ACCOUNTING FOR LEASES

Accounting by the Lessor/Lessee

A lease is a contractual agreement:

- lessor (Owner of Property) conveys the
right to use property to
- lessee (User/Renter) in return for
periodic cash payments
- For stated period of time

Classification of leases>>> 2
 CLASSIFICATION OF LEASE
LEASES

LESSEE LESSOR

CAPITAL OPERATING OPERATING CAPITAL

LEASE LEASE LEASE LEASE

transfers rental
ownership agreements DIRECT SALES
FINANCING TYPE

Classification Criteria:…>
3
 CLASSIFICATION OF LEASE
LEASES
PART I PART II
LESSEE LESSOR

CAPITAL OPERATING
LEASE LEASE

transfers rental
ownership agreements

Classification Criteria:…>
4
 Operating Lease (Rental Approach) - Lessee
Lease payment Rent Expense

Lease bonus - additional to Prepaid rent expense – subject to

periodic rental amortization over the lease term

Leasehold improvement Depreciated over the life of improvement or

lease term whichever is shorter

Residual value of leasehold Ignore in computations of depreciations

improvement

Security deposit Accounted as asset

Incentives given by lessor Includes rent free periods or contributions by

the lessor to the lessee’s relocation – is
amortized over the life of the lease. 5
 Illustration - Lessee
On January 1, 2015, Easy Company lease Rent Expense 300,000
equipment from another entity for P300,000 Cash 300,000
annually for three years.

Made a security deposit P300,000 refundable Rent Deposit 300,000

upon the lease expiration Cash 300,000

In addition to the annual rental, the company on Prepaid Rent 60,000

paid P60,000 to the lessor as a lease bonus on Cash 60,000
January 1, 201.5

Amortization of lease bonus Rent Expense 20,000

Prepaid Rent 20,000

6
 Operating Lease - Lessor
Rental receive Rent Income

Lease property Remain an asset by lessor / record the depreciation

Initial direct cost Added to the carrying amount of the leased asset and
recognized as expense over the lease term
- Maybe spread over the life of the lease or charged
when incurred.

Security deposits Accounted as liability

Lease bonus Treated as unearned rent income to be amortized over

the lease term
Difference Realized
amount and Amounts Adjusted to lease receivables or deferred income
Received
7
 Illustration - Lessor
On. Jan. 1, 2015 – Simple company purchased machinery Machinery 3,000,000
for P3,000,000 cash for the purpose of leasing it. Useful life Cash 3,000,000
of 10-year with no residual value
Leased the machine to another entity at a monthly rental of Cash (50,000x9) 450,000
P50,000, payable at the beginning of every month Rent Income 450,000
Security Deposit P600,000 Cash 600,000
Liability for rent deposit 600,000
Lease bonus P 120,000 Cash 120,000
Unearned Rent Income 120,000
Paid initial direct cost P300,000 Deferred initial direct cost 300,000
Cash 300,000
Paid repair and maintenance cost P20,000 Repair and Maintenance 20,000
Cash 20,000
Amortization of lease bonus (40,000 x 9/12) Unearned Rent Income 30,000
Rent Income 30,000
Depreciation of machinery Depreciation Expense 300,000
Accu. Depreciation 300,000
Amortization of initial direct cost Amortization of Initial Direct Cost 75,000
Deferred Initial Direct Cost 75,000

8
 Unequal Rental Payments
- Simply means that where the operating lease
requires unequal lease payments, the total
cash payment for the lease term shall be
amortized uniformly on the straight line
basis.

9
 Illustration
Aye Company leased office space to Bee
Company for a 3 year period beginning
January 1, 2015. Under the terms of the
operating lease, rent for the 1st year is
P1,000,000, and rent for the next 2 years,
P1,250,000 annually. However, as an
inducement to enter the lease, Aye granted
Bee the first six month of the lease rent free.
10
 Entries
Terms Lessor Lessee
2015 Cash 500,000 Rent Expense 1,000,000
Rent Receivable 500,000 Cash 500,000
Rent Income 1,000,000 Rent Payable 500,000

2016 Cash 1,250,000 Rent Expense 1,000,000

Rent Income 1,000,000 Rent Payable 250,000
Rent Receivable 250,000 Cash 1,250,000

2017 Cash 1,250,000 Rent Expense 1,000,000

Rent Income 1,000,000 Rent Payable 250,000
Rent Receivable 250,000 Cash 1,250,000

11
 CRITERIA
1. Transfer of Ownership
The lease contract includes a provision that the title to the
leased asset passes to the lessee by the end of the lease term

2. Bargain Purchase Option (BPO)

Makes it reasonably assured that the lessee will acquire asset
allows the lessee to buy the leased asset
at a price significantly lower than the asset’s fair value when the
option is exercisable (BARGAIN PRICE)

3. Term: 75% of economic Life – Lease term is equal to

75% or more of the economic life of the leased asset

4. Asset Value: Present value of the minimum lease payments is

greater than or equal to 90% of the FMV of the leased asset on
the lease signing - what is included in Lease payments12
CLASSIFICATION OF LEASE:LESSEE
Lease Agreement MUST MEET JUST ONE
Non-Cancellable CRITERIA O
p
e
r
a
No No No t
Transfer Bargain Lease Term
PV of i
of Payments No
Ownership Purchase >= 75%
>= 90%
n
g
L
Yes Yes Yes Yes e
a
s
Capital Lease e

13
 ACCOUNTING FOR
CAPITAL LEASE: LESSEE

LESSEE
Asset user
Asset & Liability are recognized
-Amount: PV of Lease payments
-Including any BPO or Guarantee Residual Value (GRV)

Lease payments reduction in Lease Liability &

Increases to interest expense (relates to liability) Let’s
Illustrate…
Asset is subsequently Depreciated * 14
 ACCOUNTING FOR CAPITAL LEASE
PURCHASE/OWNERSHIP
LESSEE (books)

• Determine the criteria:

• 1. Ownership transfer
• 2. Bargain purchase option
• 3. PV of MLP (minimum lease payment) is
equal to 90% of more
• 4. Lease term 75% or more of estimated
economic life
15
 Calculation of CAPITAL LEASE
LESSEE (books)

• Determine the criteria: (any one…)

• Lease is classified as: CAPITAL LEASE
LESSEE’S BOOKS
DR. ASSET: LEASE PROPERTY
CR. LEASE OBLIGATION (PAYABLE)

16
 CAPITALIZED AMOUNT
Lessee
• The Lessee records the lease an asset/liability:
LESSER OF:
1. FAIR VALUE of the asset at the inception
of lease or
2. PV of MLP (PVMLP) whichever is lower
Question: what should be included in the
PVMLP
17
 Residual Value (RV)
Guaranteed or Unguaranteed
• Estimated Value at the end of the lease term!
• GUARANTEED RV is additional payment at the
end of the lease term
•If Bargain Purchase Option:
–GRV becomes irrelevant

• UNGUARANTEED: not required to make

additional payment at the end of the lease term
18
 Accounting by the Lessee
PV OF MINIMUM LEASE PAYMENTS (PVMLP)
Minimum lease payments:

 PV rental payment (usually beginning of the period)

Plus: PV Guaranteed residual value

 (unguaranteed : NOT included in PVMLP)

19
 Illustration
On January 1, 2015, an entity leased a machinery for 4 years which is the
same as the useful life of the machinery at annual rental of P100,000
payable at the end of each year.

The lessee provides for a transfer of ownership of the leased asset to the
lessee at the end of the lease term.

The implicit interest rate is 12%.

Entry: Machinery 303,730

Lease liability 303,730

20
 Depreciation of Asset:
Rules*:
• Transfer of Ownership: Depreciate over
asset life
• Bargain purchase option: Depreciate over
the asset life
• Term (75%) : Depreciate between the life of
asset or lease term whichever is shorter
• Asset Value (90% FV): Depreciate between
the life of asset or lease term whichever is
shorter
21
 Accounting for rental payment
Interest Expense = Face Value – Present Value
= P100,000 – 303,730
= P96,270

Date Payment Interest Principal Present Value

Jan. 1, 2015 303,730
Dec. 31, 2015 100,000 36,448 63,552 240,178
Dec. 31, 2016 100,000 28,821 71,179 168,999
Dec. 31, 2017 100,000 20,280 79,720 89,279
Dec. 31, 2018 100,000 10,721 89,279

Entries
Dec. 31, 2015 Interest Expense 36,448
Lease liability 63,552
Cash 100,000 22
 Executory Costs
• Ownership of the asset is responsible for
Insurance, maintenance, etc

Capital Lease: Lessee gets the benefit of using the

asset (LESSEE’s expense)
Dr. Maintenance expense (executory costs)
Cr Cash

• (if included in lease payment – deduct to calculate

PV MLP)

• If lessor makes the payment, these costs are

reimbursed by lessee by recording the expense 23
 CAPITAL Leases - Lessee
The amount recorded (capitalized) is the
PVMLP.
However, the amount recorded cannot exceed
the fair value of the leased asset.
the interest rate used by the lessee is the lower
of:
1. Its incremental borrowing rate, or
2. The implicit interest rate used by the lessor.
 Bargain Purchase Option
Lessee Company leased a machine on January 1, 2015 with the following pertinent information:
Annual rental payable at the end of each year 1,000,000
Lease term 10-years
Useful life of machine 12-years
Incremental borrowing rate of lessee 14%
Implicit interest rate of lessor known to lessee 12%
Present value of ordinary annuity of 1 for 10 periods at
14% 5.216
12% 5.650
Present value of 1 for 10 periods at
14% 0.270
12% 0.322
Lessee Company has the option to purchase the machine upon the lease expiration on January 1, 2025
by paying P500,000 which is sufficiently lower than the expected fair value of the machine on
January 1, 2025. At the inception of the lease, the bargain purchase option is reasonably certain to
be exercised. The estimated residual value of the machine at the end of the 12-year life is
P600,000.

25
 Capitalist cost of the machine
Present value of rentals (1,000,000 x 5.65 6,650,000
Present value of bargain purchase option
(500,000 x .322) 161,000
Total lease liability 5,811,000

Schedule of payments: Page 403

Acquisition of machinery Machinery 5,811,000
Lease liability 5,811,000
First rental payment Interest Expense 697,320
Lease liability 302,680
Cash 1,000,000
Annual depreciation Depreciation 434,250
Accu. Depreciation 434,250 26
Exercise the bargain purchase option Not exercise the bargain purchase
option

Machinery 5,811,000
Lease liability 500,000 Acc. Depreciation
Cash 500,000 (434,250 x 10) 4,342,500
Carrying Amount 1/1/25 1,468,500
Lease liability 1/1/25 500,000
Loss on finance lease 968,500

Entry:
Accu. Depreciation 4,342,500
Lease liability 500,000
Loss on finance lease 968,500
Machinery 5,811,000

27
 Guaranteed residual value
Easy Company leased an equipment on January 1, 2015 with the
following information:
Annual rental payable at the end of each lease year 1,000,000
Lease term 4 years
Useful life of equipment 5 years
Implicit interest rate 10%
Present value of an ordinary annuity of 1 for 4 periods at 10% 3.16987
Present value of 1 for 4 periods at 10% 0.683
Easy Company has guaranteed a P200,000 residual value on December
31, 2018 to the lessor.

Note: As long as there is a guaranteed residual value, there is no more

bargain purchase option because the equipment will revert back to the
lessor upon the expiration of the lease on December 31, 2018.
28
 Computations
Present Value of rental payments (1,000,000 x 3.16987) 3,169,970
Present value of guaranteed residual value (200,000 x .683) 136,600
Total lease liability 3,306,470

Date Payment Interest Principal Present value

1/1/2015 3,306,470
12/31/2015 1,000,000 330,647 669,353 2,637,117
12/31/2016 1,000,000 263,711 736,289 1,900,828
12/31/2017 1,000,000 190,082 809,918 1,090,910
12/31/2018 1,000,000 109,090 890,910 200,000

29
 Entry
Acquisition
Equipment 3,306,470
Lease liability 3,306,470

Payment of rent
Interest Expense 330,647
Lease liability 669,353
Cash 1,000,000

Depreciation
Depreciation Expense 776,617
Depreciation = 3,306,470 -200,000/5 Accu. Depreciation 776,617
= 776,617

30
 Return of equipment to lessor
Final payment
Interest expense 109,090
Lease liability 890,910
Cash 1,000,000

Return of equipment to the lessor

Accu. Depreciation 3,106,470
Lease liability 200,000
Loss on finance lease = Fair Value < Equipment 3,306,470
Guaranteed residual value

And

Fair value > guaranteed residual value =

no gain because no payment the asset
revert back to lessor 31
 Illustration 2 – Guaranteed residual value
Simple Company leased an equipment on January 1, 2015 with the following information:
Annual rental payable in advance at the beginning of each year lease year 1,000,000
Initial direct cost paid on January 1, 2015 100,000
Lease term 5 years
Useful life of equipment 6 years
Implicit interest rate 8%
Present value of an annuity of I in advance at 8% for 5 years 4.3121
Present value of 1 at 8% for 5 periods .6806

The equipment has guaranteed a P300,000 residual value on January 1, 2020 to the lessor.

The equipment will revert to the lessor upon the lease expiration on January 1, 2020.

Present value of rentals (1,000,000 x 4.3121) 4,312,100

PV of guaranteed residual value (300,000 x .6806) 204,180
Lease liability 4,516,280
Initial direct cost 100,000
Total cost of equipment 4,616,280
32
 Computation
Date Payment Interest Principal Present Value
1/1/15 4,516,280
1/1/15 1,000,000 - 1,000,000 3,516,280
1/1/16 1,000,000 281,302 718,698 2,797,582
1/1/17 1,000,000 223,807 776,193 2,021,389
1/1/18 1,000,000 161,711 838,289 1,183,100
1/1/19 1,000,000 94,648 905,352 277,748
1/1/20 300,000 22,252 277,748 -

33
 Entries
2015 Equipment 4,616,280
Acquisition Lease liability 4,516,280
Cash 100,000
First payment Lease liability 1,000,000
Cash 1,000,000
Accrual of interest Interest Expense 281,302
Accrued Interest Payable 281,302
Depreciation Depreciation expense 863,256
(4,616,280 – 300,000 / 5) Accu. Depreciation 863,256
2016 Accrued interest payable 281,302
Second payment Lease liability 718,698
Cash 1,000,000
Accrual of interest Interest expense 223,807
Accrued interest payable 223,807
Depreciation Depreciation expense 863,256
Accu. Depreciation 863,256 34
 Return of asset to lessor
Assume that on January 1, 2020 the fair
market value is P400,000.
Entry:
Accumulated depreciation 4,316,280
Lease liability 277,748
Accrued interest payable 22,252
Equipment 4,616,280
35
 Unguaranteed Residual Value
Ezzy Company leased an equipment on January 1,2015 with the following information:

Annual rental payable at the end of each year 600,000

Lease term 6 years
Useful life of equipment 8 years
Implicit interest rate 10%
Present value of an ordinary annuity of 1 at 10% 4.36
Present value of 1 at 10% for 6 periods 0.56

The lease provides for neither a transfer of title nor a bargain purchase option.

Thus, the equipment will revert back to lessor upon the expiration of lease on January 1,
2021.
The equipment has an estimated residual value of P200,000 but the amount is unguaranteed
by the lessee.

36
 Entries
Acquisition Equipment 2,616,000
Lease liability 2,616,000
First payment of rental Interest Expense 261,600
Lease liability 338,400
Cash 600,000
Depreciation Depreciation expense 436,000
= 2,616,000/6 Accu. Depreciation 436,000
= 436,000
Return of equipment Accu. Depreciation 2,616,000
Equipment 2,616,000

37
 Actual purchase of lease asset
Cost = Carrying amount of lease asset
+
Cash payment
-
Balance of lease liability

38
 Illustration
An entity purchased an equipment that it had been leasing under finance lease for
P4,000,000. The balances of certain accounts on the date of actual purchase
are as follows:

Equipment under finance lease 5,000,000

Accumulated depreciation 1,500,000
Lease liability 3,800,000

Cost of equipment 5,000,000 Entry

Accu. Depreciation 1,500,000 Equipment 3,700,000
Carrying amount 3,500,000 Acc. Depreciation 1,500,000
Cash payment 4,000,000 Lease Liability 3,800,000
Total consideration 7,500,000 Equipment 5,000,000
Lease liability 3,800,000 Cash 4,000,000
Cost of equipment 3,700,000

39
 Problem 1
On December 1, 2014, Iliad Company leased office space for 5 years at a
monthly rental of P60,000. On the same date, the company paid the
lessor the following:
First month rent 60,000
Last month’s rent 60,000
Security deposit(refundable at lease expiration) 80,000
Installation of new walls and offices 360,000

How much is the total expense that Iliad should report in its December 31,
2014 profit or loss relating to the utilization of office space?

40
 Problem 2
On January 1, 2014, Nickel Co. signed a 10-year operating lease for office
space at P576,000 per year. The lease included a provision for
additional rent of 5% annual company sales in excess of P3,000,000.
Nickel’s sales for the year ended December 31, 2014 were P3,600,000.
Upon the execution of the lease, Nickel paid P144,000 as a bonus for
the lease. How much should Nickel’s rent expense for the year ended
December 31, 2014?

41
 Problem 3
On July 1, 2014, Radium Inc. leased a delivery truck from Titanium
Corp. Under a 3-year operating lease. Total rent for the term of the
lease will be P360,000 payable as follows:

12 months at P5,000 per month = P60,000

12 months at P7,500 per month = 90,000
12 months at P17,500 per month = 210,000

All expenses were made when due. In Radium’s June 30, 2016 balance
sheet, what amount should be reported as accrued rent payable?

42
 Problem 4
As an inducement to enter a lease, Athena, a lessor, grants Zeus Corp. a
lessee, months of free rent under a 5-year operating lease. The lease is
effective July 1, 2014 and provides for a monthly rental of P20,000 to
begin April 1, 2015.

In Zeus’ income statement for the year ended June 30, 2015, how much
should be reported as rent expense?

43
 Problem 5
Wall Co. leased office premises to Fox, Inc. for a 5-year term beginning
January 1, 2014.Under the terms of the operating lease, rent for the
first year is P80,000 and rent for 2 years to 5 is P125,000 per annum.
However, as an inducement to enter the lease, Wall granted Fox the
first 6 months of the lease rent-free. In its December 31, 2014 profit or
loss, what amount should Fox as rental expense?

44
 Problem 6
Christian Company, a lessor of office machines, purchased a new machine
for P600,000 on January 1, 2014 which was leased the same day to
Dior. The machine will be depreciated at P55,000 per year. The lease
is for four-year period expiring January 1, 2018 and provides for
annual rental payments of P100,000 beginning January 1, 2014. In
addition, Dior paid P64,000 to Christian as lease bonus. In its 2014
profit and loss, what amount of revenue and expense should Christian
report on this leased asset?

45
 Problem 7
Dream Company, a lessor of office machines, purchased a new machine
for P500,000 on January 1, 2014, which was leased the same day to
Girl Company. The machine is expected to have a ten-year life and
will be depreciated P50,000 per year. The lease is for three-year period
expiring January 1, 2017 and provides for annual rental payments of
P100,000 beginning January 1, 2014.In Addition, Girl paid P60,000 as
a lease bonus to obtain a three-year lease. In its 2014 profit or loss,
what amount should Dream report as operating profit on this leased
asset?

46
 Problem 8
On December 31, 2014, Soap Corporation signed an operating lease for a
warehouse with Opera Company for ten years at P30,000 per year.
Upon the execution of the lease, Opera paid Soap P60,000, covering
rent reported P60,000 as gross income in its 2014 income tax return.
How much should shown in Soap’s 2014 profit or loss as gross rental
income?

47
 Problem 9
On January 1, 2014, Bauman Company leased a warehouse to Cuban
under an operating lease for ten years at P100,000 per year, payable
the first day of each lease year. Bauman paid P45,000 to real estate
broker as finder’s fee. The warehouse is depreciated P25,000 per year.
During 2014, Bauman incurred insurance and property tax expense of
P18,750, How much should Bauman’s net rental income for 2014?

48
 Problem 10
On January 2, 2014, Sunrise Company leased a warehouse to
Sunshine Corporation under operating lease for ten years at
P80,000 per year payable on the first day of each lease
year. Sunrise Company agrees to pay the lessee’s
relocation/moving cost as an incentive to Sunshine
Corporation for entering into the new lease. The moving
cost is P6,000. What amount of rent income should Sunrise
Company recognize in its 2014 profit or loss?

49
 LEASE
PART II
Accounting for Leases- Lessor

• Classification of Lease: LESSOR’S BOOK

50
 CLASSIFICATION OF LEASE: LESSOR
LEASES

LESSEE LESSOR

CAPITAL OPERATING OPERATING CAPITAL

LEASE LEASE LEASE LEASE

DIRECT SALES
FINANCING TYPE

Classification Criteria:…>
51
 Accounting by the Lessor
Classification of Leases by the Lessor

52
 Accounting by the Lessor
Classification of Leases by the Lessor

If any costs to the lessor to be incurred, are reasonably predictable

A lessor may classify a lease as an operating lease but the lessee

may classify the same lease as a capital lease. 53
 Nonoperating Leases:
- Lessor

If the lessor is not a manufacturer or

dealer, the fair value of the leased
asset is typically the lessor’s cost-
DIRECT FINANCING LEASE
When the lessor is a manufacturer or dealer,
the fair value of the property at the inception
of the lease is likely to be its normal selling
price
– SALES TYPE LEASE
Direct-Financing Lease: Lessor
 Depreciation:
NOT RECORDED BY LESSOR
• Asset is removed from the Lessor’s books

Illustration: DIRECT FINANCING…. LESSOR-

56
 Direct Financing Lease
Source of Income – interest income

- Is actually engaged in financing business.

- No dealer profit is recognized because the

Fair Value = Cost of the Asset

57
 Accounting Considerations
Gross Investment = Gross rentals + absolute amount of
Residual value (whether guaranteed
or unguaranteed)

Net Investment in lease = Cost of the asset + Initial direct cost

paid by the lessor

Unearned Interest Income = Gross Investment – Net investment in

lease

Initial direct cost = added to the cost of the asset

= subject for amortization

58
 Illustration
On January 1, 2015, Lessor Company leased a machinery to another entity with
the following details:
Cost of machinery 1,518,650
Annual rental payable at the end of each year 500,000
Lease term 4 years
Useful life of machinery 4 years
Implicit interest rate 12%
Present value of annuity of 1 for 4 years at 12% 3.0373
The initial problem is the determination of annual rental which will give the
lessor fair rate of return on the net investment in the lease. Assume desired rate
of return is 12%

59
 Computation
Gross rentals or lease receivables (500,000 x 4) 2,000,000
Less: PV of the gross rentals (equal to the net investments
in the lease or cost of machinery) 1,518,650
Unearned Interest Income 481,350
Entry:
Lease receivable 2,000,000
Machinery 1,518,650
Unearned Interest Income 481,350
Collection:
Cash 500,000
Lease Receivable 500,000
Amortization of Interest
Unearned Interest Income 182,238
Interest Income 182,238
Amortization Table: See page 454 60
 Direct Financing – with initial direct cost
On January 1, 2015, Lessor Company leased a machinery to another entity with
the following details:
Cost of machinery 1,518,650
Annual rental payable at the end of each yea 500,000
Lease term 4 years
Useful life of machinery 4 years
Implicit interest rate 12%
Present value of annuity of 1 for 4 years at 12% 3.0373
On January 1, 2015, The lessor Company paid initial direct cost of P66,300.
Computations:
Cost of machinery 1,518,650
Initial direct cost 66,300
Net investment in the lease 1,584,950

Determine the reduced implicit interest rate?

 Direct Financing – with residual value
On January 1, 2015, Lessor Company leased a machinery to another entity
with the following details:
Cost of machinery 3,194,410
Residual Value 500,000
Lease term 4 years
Implicit Interest Rate 10%
Present value of 10% for 4 periods .6830
PV of an ordinary annuity of 1 at 10% for 4 years 3.1699
The machinery will revert to the lessor at the end of the lease term because
there is neither a transfer of title nor a bargain purchase option.
Determine the annual payment?
Cost of machinery 3,194,410
Less: Present value of Residual Value 341,500
Net investment to be recovered from rental 2,852,910
Divide by PV of an ordinary annuity of 1 3.1699
Annual rental payment 900,000
 Amortization Table
Gross Rentals (900,000 x 4) 3,600,000
Residual Value 500,000
Gross Investment 4,100,000
Less: Cost of machinery 3,194,410
Unearned Interest Income 905,590
Date Payment Interest Principal Present Value
1-1-2015 3,194,410
12-31-2015 900,000 319,441 580,559 2,613,851
12-31-2016 900,000 261,385 638,615 1,975,236
12-31-2017 900,000 197,524 702,476 1,272,760
12-31-2018 900,000 127,240 772,760 500,000

63
 Entry
To record the lease - 2015 Lease Receivable 4,100,000
Machinery 3,194,410
Unearned interest income 905,590
Annul collection Cash 900,000
Lease receivable 900,000
Interest Income Unearned interest income 319,441
Interest income 319,441
Expiration – Guaranteed or not Machinery 500,000
Revert back to lessor Lease receivable 500,000
FMV < Residual Value Cash 100,000
Guaranteed – Lessee will pay Machinery 400,000
Lease receivable 500,000
Unguaranteed Loss on finance lease 100,000
Machinery 400,000
Lease receivable 500,000

64
 Direct Financing – wl R/V – advance payment
On January 1, 2015, Lessor Company leased a machinery to another entity with
the following details:
Cost of machinery 3,760,100
Residual Value - guaranteed 400,000
Lease term 4 years
Implicit interest rate 10%
Present value of 10% for 4 periods .6830
PV of an ordinary annuity of 1 in advance 3.4869
The annual rental is payable in advance on January 1 of each year starting
January 1, 2015.
Computation:
Cost of machinery 3,760,100
Less: PV of R/V (400,000 x. 6830) 283,200
Net investment to be recovered from rental 3,486,900
Divide : PV of annuity in advance 3.4869
Annual rental payment 1,000,000
 Initial Direct Costs
costs incurred by the lessor in
negotiating/preparing a lease agreement.
e.g. Legal fees, commissions
• Operating Leases − Capitalize and amortize
over the lease term by the lessor.
• Direct Financing Leases − not expensed ;
deferred and recognized over the lease term
• Sales type leases: expensed at the inception
of the lease (selling expense)
 How should the lease be
classified by LESSOR
• Since the fair value equals the lessor’s
carrying value, there is no dealer’s profit,
making this a direct financing lease.

• Prepare appropriate entries for Canfor

(lessor)

67
Sales-Type Lease: LESSOR

Total payments – sale price = interest

 Accounting for Sales-Type Lease
LESSOR
Record:
1. Receivable (PV) & Sales
2. Cost of goods sold / reducing the
inventory
3. Any Initial Direct Costs recognized as an
expense immediately
4. Reimbursement of executory costs – same
as direct financing
69
 Sales Type Lease with Guaranteed
Residual Value
• Guaranteed Residual Value: Both Lessee and
Lessor include Guaranteed Residual Value in
calculating MLP
• If RV is not guaranteed by Lessee (Lessee exclude
in MLP)
• LESSOR:
– Lessor : even if it is not guaranteed by lessee, lessor
expects to receive from 3rd party
– Includes residual value in their receivable
– But the sales revenue and COGS are reduced by the
same amounts
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 Lessee Disclosures
• For capital leases, disclose
– Gross amount of assets recorded under
capital leases.
– Future MLP in the aggregate and for each
of the five succeeding years.
– Total minimum sublease rentals to be
received in the future under non-
cancelable subleases.
(continued)
 International Accounting
of Leases
• IAS 17 relies on the exercise of accounting
judgment to distinguish between operating and
capital leases.