Finally, this vehicle must be amortized over its lease term, using the straight-line method. I computed
annual amortization of $2,889 (the initial right–of-use asset, $5,778, divided by the 2-year lease term).
The client was advised to make the following entry to record 2020 amortization:
*CA 21.7
(a) The major accounting issue is whether the transaction is a sale or a financing. To determine
whether it is a sale, the revenue recognition guidelines are used. That is, if control has passed
from seller to buyer then a sale has occurred. Conversely, if control has not passed from seller
to buyer the transaction is recorded as a financing (often referred to as a failed sale).
FINANCIAL REPORTING PROBLEM
Note to instructor: P&G has not yet adopted the new lease standard; its
reporting reflects application of prior GAAP.
(a) In P&G’s Management’s Discussion and Analysis (under Contractual
Commitments), both capital leases and operating leases are disclosed.
(c) P&G in note 12 disclosed future minimum rental commitments under
noncancelable operating leases in excess of one year as of June 30, 2017,
of:
2018—$261 million
COMPARATIVE ANALYSIS CASE
Note to instructor: Southwest and Delta have not yet adopted the new lease
standard; their reporting reflects application of prior GAAP.
(a) Southwest uses both capital leases and long-term operating leases.
(c) Future minimum commitments under noncancelable leases are set forth
below (in millions):
Capital
Operating
Operating
(after
subleases)
2018 …………………………………………….
$107
$ 359
$257
2019 …………………………………………….
2022 …………………………………………….
(d) At year-end 2017, the present value of minimum lease payments under
capital leases was $780 million. Imputed interest deducted from the future
minimum annual rental commitments was $150 million.
(e) The details of rental expense are set forth below:
Note to instructor: Wal-Mart has not yet adopted the new lease accounting
standard; its reporting reflects application of prior GAAP.
($ millions)
ACCOUNTING, ANALYSIS, AND PRINCIPLES
Accounting
(a) There are five lease capitalization tests. They are (1) transfer of ownership,
(2) bargain-purchase option, (3) the lease term is 75% or more of the economic
life of the leased asset, (4) the present value of the lease payments is 90% or
more of the leased asset’s fair value, and (5) alternative use test.
This lease does not transfer ownership. The option to purchase at the end of
the lease is clearly not a bargain. The lessor has an alternative use for the
Therefore, the present value test is not met either. Consequently, this lease is
accounted for as an operating lease. Therefore, Salaur makes the following
journal entries at the commencement date.
1/1/20
ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued)
SALAUR COMPANY
Lease Amortization Schedule
Annuity-Due Basis
Date
Annual
Payment
Interest (12%)
on Liability
Reduction
of Lease
Liability
Lease Liability
1/1/20
$8,224.16
1/1/22
Lease Expense Schedule
Date
(A)
Straight-Line
Expense
(B)
Interest (12%)
on Lease
Liability
(C)
Amortization of
ROU Asset
(A–B)
Carrying Value
of ROU Asset
1/1/20
$8,224.16
The entry to record lease expense in 2020 is as follows.
12/31/20
ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued)
(b) With the bargain purchase option, the lease is now classified as a finance
lease. Salaur computes the lease liability and right–of-use asset, as follows.
Salaur makes the following entries at lease commencement.
1/1/20
Right-of–Use Asset ………………………………………… 8,295.34
SALAUR COMPANY
Lease Amortization Schedule
Date
Annual Lease
Payment Plus
BPO
Interest
(12%) on
Liability
Reduction
of Lease
Liability
Lease
Liability
1/1/20
$8,295.34
ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued)
12/31/20
Interest Expense …………………………………………… 628.57
Lease Liability ……………………………………….. 628.57
Analysis
While all leases with terms longer than one year are capitalized (recorded on the
balance sheet), the amounts differ depending on whether the lease is classified
as a finance or operating lease. As indicated in the entries above, the right–of–
use asset increases and the denominator of the return on assets ratio (ROA =
Net income ÷ Average assets) will increase, but by different amounts (generally
compare the companies based on ROAs and debt to total asset ratios.
ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued)
Principles
The fundamental quality is faithful representation. The lease criteria are
designed to report leases according to their economic substance. Thus, if
through a lease arrangement a company has control of the leased asset (whether
CODIFICATION EXERCISES
CE21.1
Master Glossary
(a) Commencement date of the lease (commencement date) is the date on which a lessor
makes an underlying asset available for use by a lessee.
CE21.2
According to FASB ASC 842-10–30-5 to 6: Initial Measurement of the Lease Payments
At the commencement date, the lease payments shall consist of
the following payments relating to the
use of the underlying asset during the lease term:
• Fixed payments, including in substance fixed payments, less any lease incentives paid or payable to
the lessee (see paragraphs 842-10–55–30 through 55-31).
• Variable lease payments that depend on an index or a rate (such as the Consumer Price Index or a
Lease payments do not include any of the following:
• Variable lease payments other than those in paragraph 842–10–30-5(b)
• Any guarantee by the lessee of the lessor’s debt
• Amounts allocated to nonlease components in accordance with paragraphs 842-10–15-33
through 15-42.
LO: 2, 4, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, Research, Technology and Tools, AICPA PC:
Communication
CODIFICATION EXERCISES (Continued)
CE21.3
According to 842–20–50-3 (Disclosure):
A lessee shall disclose all of the following:
a. Information about the nature of its leases, including:
1. A general description of those leases.
in the disclosures provided in (1) through (5), as applicable.
b. Information about leases that have not yet commenced but that create significant rights and obligations for
the lessee, including the nature of any involvement with the construction or design of the underlying asset.
c. Information about significant assumptions and judgments made in applying the requirements of this Topic,
which may include the following:
1. The determination of whether a contract contains a lease (as described in paragraphs 842-10–15–2
842–20–50–4 For each period presented in the financial statements, a lessee shall disclose the following
amounts relating to a lessee’s total lease cost, which includes both amounts recognized in profit or loss during
the period and any amounts capitalized as part of the cost of another asset in accordance with other
Topics, and the cash flows arising from lease transactions:
a. Finance lease cost, segregated between the amortization of the right–of-use assets and interest on
the lease liabilities.
f. Net gain or loss recognized from sale and leaseback transactions in accordance with paragraph 842-
40–25–4.
g. Amounts segregated between those for finance and operating leases for the following items:
1. Cash paid for amounts included in the measurement of lease liabilities, segregated between