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E12-17. Classifying leases under ASC 840, IAS 17 and ASU (2016-02
(ASC 842) (LO 12-3, LO 12-6, LO 12-10)
Requirement 1: Classification under ASC 840
The lease would be a capital lease because the lease term of 5
years is 83% of the expected useful life. This meets the third lease
criteria of greater than or equal to 75% of the economic life. If the
Requirement 2: Classification under IAS 17
There are no bright lines under IAS 17, but one would still consider
the ratio of lease term to economic life and the present value of
minimum lease payments to the fair value of the leased asset. In
Requirement 3: Classification under ASU 2016-02 (ASC 842)
E12-18. Lessee accounting under ASC 840 and ASU 2016-02 (LO
12-3, LO 12-6)
Requirement 1: Initial entry under ASC 840
Requirement 2: Initial entry under ASU 2016-02
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 12-1
The $1,332,565 is determined by multiplying the lease payment by
the PVOA factor for five years and 7%. Specifically, we make the
following calculation:
$325,000 × 4.10020 = $1,332,565
Requirement 3: Financial Statement effects under ASU
2016-02
Most of the information needed comes from the amortization table
presented below. Although only the first three rows are needed to
answer this question, the table for all five years of the lease is
presented.
Interest Principal
Date Expens
e
Payment Reduction Balance
01/01/2017 $ 1,332,565
12/31/2017 $93,280 $ 325,000 $
231,720
1,100,845
12/31/2018 77,059 325,000
247,941
852,904
12/31/2019 59,703 325,000
265,297
587,607
12/31/2020 41,132 325,000
283,868
303,739
12/31/2021 21,261 325,000
303,739
-
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 12-2
For an operating lease under ASU 2016-02, asset
amortization equals the difference between rent expense
(based on dividing total lease payments divided by the
number of payments) and interest expense on the obligation.
The accounting for the obligation follows the normal
approach for amortizing a loan or lease. The Lease obligation
Although amortization and interest expense comprise total
lease expense, the depreciation and interest expense are not
handled separately in the income statement or on the
Balance sheet at December 31, 2017
Income statement for year ended December 31, 2017
Statement of cash flows for year ended December 31, 2017
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 12-3
(Direct method)
Cash from operating activities
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 12-4
Financial Reporting and Analysis (7th Ed.)
Chapter 12 Solutions
Financial Reporting for Leases
Problems
Problems
P12-1. Making computations and journal entries for lessee under ASC
840 (LO 12-3, LO 12-5)
Requirement 1: Lease classification
Criterion 2:
Criterion 4:
Present value of an ordinary annuity factor for 3 years at 9%
Criterion 4 is not met.
Requirement 2: Amortization table
Amortization Table
(1) (2) (3) (4) (5) (6)
Date
Total
Payment
Interest
Expense
Principal
Payment
Lease
Obligation
Balance
Amortization
of Asset
Total Annual
Capital
Lease Expense
(Col. 2 + Col. 5)
$18,985
Requirement 3: Journal entries for first two years
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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 12-5
01/01/17
CR Cash $ 7,500
DR Depreciation Expense—Capital Lease $ 6,328
CR Accum. Depreciation—Capital Lease $ 6,328
12/31/18
Requirement 4: Useful life of six years
Because criterion 2 is no longer met, this must be recorded as an
operating lease. Therefore, the same journal entry will be prepared
each year for the three-year lease term:
Requirement 5: Financial statement effects
Effects on assets, liabilities, and equity of capital versus operating
lease treatment:
Assets Liabilities Equity
Capital lease
12/31/17
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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 12-6
Differential effect as
So comparing across the two methods at December 31, 2017,
assets would
P12-2. Making comparisons for lessee and lessor under ASC 840 (LO
12-1, LO 12-3, LO 12-5, LO 12-7)
Requirement 1:
The computation of the annual lease payments is shown below:
Requirement 2:
Since the residual value is not guaranteed, it is not included in the
lease obligation. The computation of the lessee’s lease obligation at
signing is illustrated below.
*Rounded
Requirement 3:
Partial lease amortization schedules appear below for the lessee
and lessor, assuming a 10% discount rate. Note that the entire
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 12-7
$8,192 of interest expense based on the present value of the lease
obligation of $81,920 following the initial payment.
Lessee Co. Lease Amortization Schedule
Year
Annual
Payment
Interest
Expense
Reduction of Lease
Obligation
Lease
Obligation
The lessor will recover $100,000 because the machine will have
residual value at the end of the lease, even though it may be
unguaranteed. Thus, by the end of the first year the lessor has
earned $8,578 in interest revenue from the lease based on the
present value of the net investment of $85,775 following the initial
payment.
Lessor Co. Lease Amortization Schedule
Year
Annual
Payment
Interest
Revenue
Net Investment
Recovery
Net
Investment
Requirement 4:
a) If the residual value were guaranteed, it would change the lease
obligation as follows:
8554
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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 12-8
b) A revised amortization table for Lessee Co. follows:
Year
Annual
Payment
Interest
Expense
Reduction of Lease
Obligation
Lease
Obligation
As shown in the table, the interest expense for Lessee Co. for year
1 is now $8,578 instead of $8,192 under Requirement 3.
The computation for Lessor Co. would not change if the residual
P12-3. Accounting for lessee capital leases under ASC 840 (LO 12-3,
LO 12-5)
Requirement 1: Rationale for classification
Given that the leased asset has an expected useful life of 6 years,
Requirement 2: Calculation of present value and amortization
table
Present value of future lease payments:
Appearing below is the amortization schedule for the lease liability:
Amortization of Capital Lease Liability
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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 12-9
Seven Wonders Incorporated
(In thousands)
Interest Cash
Reduction of
Lease Lease
Date Portion1Payment2Obligation3Obligation4
*Rounded by $1.85
1 The interest portion is 12% of the carrying amount at the beginning of the
period.
2 The cash payment is fixed by the lease at $277,409.44.
Requirement 3:
The journal entries are:
1/1/2017:
CR Obligations under capital leases
$1,000,000.00
12/31/2017:
CR Cash
$277,409.44
12/31/2018:
CR Cash
$277,409.44
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 12-10
2017 and 2018:
Requirement 4:
Under the capital lease method, the total expense recognized in
2017 is the interest expense of $120,000 plus the depreciation of
$200,000 for a total of $320,000. Under the operating lease method,
© 2018 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or
posted on a website, in whole or part. 12-11
