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P12-16. Evaluating sale and leaseback under ASC 840 and ASU 2016-02 (ASC 842) (LO
12-3, LO 12-4, LO 12-6)
Requirement 1: Lease type under ASC 840
This is a capital lease for Merchant because the lease meets at least one of the criteria
for capital lease treatment. In fact, the lease meets two of the capital lease criteria. The
lease term is 75% of the tractor’s remaining economic life (75% x 6 years = 4.5 years),
and the present value of the minimum lease payments exceeds 90% of the tractor’s fair
value:
Requirement 2: Gain on transaction under ASC 840
Since this is a sale and leaseback transaction, Merchant will not report the gain on its
Requirement 3: Journal entries under ASC 840
Journal entries at January 1, 2017:
Requirement 4: Sale-leaseback under ASC 842
Under normal circumstances, the lease would be classified as a finance lease. However,
under ASU 2016-02, the company would have continuing interest in the asset and would
P12-17. Visualizing the asset-liability relationship over time for a capital (finance)
lease (LO 12-1, LO 12-3, LO 12-6)
Requirement 1:
a) At 8%, the accrual of interest causes the liability at the end of the first year to total
$103,718.87 (i.e., a beginning balance of $96,035.99 plus accrued interest of
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b) At 12%, the accrual of interest causes the liability at the end of the first year to total
$82,496.70 (i.e., a beginning balance of $73,657.77 plus accrued interest of
c) As in parts 1(a) and (b), the accrual of interest causes the liability to exceed the asset
Requirement 2:
a) With payments at the end of each year, the carrying value of the asset will never
b) Raising the interest rate and/or shortening the duration of the lease does not change
P12-18. Accounting for lessee with uneven payments under ASU 2016-02 and
IFRS 16 (LO 12-1, LO 12-5, LO 12-6)
Requirement 1: Journal entry at 1/1/2017 under ASU 2016-02
Payment
Number Payment
PV
assumption
8% PV
factor
Present
Value
To record first payment
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Requirement 2: Amortization table
Total Interest Principal
Date Payment Expense Reduction Balance
Requirement 3: Journal entries at 12/31/2017
To record increase in liability for interest payable
(Straight-line expense of $12,700 less interest of
$3,502.09)
Requirement 4: Operating lease liability and right-of-use asset
Relation between lease liability and right-of-use asset
Less difference between prior cash
payments and rent expense -
Total payments for first two years of $21,000 less expense
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whole or part. 12-3
Check, using journal entry and T-account approach:
31-Dec-18
Right-of-use asset
Requirement 5: Finance lease liability and right-of-use asset under IFRS 16
The book value of the asset under IFRS 16 is $2,514.77 less than the operating lease
asset under ASU 2016-02. This difference also represents the additional amortization
that was recognized as part of pretax income over the prior two years. This difference
would be reflected in Retained earnings. To keep the fundamental accounting equation
in balance, if assets are less, then equities also must be less.
P12-19. Analyzing ASC 840 and IAS 17 operating lease disclosures (LO 12-10, LO
12-11)
Requirement 1:
The United Continental Holdings note disclosure is more informative because it articulates
Requirement 2:
The aggregation of multiple years’ expected future minimum lease payment cash flows is
problematic because it makes it more difficult to estimate precisely discounted cash flows.
When estimating annual cash flows, the Appendix to this chapter suggests the analyst
consider trends (e.g., declines) that are evident in the note. For Singapore Airlines, this is
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whole or part. 12-4
estimate $1,968.1÷ 4 aggregated years to approximate an annual cash flow of 492.025 for
each of the years 2, 3, 4, and 5. Another alternative is somewhat more complicated and
Year 2-3 Year 3-4 Year 4-5
If we assume Singapore Airlines observes a similar decline trend (which we could also
validate from other competitors), we can algebraically compute the following:
Year 2 Year 3 Year 4 Year 5 Total
Solving for x, we would compute (approximations due to rounding error):
Year 2 Year 3 Year 4 Year 5 Total
The analysts’ assumptions matter because the net present value of the sum of these
discounted cash flows can vary materially based on the assumed cash flows through time.
Financial Reporting and Analysis (7th Ed.)
Chapter 12 Solutions
Financial Reporting for Leases
Cases
C12-1. Delta Air Lines Inc: Calculating the effects of ASU 2016-02 (LO 12-2, LO 12-5, LO
12-6, LO 12-11)
Requirement 1:
A. Total minimum lease payments is the sum of the annual payments of capital leases
listed in Note 7.
B. Present value of net minimum lease payments is $383. It is the sum of Current
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Requirement 2: Capital lease net asset
From balance sheet information:
Requirement 3: Reason for difference between 1 and 2
A capital lease asset is amortized using Delta's normal depreciation policies, whereas the
Requirement 4: Total debt to total assets
Requirement 5: Entry to record capital lease in 2016
Requirement 6: Operating lease obligation on the balance sheet
There appears to be $0 operating lease obligation on the balance sheet. However, note 7
Requirement 7: Present value of operating lease payments
Requirement 7 gives the assumed interest rate of 11%. However, it was estimated by
examining the relation between the 2016 interest expense and the average 2016 lease
liability for capital leases as follows:
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To obtain the present value of the lease payments, the timing for the thereafter amount must be
estimated as follows:
Estimated life for thereafter
Estimate of thereafter annuity
Present value calculation
Discount
Rate 11.0%
Year
# of Years
discounte
d
Operatin
g Lease
Payment
PV
factor
@13.0%
PV of
Operating
Lease
The thereafter factor of 3.27108 equals an ordinary annuity for 12 years less an ordinary
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Requirement 8: Entry to constructively capitalize the operating leases
Requirement 9: Change in debt to total assets ratio
In this case, the increase to the debt asset ratio is minor because of the existing high debt
asset ratio
C12-2. IFRS and FASB/IASB Exposure Draft (LO 12-10, LO 12-11)
Requirement 1: Differences from IAS 17
1. If we use British Airways in Exhibit 12.7 as an indication of accounting under IAS 17,
then we would expect to see more of Delta’s operating leases treated as capital
Requirement 2: Differences from IFRS 16
1. All of Delta’s operating leases would be capitalized using the implicit rate if known.
2. The existing capital leases would also be recomputed using the implicit rate if known.
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operating section of the income statement, but the interest would be in the
nonoperating section. On the statement of cash flows, interest expense would be
C12-3.Walgreens Boots Alliance: Lessee reporting and constructively capitalizing operating
leases (LO 12-2, LO 12-5, LO 12-6, LO 12-11)
All answers are in millions of U.S. dollars.
Requirement 1: Debt-equity and Return-on-assets
Requirement 2: Present value of operating lease payments
Discount
Rate 5.0%
Year
# of Years
discounted
Operating
Lease
Payment
PV
factor
@5.0%
PV of
Operating
Lease
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*9.89864 pvoa 14, 5% less 4.32948 pvoa 5, 5% = 5.56916
Requirement 3: Journal entry to capitalize operating leases
Requirement 4: Journal entries to record depreciation and interest
To record interest and payment for obligation
(Cash of $3,141 less interest of $1,355)
To record amortization of right-of-use asset
Requirement 5: Debt to equity ratio
Note from Requirement 3 that there is no effect on Shareholders’ equity. Therefore, we
compute a new amount of debt and compute the new ratio as follows.
Requirement 6: Return on assets
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Under the ASC 842, there would be no adjustment to EBI for Walgreens Boots. The specific
calculations follow:
Requirement 7: Commentary on differences in ratios
Both of the revised ratios make Walgreens Boots look less healthy. The debt/equity ratio
increases by 72.2% and makes the company look riskier. The return-on-assets ratio
Requirement 8: Difference between IFRS 16 and ASC 842
Under IFRS 16, the right-of-use asset will be amortized using a firm’s normal depreciation
method, which is usually the straight-line method. This will result in a lower right-of-use
asset than we see under ASC 842. Consequently, equity will be lower, and the debt/equity
We can illustrate the higher ROA ratio simply by adjusting net income. The ratio would be
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The 6.0% is 13.3% lower than the ASC 840 ratio of 6.9%, whereas the ASC 842 ratio of
4.9% is 29.0% lower.
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whole or part. 12-12
