*EXERCISE 21.25 (20-25 minutes)
(a) The lease will be classified as an operating lease for Jabari, but will meet the
classification tests of a direct financing lease for Giannis. None of the lease
classification tests are met for a finance/sales-type lease. That is, ownership
does not transfer at the end of the lease, there is no bargain purchase option, the
The guaranteed residual value is not included in the finance/sales-type lease
classification test, as it is not guaranteed by the lessee, but rather an independent
3rd party. Therefore, Jabari classifies the lease as an operating lease.
However, the 3rd party residual value guarantee is taken into account when
determining whether or not the lease is classified as a direct financing lease for
Present value of lease payments ……………………………. $26,632
Present value of residual value guarantee ………………. $7,367
Present value of lease payments plus
3rd party residual value guarantee (rounded) ……….. $34,000
Fair value of the equipment …………………………………… ÷ 34,000
Present value as a percentage of fair value …………….. 100%
*EXERCISE 21.25 (Continued)
Because the lease qualifies as a direct financing lease, the gross profit from the
lease is deferred and recognized over the course of the lease.
(b)
GIANNIS CORPORATION (Lessor)
Lease Amortization Schedule
Sales-Type Lease
Date
Annual Lease
Payment
Interest (5%)
on Lease
Receivable
Recovery
of Lease
Receivable
Lease
Receivable
1/1/20
$34,000
12/31/20
$3,449
$1,700
$1,749
32,251
12/31/21
3,449
1,613
1,836
30,415
12/31/22
3,449
1,521
1,928
28,486
12/31/23
26,462
3,449
1,323
2,126
24,336
3,449
1,217
22,104
19,760
3,449
2,461
17,299
3,449
2,584
14,715
12,000
12/31/30
*EXERCISE 21.25 (Continued)
GIANNIS CORPORATION (Lessor)
Lease Amortization Schedule
Direct Financing Lease
Date
Annual Lease
Payment
Interest
(13.24%) on
Receivable
Reduction of
Net Lease
Receivable
Net Lease
Receivable
1/1/20
$22,000
12/31/20
$3,449
$2,913
$536
21,464
12/31/21
3,449
2,842
607
20,857
3,449
2,567
882
18,508
3,449
2,450
999
17,509
16,378
3,449
2,168
15,097
3,449
1,999
13,647
12,000
12/31/29
*Rounded $5
The difference between the interest under a sales-type lease (ex. in first year,
*EXERCISE 21.25 (Continued)
(c)
1/1/20
Lease Receivable ………………………………………………….. 34,000
12/31/20
Cash …………………………………………………………………….. 3,449
Deferred Gross Profit** …………………………..……………… 1,213
12/31/21
Cash …………………………………………………………………….. 3,449
Deferred Gross Profit** …………………………..……………… 1,229
(d)
1/1/20
Right-of–Use Asset ………………………………………. 26,632
*EXERCISE 21.25 (Continued)
JABARI, INC.
Lease Amortization Schedule (partial)
Annuity-Due Basis
Date
Annual
Payment
Interest (5%) on
Liability
Lease Liability
Lease Expense Schedule (partial)
Date
(A)
Lease Expense
(Straight-Line)
(B)
Interest (5%) on
Lease Liability
(C)
Amortization of
ROU Asset
(A–B)
Carrying
Value of ROU
Asset
1/1/20
$26,632
12/31/20
Lease Expense ………………………………. 3,449
Lease Liability ………………………………… 2,117
*EXERCISE 21.25 (Continued)
(e) The rate of return required to amortize the net lease receivable to zero would
increase greatly. Recall the rate’s purpose is to create a rate to multiply by the
net lease receivable in order to amortize a portion of the deferred gross profit in
(f) Had Jabari guaranteed the residual value of the building itself, it would be
required to classify the lease as a finance lease because it would then include
the present value of the residual value guarantee in the calculation of the present
value of the lease payments when determining the present value test. When this
is done, as shown in part (a), the present value of the lease payments are 100%
of the fair value of the building, and thus the lease meets the 90% test. Under a
TIME AND PURPOSE OF PROBLEMS
Problem 21.1 (Time 25–35 minutes)
Purpose—to provide an understanding of the journal entries to be recorded for a finance lease by the lessee
Problem 21.2 (Time 20–30 minutes)
Purpose—to develop an understanding of the accounting by the lessee for a finance lease. The student is
Problem 21.3 (Time 25–30 minutes)
Purpose—to develop an understanding of the accounting for a finance lease by the lessee in an annuity due
Problem 21.4 (Time 20–30 minutes)
Purpose—to develop an understanding of the accounting for a finance lease by a lessee in an annuity-due
Problem 21.5 (Time 20–25 minutes)
Purpose—to develop an understanding of the accounting principles used in a finance lease with a bargain
Problem 21.6 (Time 20–25 minutes)
Problem 21.7 (Time 30–40 minutes)
Purpose—to develop an understanding of a sales-type lease with a guaranteed residual value. The student
Problem 21.8 (Time 30–40 minutes)
Purpose—to develop an understanding of a finance lease with a guaranteed residual value. The student
Problem 21.9 (Time 30–40 minutes)
Purpose—to develop an understanding of the accounting treatment accorded a sales-type lease involving an
Problem 21.10 (Time 30–40 minutes)
Purpose—to develop an understanding of lessee accounting for a finance lease with an unguaranteed residual
Problem 21.11 (Time 30–40 minutes)
Purpose—to develop an understanding of how residual values affect the accounting for the lessee and the
Problem 21.12 (Time 35–45 minutes)
Purpose—to develop an understanding of the accounting procedures involved in a finance/sales-type leasing
Problem 21.13 (Time 30–40 minutes)
Purpose—to provide an understanding of how lease information is reported on the balance sheet and income
Problem 21.14 (Time 40–50 minutes)
Purpose—to provide an understanding of how lease information is reported on the balance sheet and income
Problem 21.15 (Time 30–40 minutes)
Purpose—to develop an understanding of the accounting treatment for operating leases. The student is
Problem 21.16 (Time 30–40 minutes)
Purpose—to develop an understanding of the accounting treatment for an operating lease. The student is
Problem 21.17 (Time 20–30 minutes)
Purpose—to develop an understanding of the accounting treatment for operating leases. The student is
SOLUTIONS TO PROBLEMS
PROBLEM 21.1
Note: This lease is a finance lease to the lessee because the lease term
(six years) exceeds 75% of the remaining economic life of the asset (six years). Also,
the present value of the lease payments exceeds 90% of the fair value of the
asset.
$ 113,864 Annual rental payment
However, for purposes of measuring the initial lease liability, only amounts
expected to be owed under the residual value guarantee should be included.
That is, only the present value of the difference between the residual value
guarantee and the expected residual value at the end of the lease term should be
included.
$ 113,864 Annual rental payment
X 4.99271 PV of an annuity-due of 1 for n = 6, i = 8%
$ 568,490 PV of periodic rental payments
PROBLEM 21.1 (Continued)
(a) VANCE COMPANY (Lessee)
Lease Amortization Schedule
Date
Annual
Lease
Payment
Plus GRV
Interest (8%)
on Liability
Reduction
of Lease
Liability
Lease
Liability
1/1/20
$571,641
1/1/20
$113,864
$ –0–
$113,864
457,777
1/1/21
1/1/22
12/31/25
(b) January 1, 2020
Right-of–Use Asset ………………………………………………… 571,641
Lease Liability ……………………………………………….. 571,641
Lease Liability ………………………………………………………. 113,864
Cash ……………………………………………………………… 113,864
PROBLEM 21.1 (Continued)
December 31, 2021
Interest Expense …………………………………………………… 30,443
Lease Liability ……………………………………………….. 30,443
Amortization Expense …………………………………………… 95,274
Right-of–Use Asset …………………………………………. 95,274
Note to instructor: The guaranteed residual value is not subtracted from the
(c) A lease incentive does not impact the measurement of the lease liability.
However, a reduction in the right-of-use asset must be made. Thus, the right–of–
use asset would be measured at $566,641 ($571,641 – $5,000).
PROBLEM 21.2
(a) The $550,000 is the present value of the five annual lease payments of
$120,987 to be made at the beginning of each year discounted at 5% since
*Rounded.
Lease Liability ……………………………………………….. 120,987
Cash ……………………………………………………….. 120,987
CAGE COMPANY (Lessee)
Lease Amortization Schedule (partial)
Date
Annual
Lease
Payment
Interest (5%)
on Liability
Reduction
of Lease
Liability
Lease
Liability
1/1/20
$550,000
PROBLEM 21.2 (Continued)
(e) CAGE COMPANY
Balance Sheet (Partial)
December 31, 2020
Noncurrent:
(f) Insurance payments are an executory cost. Assuming a gross lease, the
insurance payments must be included in the present value of the lease payments
when initially valuing the lease liability. Therefore, the initial liability would be
measured as follows:
Assets
Liabilities
Non-current assets:
Current:
PROBLEM 21.3
(a) December 31, 2020
Right-of–Use Asset ………………………………………………… 175,888
Lease Liability ……………………………………………….. 175,888*
(To record leased asset and related
December 31, 2020
Lease Liability ……………………………………………….. 40,000
Cash ……………………………………………………….. 40,000
(To record the first rental payment)
(b) LUDWICK STEEL COMPANY (Lessee)
Lease Amortization Schedule
(Annuity Due Basis)
Date
Annual
Lease
Payment
Interest (8%)
on Liability
Reduction
of Lease
Liability
Lease
Liability
12/31/20
—
—
—
$175,888
12/31/21
PROBLEM 21.3 (Continued)
December 31, 2021
Amortization Expense …………………………………….. 25,127
Right-of-Use Asset …………………………………… 25,127
December 31, 2021
Interest Expense …………………………………………….. 10,871
Lease Liability ……………………………………………….. 29,129
of $135,888)
(c) December 31, 2022
Amortization Expense ……………………………………….. 25,127
Right-of-Use Asset ……………………………………… 25,127
(To record annual amortization on leased
assets)
PROBLEM 21.3 (Continued)
(d) LUDWICK STEEL COMPANY
Balance Sheet (Partial)
December 31, 2022
Non-current assets:
Current liabilities:
PROBLEM 21.4
Entries on August 1, 2020:
(1) Right-of–Use Asset ……………………………………… 4,119,480
Lease Liability ………………………………………. 4,119,480
(2) Lease Liability ………………………………………….. 40,000
Cash ………………………………………………….. 40,000
Entries on August 31, 2020:
(1) Interest Expense ……………………………………….. 20,397
Lease Liability …………………………………….. 20,397
(2) Amortization Expense ……………………………….. 28,608
Right-of-Use Asset ……………………………… 28,608
PROBLEM 21.5
(a) GRISHELL TRUCKING COMPANY
Schedule to Compute the Discounted Present Value
of Terminal Facilities and the Related Obligation
January 1, 2020
Present value of first 10 payments:
Immediate payment ………………………………… $ 800,000
Present value of an ordinary annuity for
9 years at 6% ($800,000 X 6.801692) …….. 5,441,354 $6,241,354*
Discounted present value of terminal
facilities and related obligation ……………. $7,635,410
(Note to instructor: The student can compute the $6,241,354 by using the
present value of an annuity due for 10 periods at 6%.
*The calculation could also be done as a pure annuity due of 1 for 10
periods as follows ($2 rounding difference):
PROBLEM 21.5 (Continued)
(b) GRISHELL TRUCKING COMPANY
Journal Entries
(1) 1/1/22
Partial Amortization Schedule
(Annuity-Due Basis)
Date
Lease
Payment
Interest (6%)
on Lease
Liability
Reduction of
Lease
Liability
Lease
Liability
1/1/20
$7,635,410
(2) 12/31/22
Amortization Expense …………………………………….. 190,885
(3) 12/31/22
Interest Expense …………………………………………….. 361,936
PROBLEM 21.6
(a) This is a finance lease for Jensen since the lease term is greater than 75% of
the economic life of the leased asset. The lease term is 78% (7 ÷ 9) of the
(b) Calculation of annual rental payment
(c) Computation of lease liability, or present value of lease payments:
PV of annual payments: $109,365 X 5.91732* = $647,148
Note to the Instructor: The lease liability only includes the amount expected
to be owed under a residual value guarantee. This contrasts with the
classification test, which includes the full value of a guaranteed residual.
The classification test would be performed as done below: