CHAPTER 21
Accounting for Leases
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics
Questions
Brief
Exercises
Exercises
Problems
Concepts
for
Analysis
1. Rationale for leasing.
1, 2, 3
28, 29
18, 19
6
4. Special Issues
Other lease costs;
26, 27
15, 16, 21,
22, 23, 24,
25
9, 16, 17
6, 7, 8, 12,
13, 14
3, 4, 5
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning
Objectives
Questions
Exercises
Problems
Concepts for
Analysis
1. Describe the
environment
related to
leasing
transactions.
1, 2, 3
3. Explain the
accounting for
leases by
lessors.
11, 13,
6, 7, 9,
2, 5
2. Explain the
4, 5, 6, 7,
1, 2, 3, 4, 7,
1, 2, 3, 4,
1, 2, 3, 4 5
accounting for
sale-leaseback
transactions.
28, 29
18, 19
6
4. Discuss the
accounting and
reporting for
special
10, 21,
23, 26,
27
6, 9, 10, 11,
12, 14, 16,
17
1, 2, 7, 8,
12, 13, 14
3, 4, 5
ASSIGNMENT CHARACTERISTICS TABLE
Item
Description
Level of
Difficulty
Time
(minutes)
E21.1
Lessee Entries; No Residual Value
Moderate
15–20
E21.2
Lessee Entries; Lease with Unguaranteed Residual
Value
Moderate
15–20
E21.3
Lessee Computations and Entries; Lease with
Guaranteed Residual Value
Moderate
20–25
E21.4
Lessee Entries; Lease and Unguaranteed Residual
Value
Moderate
20–30
E21.5
Computation of Rental; Journal Entries for Lessor
15–25
E21.6
Lessor Entries; Sales-Type Lease with Option to
Purchase
Moderate
20–25
E21.7
Moderate
15–20
E21.8
Lessor Entries; Sales-Type Lease
Moderate
15–20
E21.9
Lessee Entries; Initial Direct Costs
Moderate
20–25
E21.10
Lessee Entries with Bargain-Purchase Option
Moderate
20–30
E21.11
Lessor Entries with Bargain-Purchase Option
Moderate
20–30
E21.12
Lessee-Lessor Entries; Sales-Type Lease with a
Bargain Purchase Option
Moderate
20–25
E21.14
Lessee Entries; Initial Direct Costs
20–25
E21.15
Moderate
20–30
Moderate
20–25
E21.17
Lessor Accounting for an Operating Lease
Moderate
25–30
*E21.18
Sale-Leaseback
Moderate
20–30
*E21.19
Lessee-Lessor, Sale-Leaseback
Moderate
20–30
P21.1
Lessee Entries.
Simple
20–25
P21.2
Lessee Entries and Statement of Financial Position
Presentation.
Simple
20–30
P21.3
Lessee Entries and Statement of Financial Position
Finance Lease.
Moderate
35–45
P21.4
Lessee Entries, Lease with Monthly Payments.
P21.5
Basic Lessee Accounting with Difficult PV Calculation
P21.6
Lessee-Lessor Entries, Finance Lease with a
Guaranteed Residual Value.
P21.7
Lessor Computations and Entries, Sales-Type Lease
with Guaranteed Residual Value.
P21.8
Lessee Computations and Entries, Lease with
Guaranteed Residual Value.
Complex
30–40
P21.9
Lessor Computations and Entries, Sales-Type Lease
with Unguaranteed Residual Value.
Complex
30–40
P21.10
Lessee Computations and Entries, Finance Lease with
Unguaranteed Residual Value.
Complex
30–40
P21.11
Lessee-Lessor Accounting for Residual Values.
30–40
P21.12
Lessee-Lessor Entries, Statement of Financial Position
Presentation, Finance and Sales-Type Lease.
35–45
P21.13
Statement of Financial Position and Income Statement
35–45
P21.14
Operating lease.
Moderate
30–40
P21.15
Lessee-Lessor Entries, Operating Lease with an
Unguaranteed Residual Value.
Moderate
30–40
CA21.1
Lessee accounting and reporting.
Moderate
15–25
CA21.2
Lessor and lessee accounting and disclosure.
Moderate
25–35
CA21.3
Lessee accounting.
Moderate
20–30
CA21.4
Lease capitalization, bargain-purchase option.
Moderate
20–25
CA21.5
Short-Term lease vs. finance lease.
Moderate
20–30
Sale-Leaseback.
Moderate
15–25
ANSWERS TO QUESTIONS
1. The major lessor groups in the United States are banks, captives, and independents. Banks are the
largest players in the leasing business. Captives are subsidiaries whose primary business is to perform
leasing operations for the parent company. They have the point of sale advantage in finding leasing
2. (a) Possible advantages of leasing for the lessee:
1. Leasing may be more flexible in that the lease agreement may contain less restrictive
provisions than the bond indenture.
Assuming that funds are readily available through debt financing, there may not be great advantages (in
addition to the above-mentioned) to signing a noncancelable, long-term lease. One additional advantage
of leasing is its availability when other debt financing is unavailable.
(b) Given the new reporting standard on leasing the financial statement effects of a long-term
noncancelable lease versus the purchase of the asset are somewhat similar. That is assets under a
3. Possible advantages of leasing for a lessor:
1. It often provides profitable interest margins.
2. It can stimulate sales of a lessor’s product whether it be from a dealer (lessor) or a
4. The discount rate used by the lessee in the present value test and for valuing the lease liability is the
implicit interest rate used by the lessor. This rate is defined as the discount rate that, at the
commencement of the lease, causes the aggregate present value of the lease payments and
Questions Chapter 21 (Continued)
5. Paul Singer is for the most part correct. As long as the lease has a lease term of over 12 months and the
lease is not low value, Paul is correct that the lease must be recognized on the statement of financial
6. (a) Residual value is the expected value of the leased asset at the end of the lease term.
(b) A guaranteed residual value is a guarantee made to a lessor that the value of the leased asset
7. A bargain purchase option is a lease purchase option in which the lessee can buy the asset for a price
that is significantly lower than the underlying asset’s expected fair value at the date the option becomes
exercisable, thus making the exercise of the option reasonably certain. A bargain renewal option is
essentially the same conceptually as a bargain purchase option, except the option is to renew the lease
8. The lease liability is recorded at the present value of the lease payments. This includes the periodic
rental payments made by the lessee, bargain-purchase option if any, and amounts probable to be owed
9. Wonda Stone is correct in her interpretation. For purposes of lease classification by the lessor the
present value of the guaranteed residual value is used in determining whether the present value (90%)
Questions Chapter 21 (Continued)
10. The right–of-use asset is initially measured as the same amount as the lease liability (i.e. present value of
lease payments), adjusted for initial direct costs, prepayments and lease incentives. Initial direct costs
11. Variable lease payments should be included at the level of the index/rate at the commencement date.
Increases or decreases in the index should not be assumed when valuing the lease liability. Thus, for the
12. The lessee records a right-of-use asset and lease liability at commencement of the lease. The lessee
then recognizes interest expense on the lease liability over the life of the lease using the effective
interest method and records depreciation expense on the right-of-use asset generally on a straight-line
13. A low value lease is a lease of an underlying asset with a value of $5,000 or less. Rather than recording
a right-of-use asset and lease liability, a lessee may elect to expense the lease payments as incurred.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Reflective Thinking, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
14. A short-term lease is a lease that, at the commencement date, has a lease term of 12 months or less.
15. If a bargain-purchase option exists, the lessee must increase the present value of the lease payments by
the present value of the option price. This is the case for both classification and initial measurement of
16. From the standpoint of the lessor, leases will (with few exceptions) be classified for accounting purposes as
either (a) operating leases or (b) finance (sales-type) leases.
A finance (sales-type) lease meets one or more of the following five tests:
Questions Chapter 21 (Continued)
3. The lease term is a major part of the remaining economic life of the underlying asset (i.e. equal to
75% or more of the estimated economic life of the property),
If none of the above five tests are met, the lease will be treated as an operating lease. The IASB
concluded that by meeting any one of the lease classification tests, the lessor transfers control of the
leased asset and therefore satisfies a performance obligation, which is required for revenue recognition
17. (a) If a lease is for a major part of the economic life of the lease, the lease is classified as a finance
lease. In practice, 75% of the economic life of the asset is generally used to meet this classification test.
That is, if the lease term is 75% or greater of the economic life of the asset, the lease is classified as a
finance lease.
18. A lease receivable is defined as the present value of the periodic rental payments plus any guaranteed
residual value. A net investment in the lease includes not only the components of the lease receivable but
19. Under the operating method, each rental receipt of the lessor is recorded as lease revenue. The
underlying leased asset is still recognized on the statement of financial position of the lessor and
depreciated in the normal manner. In addition to depreciation, any other related costs to the lease
arrangement (i.e. insurance, maintenance, taxes, etc.) are recorded in the period incurred.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Reflective Thinking, AICPA BB: None, AICPA FC: Reporting, Measurement, AICPA PC: None
20. Under a finance (sales-type) lease, lessors report in the income statement Sales Revenue and Cost of
Goods Sold (and resultant gross profit) at commencement of the lease. During the lease term Interest
Questions Chapter 21 (Continued)
21. Walker Company can use the finance (sales-type) lease method if the lease meets one or more of the
following five tests:
(1) The lease transfers ownership of the property to the lessee,
(2) The lease contains a bargain-purchase option,
22. Metheny Group should recognize the present value of the lease payments (normal sales price) as sales
revenue, and the carrying amount (book value) of the asset as cost of goods sold. Thus, the gross profit
23. Although not part of the classification tests, the lessor must also determine whether the collectibility of
payments from the lessee is probable, as it has implications for the subsequent accounting of the lease.
24. (a) (1) The lessee’s accounting for a lease with an unguaranteed residual value is the same as the
accounting for a lease with no residual value. That is, unguaranteed residual values are not
included in the lessee’s lease payments, either for classification or measurement purposes.
(b) The value of the lease liability may be made up of two components—the periodic rental payments
and amounts probable to be owed under a guaranteed residual value. That is, if the expected
residual value at the end of the lease term is less than the guaranteed residual value, then the
25. The amount to be recovered by the lessor is the same whether the residual value is guaranteed or
unguaranteed. Therefore, the amount of the periodic rental payments is set the same way by the lessor
Questions Chapter 21 (Continued)
26. Initial direct costs are the incremental costs of a lease that would not have been incurred had the lease not
been executed. For the lessee, some costs that are included in the right-of–use asset are commissions,
legal fees from the execution of the lease, lease documentation preparation costs incurred after the
27. Lessees and lessors must provide additional qualitative and quantitative disclosures to help financial
statement users to assess the amount, timing, and uncertainty of future cash flows. Qualitative lease
disclosures include the nature of the leases, how variable lease payments are determined, the existence
*28. In a sale-leaseback arrangement, a company (the seller-lessee) transfers an asset to another company
(the buyer-lessor) and then leases that asset back from the buyer-lessor. In order to qualify for sale-
leaseback treatment, the initial transfer of the asset must be such that the seller-lessee gives up control
*29. The sale and subsequent lease will receive sale-leaseback accounting treatment. The initial transfer of
the asset was a sale, and the seller-lessee gave control of the asset to the buyer-lessor. In addition, the
subsequent leaseback is classified as an operating lease, and thus Sanchez never takes control of the
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 21.1
The lease payments in the lease arrangement will include both the annual fixed
payments of $800,000 each year, plus the €11,000,000 bargain purchase option
BRIEF EXERCISE 21.2
The lease payments for years 1 and 2 will be $1,700 ($2,000 annual rental minus
BRIEF EXERCISE 21.3
Variable payments in a lease are not considered in determining the initial value
of the lease liability and right–of–use asset. Because the lease payments are
based on 4% of net sales, these payments are considered variable, as they are
BRIEF EXERCISE 21.4
12/31/18
Right-of–Use Asset ($41,933 X 3.57710*) …………………. 150,000**
Lease Liability ……………………………………………….. 150,000
Cash ……………………………………………………………… 41,933
BRIEF EXERCISE 21.4 (Continued)
*Present value of an annuity-due of 1 for 4 periods at 8%.
**Rounded by $1.
12/31/19
Interest Expense [($150,000 – $41,933) X 8%] ………….. 8,645
BRIEF EXERCISE 21.5
12/31/19
Interest Expense [(€300,000 – €48,337) X 8%] ………….. 20,133
BRIEF EXERCISE 21.6
1/1/19
Right-of–Use Asset ………………………………………………… 33,975*
Lease Liability ……………………………………………….. 33,975
BRIEF EXERCISE 21.6 (Continued)
12/31/19
Interest Expense [(£33,975 – £5,300) X 8%] …………….. 2,294
Lease Liability ……………………………………………….. 2,294
BRIEF EXERCISE 21.7
Fair value of leased asset £70,000
Less: Present value of guaranteed residual value
BRIEF EXERCISE 21.8
Fair value of leased asset $47,000
Less: Present value of lessor’s expected residual value*
($30,000 X .79209**) 23,763
BRIEF EXERCISE 21.9
Lease Receivable (4.99271* X £30,044) …………………… 150,001
Cost of Goods Sold ………………………………………………. 120,000
Sales Revenue ……………………………………………….. 150,001
BRIEF EXERCISE 21.10
Cash …………………………………………………………………….. 30,044
BRIEF EXERCISE 21.11
Lease Receivable (€40,800 X 4.31213*) …………………… 175,935
Cost of Goods Sold ………………………………………………. 120,000
Sales Revenue ……………………………………………….. 175,935
BRIEF EXERCISE 21.12
Cash …………………………………………………………………….. 40,800
Deposit Liability* ……………………………………………. 40,800
BRIEF EXERCISE 21.13
Lease Receivable ………………………………………………….. 57
Interest Revenue ……………………………………………. 57
Inventory………………………………………………………………. 1,000
Lease Receivable …………………………………………… 1,000
BRIEF EXERCISE 21.14
1/1/19
Right-of–Use Asset (2.83339* X £35,000) …………………. 99,169
Lease Liability ……………………………………………….. 99,169
Schedule A
KINGSTON PLC
Lease Amortization Schedule
Annuity-Due Basis
Date
Annual Payment
Interest (6%)
on Liability
Reduction
of Lease
Liability
Lease Liability
1/1/19
£99,169
BRIEF EXERCISE 21.14 (Continued)
12/31/19
Interest Expense …………………………..………………………. 3,850
Lease Liability ……………………………………………….. 3,850
BRIEF EXERCISE 21.15
1/1/19
Cash …………………………………………………………………….. 35,000
Unearned Lease Revenue ……………………………….. 35,000
BRIEF EXERCISE 21.16
1/1/19
Right-of–Use Asset (2.78326* X $12,000) …………………. 33,399
Lease Liability ……………………………………………….. 33,399
*Present value of an annuity-due of 1 for 3 periods at 8%.
Schedule A
RODGERS CORPORATION
Lease Amortization Schedule
Annuity-Due Basis
Date
Annual
Payment
Interest (8%) on
Liability
Reduction
of Lease
Liability
Lease Liability
1/1/19
$33,399
12/31/19
Interest Expense …………………………..………………………. 1,712
Lease Liability ……………………………………………….. 1,712
BRIEF EXERCISE 21.17 (Continued)
Depreciation Expense …………………………………………… 6,000
Accumulated Depreciation–
Leased Equipment [$60,000 ÷ 10] ……………………. 6,000
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
BRIEF EXERCISE 21.18
BRIEF EXERCISE 21.19
(a) The value of the lease liability would remain the same if the only fact changed
(b) Following from the above reasoning, if the expected residual value drops to
£5,000 and Escapee guarantees a residual of £9,000, Escapee will need to
account for the difference between the expected and guaranteed residual
value in calculating the initial lease liability as follows:
BRIEF EXERCISE 21.19 (Continued)
Note to Instructor: The measurement of the lease liability/right-of-use asset
BRIEF EXERCISE 21.20
12/31/2018
Right-of–Use Asset ………………………………………………… 215,544*
Lease Liability ……………………………………………….. 215,544
*Present value of an annuity-due of 1 for 6 periods at 6%.
**Present value of 1 for 6 periods at 6%.
***The lessee need only include in the initial lease liability the amount of the
BRIEF EXERCISE 21.21
12/31/18
Lease Receivable ………………………………………………….. 222,593*
Cost of Goods Sold ………………………………………………. 180,000
BRIEF EXERCISE 21.21 (Continued)
Cash …………………………………………………………………….. 40,000
Lease Receivable …………………………………………… 40,000
12/31/19
Cash …………………………………………………………………….. 40,000
BRIEF EXERCISE 21.22
Lease Liability
In calculating the lease liability, Forrest must determine which of the executory
costs are considered a component of the lease (to be considered in the
measurement of the lease liability).
• The real estate taxes in this case are variable payments and therefore are not
PV of rental payments (4.31213* X $4,638): $20,000
Right-of–Use Asset
The right-of–use asset is initially measured the same as the lease liability, though it
is also adjusted for any initial direct costs, prepaid rent, and lease incentives