ 1..,...
/irst LeaseCor& 7Lessor8
Cash ;lease pament<............................................... 1..,...
Lease receivable ;difference<.......................... *$,.-$
Interest revenue ;1.F " RI'+-,.+- E 1..,...S<..... &+,-.,
Illustration 15-$a
T15-+
15-15
Chapter 15 - Leases
LEASE A0ORT">AT"O+ SCHE.;LE
E$$ective .ecrease Outstan!ing
Pay(ents "nterest in -alance -alance
1.F " =utstanding 9alance
1/1/11 '+-,.+-
1/1/11 1..,... 1..,... &+-,.+-
1$/&1/11 1..,... .1. ;&+-,.+-< P &+,-., *$,.-$ &1*,-,+
1$/&1/1$ 1..,... .1. ;&1*,-,+< P &1,*-- *,,&.1 $',,*,*
1$/&1/1& 1..,... .1. ;$',,*,*< P $',,*- +5,1&1 1+&,555
1$/&1/1' 1..,... .1. ;1+&,555< P 1+,&55 ,$,*'5 -.,-1.
1$/&1/15 1..,... .1. ;-.,-1.< P -,.-. O -.,-1. .
?@@6@@@ 12@6A21B 4CA6@CA
O ad#usted for rounding of other numbers in the schedule
2raphic 15-5
T15-,
15-1*
Chapter 15 - Leases
.EPREC"AT"O+
)epreciation is recorded for leased assets in a manner consistent with
the lessee@s usual polic for depreciating its operational assets.
End of Each Year
Sans Seri$ Publisers6 "nc# 7Lessee8
)epreciation e"p. ;I'+-,.+- Q * earsO<................ +-,,'+
3ccumulated depreciation............................... +-,,'+
O if the lessee depreciates assets b the straight-line method
The lessee normall should depreciate a leased asset over the term of the
lease. Jowever, if:
;a< ownership transfers or
;b< a bargain purchase option is present
;i.e., either of the first two classification criteria is met< the asset should be
depreciated over the assetBs useful life. This means depreciation is
recorded over the useful life of the asset to the lessee.
T15--
15-1+
Chapter 15 - Leases
SALES,T9PE LEASES
=n Hanuar 1, $.11, 1ans 1erif 4ublishers, Inc. leased a copier from
Compu)ec Corporation at a 6price7 of I'+-,.+-.
The lease agreement specifies annual paments of I1..,...
beginning Hanuar 1, $.11, the inception of the lease, and at each
)ecember &1 through $.1*. The si"-ear lease term is e8ual to the
estimated useful life of the copier.
Co(&u.ec (anu$acture! te co&ier at a cost o$ D3@@6@@@#
Compu)ec@s interest rate for financing the transaction is 1.F.
Lease receivable ;4T of minimum lease paments<..... '+-,.+-
Cost of goods sold ;lessor@s cost<......................... &..,...
1ales revenue ;4T of minimum lease paments<..... '+-,.+-
Inventor of e8uipment ;lessor@s cost<............. &..,...
/irst Lease Pay(ent
Cash.................................................................. 1..,...
Lease receivable .......................................... 1..,...
Illustration 15-&
T15-1.
15-1,
Chapter 15 - Leases
LEASE PA90E+T RELAT"O+SH"PS
Lessor Lessee
SALES,T9PE LEASE CAP"TAL LEASE
2ross Investment I*..,... Dinimum Lease
in LeaseO 4aments
L%11:
Interest during lease term
RI1$.,-$1S
%U03L1:
1elling 4rice: I'+-,.+- 4urchase 4rice:
4resent Talue of 4aments 4resent Talue of 4aments
L%11:
$rofit on !ale&&
RI1+-,.+-S
%U03L1:
Cost to Lessor I&..,... LIrrelevant to LesseeN
B The lessor@s gross investment in the lease also would include an unguaranteed residual
value in addition to the minimum lease paments. 3lso, an residual value guaranteed b
the lessee is included in the minimum lease paments ;both companies<.
OB If profit is >ero, this would be a direct financing lease.
2raphic 15-+
T15-11
15-1-
Chapter 15 - Leases
E//ECT O/ A -AR5A"+ P;RCHASE OPT"O+
3 bargain &urcase o&tion 7-PO8 is a provision of some lease
contracts that gives the lessee the option of purchasing the leased propert
at a 6bargain7 price. The e"pectation that the option price will be paid
effectivel adds an a!!itional cas $low to the lease for both the lessee
and the lessor. That additional pament is included as a component of
minimum lease paments for both the lessor and the lessee.
The lessor, when computing periodic lease paments, subtracts the
present value of the 94= price from the amount to be recovered
;fair mar/et value< to determine the amount that must be recovered
from the lessee through the periodic rent paments.
The lessee adds the present value of the 94= price to the present
value of periodic paments when computing the amount to be
recorded as a leased asset and a lease liabilit.
2raphic 15-,
T15-1$a
15-$.
Chapter 15 - Leases
EHE+ A -PO "S EFERC"SA-LE
-E/ORE THE E+. O/ THE LEASE TER0
1ince a 94= is e"pected to be e"ercised, the lease term ends for
accounting purposes when the option becomes e"ercisable.
5or e"ample, let@s sa a 94= in a si"-ear lease could be
e"ercised at the end of the fifth ear. The effect this would have
on accounting for the lease is to change the lease term to five
ears, from si".
T15-1$b
15-$1
Chapter 15 - Leases
RES".;AL *AL;E
LESSEE O-TA"+S T"TLE
If the lessee obtains title to the leased asset, the lessorGs
computation of lease paments is unaffected b an residual value.
The residual value influences the lessee onl b the fact that
depreciation calculations reflect a reduced depreciable amount. In
determining the amount to capitali>e as a leased asset and to record
as a lease liabilit, the residual value is ignored.
LESSOR RETA"+S T"TLE
If the lessor retains title to the leased asset, the amount needed to
be recovered through periodic lease paments is reduced b the
present value of the residual value.
=n the other side of the transaction, whether the lessee considers
the 6purchase7 price of the copier to include the present value of
the residual value depends on whether the residual value is viewed
as an additional 6pament7 b the lessee. It is viewed as an
additional pament when the lessee guarantees the residual value
to be a particular amount at the end of the lease term.
T15-1&
15-$$
Chapter 15 - Leases
RES".;AL *AL;E
=n Hanuar 1, $.11, 1ans 1erif 4ublishers, Inc. leased a color copier
from Compu)ec Corporation at a 6price7 of I'+-,.+-. The lease
agreement specifies annual paments beginning Hanuar 1, $.11, the
inception of the lease, and at each )ecember &1 through $.1*. Te
esti(ate! use$ul li$e o$ te co&ier is seven years# At te en! o$ te
si<,year lease ter( te co&ier is e<&ecte! to be wort D?@6@@@.
Compu)ec manufactured the copier at a cost of I&..,....
Compu)ec@s interest rate for financing the transaction is 1.F.
LESSORGS CALC;LAT"O+ O/ THE LEASE PA90E+TS "+CL;."+5 A
RES".;AL *AL;E
3mount to be recovered ;fair value< I'+-,.+-
%ess& 4T of the residual value ;I*.,... " .5*''+
O
< ;&&,,*, <
3mount to be recovered through
periodic lease paments I''5,$11

Lease paments at the beg.
of each of the ne"t si" ears: ;I''5,$11 Q '.+-.+-
OO
< I -$,-&1
O
present value of I1: nP*, iP1.F
OO
present value of an annuit due of I1: nP*, iP1.F
Illustration 15-59
T15-1'
15-$&
Chapter 15 - Leases
LESSEEGS CALC;LAT"O+ O/ THE A0O;+T RECOR.E. AS A LEASE.
ASSET A+. L"A-"L"T9 "+CL;."+5 A RES".;AL *AL;E
=n the other side of the transaction, the lessee ;1ans 1erif 4ublishers<
considers the 6purchase7 price of the copier to include, at a
minimum, the present value of the periodic lease paments
;I''5,$11<:
I-$,-&1 " '.+-.+-OO P I''5,$11
lease present
paments value
OO
present value of an annuit due of I1: nP*, iP1.F
"/ RES".;AL *AL;E "S 5;ARA+TEE.:
4T of periodic paments ;I-$,-&1 " '.+-.+-
OO
< I''5,$11
$lus& 4T of the residual value ;I*.,... " .5*''+
O
< &&,,*,
4T of minimum lease paments
R(ecorded as a leased asset and a lease liabilitS I'+-,.+-
O
present value of I1: nP*, iP1.F
OO
present value of an annuit due of I1: nP*, iP1.F
Illustration 15-53
T15-15
15-$'
Chapter 15 - Leases
A0ORT">AT"O+ SCHE.;LE
E"TH RES".;AL *AL;E
'( E"TH -PO
E$$ective .ecrease Outstan!ing
Pay(ents "nterest in -alance -alance
1.F " =utstanding 9alance
1/1/11 '+-,.+-
1/1/11 -$,-&1 -$,-&1 &,*,1',
1$/&1/11 -$,-&1 .1. ;&,*,1',< P &,,*15 5',&1* &&1,,&$
1$/&1/1$ -$,-&1 .1. ;&&1,,&$< P &&,1,& 5-,+', $+$,.,'
1$/&1/1& -$,-&1 .1. ;$+$,.,'< P $+,$., *5,+$& $.*,&*1
1$/&1/1' -$,-&1 .1. ;$.*,&*1< P $.,*&* +$,$-5 1&',.**
1$/&1/15 -$,-&1 .1. ;1&',.**< P 1&,'.+ +-,5$' 5',5'$
1$/&1/1* *.,... .1. ;5',5'$< P 5,'5, O 5',5'$ .
?1C65H? 13H65@C 4CA6@CA
O ad#usted for rounding of other numbers in the schedule
2raphic 15--
T15-1*
15-$5
Chapter 15 - Leases
E//ECT O/ A RES".;AL *AL;E: A S;00AR9
Is the resi!ual value of a leased asset included in ;a< the lessor@s gross investment in the lease
Rthus affecting the computation b the lessor of the amount of the periodic lease pamentsS, ;b<
the lessor@s minimum lease paments Rthe present value is sales revenue in a sales-tpe leaseS, or
;c< the lessee@s minimum lease paments Rthe present value is the amount to be capitali>edSK
LessorGs LesseeGs
a b c
0ini(u( 0ini(u(
Co(&utation Lease Lease
o$ Pay(ents Pay(ents Pay(ents
Lessee gets the residual value E
b transfer of title or the e"pected +o +o +o
e"ercise of a bargain purchase option
Lessor gets the residual value
;title does not transfer? no
bargain purchase option<:
I (esidual value is not guaranteed 9es +o +o
I (esidual value is guaranteed
b the lessee. Ves 9es 9es
I (esidual value is guaranteed
b a third party guarantor. 9es 9es +o
2raphic 15-1.
T15-1+
15-$*
Chapter 15 - Leases
EFEC;TOR9 COSTS
Dinimum lease paments e"clude 6e<ecutory costs7 to be paid b
the lessee, such as maintenance, insurance, and ta"es. These
e"penditures simpl are e"pensed b the lessee as incurred: repair
e"pense, insurance e"pense, propert ta" e"pense, etc. The lessor is
unaffected b e"ecutor costs paid b the lessee.
1ometimes, as an e"pedienc, a lease contract will specif that the
lessor is to pa e"ecutor costs, but that the lessee will reimburse the
lessor through higher lease paments. !hen lease paments are
inflated for this reason, these e"ecutor costs are e"cluded in
determining the minimum lease paments. The still are e"pensed b
the lessee, even though paid b the lessor.
T15-1,
15-$+
Chapter 15 - Leases
."SCO;+T RATE
The lessor@s implicit rate is the effective interest rate the lease
paments provide the lessor over and above the 6price7 at which the
asset is 6sold7 under the lease. It is the desired rate of return the
lessor has in mind when deciding the si>e of the lease paments.
0suall, the lessee is aware of the lessor@s implicit rate or can
infer it from the asset@s fair mar/et value. !hen the lessor@s implicit
rate is un/nown, the lessee should use its own incremental
borro'ing rate. !hen the lessor@s implicit rate is /nown, the lessee
should use the lower of the two rates. This is the rate the lessee
would be e"pected to pa a ban/ if funds were borrowed to bu the
asset.
T15-1-
15-$,
Chapter 15 - Leases
"+TER+AT"O+AL /"+A+C"AL REPORT"+5 STA+.AR.S
Joint Lease Project:

The I319 and 5319 are collaborating on a #oint pro#ect for a
revision of leasing standards.
The 9oards have agreed that a 6right of use7 model is the most
appropriate conceptual approach which recogni>es assets and
liabilities that corresponded to the conceptual framewor/
definitions.
0nder this conceptual model, the lessee recogni>es an asset
representing the right to use the leased asset for the lease term
and also recogni>es a corresponding liabilit for the lease
rentals, whatever the term of the lease.
Dan people e"pect the new standard to result in most, if not all,
leases being recorded as an intangible asset for the right of use
and a liabilit for the present value of the lease paments.
Te i(&act o$ any canges will be signi$icantK ;#S# co(&anies
alone ave over D1#25 trillion in o&erating lease
obligations)
15-$-
Chapter 15 - Leases
."//ERE+CES: "/RS vs# 5AAP:
Leases o$ lan! an! buil!ings# 0nder I! "o. #7, land and
buildings elements are considered separatel unless the land
element is not material. 0nder 0.1. 2334, land and
building elements generall are accounted for as a single
unit, unless land represents more than $5F of the total fair
value of the leased propert.
Present value o$ (ini(u( lease &ay(ents# 0nder I!
"o. #7, both parties to a lease generall use the rate implicit
in the lease to discount minimum lease paments. 0nder
0.1. 2334, lessors use the implicit rate and lessees use the
incremental borrowing rate unless the implicit rate is /nown
and is the lower rate.
RecogniLing a gain on a sale an! leasebac% transaction.
!hen the leasebac/ is an operating lease, under I! "o. #7,
the gain is recogni>ed immediatel but is amorti>ed over the
lease term under 0.1. 2334. !hen the leasebac/ is a
finance ;capital< lease, under I! "o. #7, the gain is
recogni>ed over the lease term but is recogni>ed over the
useful life of the asset under 0.1. 2334.
15-&.
Chapter 15 - Leases
15-&1