21–61
PROBLEM 21-12 (Continued)
Partial Amortization Schedule
(Annuity Due Basis)
Date
Lease
Payment
Executory
Costs
Interest
(6%) on
Lease
Liability
Reduction
of Lease
Liability
Lease
Liability
(2) (12/31/14)
Depreciation Expense …………………………………….. 190,000
Accumulated Depreciation—Capital
Leases …………………………………………………. 190,000
(3) (12/31/14)
Interest Expense …………………………………………….. 359,549
Interest Payable ……………………………………….. 359,549
PROBLEM 21-13
(a) The noncancelable lease is a sales-type lease because: (1) the lease
term is for 83% (10 ÷ 12) of the economic life of the leased asset,
(2) the present value of the minimum lease payments exceeds 90% of
the fair value of the leased property, (3) the collectibility of the lease
1. Lease Receivable:
Present value of annual payments of $60,000
2. Sales price is the same as the present value of
minimum lease payments ………………………………………. $411,324
21–63
PROBLEM 21-13 (Continued)
(b) AMIRANTE INC. (Lessor)
Lease Amortization Schedule
(Annuity due basis, guaranteed residual value)
Beginning
of Year
Annual Lease
Payment Plus
Residual Value
Interest (10%)
on Lease
Receivable
Lease
Receivable
(a)
(b)
(d)
Initial PV
—
—
$411,324
1
$ 60,000
—
351,324
2
60,000
$ 35,132
326,456
3
60,000
32,646
299,102
*Rounding error is $4.00.
(a) Annual lease payment required by lease contract.
(b) Preceding balance of (d) X 10%, except beginning of first year of lease term.
(c) (a) minus (b).
(d) Preceding balance minus (c).
(c) Lessor’s journal entries:
4
269,012
5
60,000
33,099
235,913
6
199,504
7
159,454
8
60,000
44,055
115,399
9
$615,000
$411,324
PROBLEM 21-13 (Continued)
Cash ………………………………………………………………… 60,000
Lease Receivable ……………………………………….. 60,000
(To record receipt of the first lease
payment)
21–65
PROBLEM 21-14
(a) The noncancelable lease is a capital lease because: (1) the lease term is
for 83% (10 ÷ 12) of the economic life of the leased asset and (2) the
present value of the minimum lease payments exceeds 90% of the fair
market value of the leased asset.
(b) CHAMBERS MEDICAL (Lessee)
Lease Amortization Schedule
(Annuity Due Basis, GRV)
Beginning
of Year
Annual Lease
Payment Plus
GRV
Interest (10%)
on Unpaid
Liability
Lease
Liability
(a)
(b)
(d)
Initial PV
—
—
$411,324
1
$ 60,000
—
351,324
2
60,000
$ 35,132
326,456
3
60,000
32,646
299,102
4
60,000
29,910
269,012
5
60,000
26,901
235,913
6
60,000
199,504
7
60,000
19,950
159,454
8
60,000
15,945
115,399
9
60,000
11,540
60,000
*Rounding error is $4.
(a) Annual lease payment required by lease contract.
PROBLEM 21-14 (Continued)
(c) Lessee’s journal entries:
Lease Liability ……………………………………………….. 60,000
Cash ……………………………………………………….. 60,000
(To record payment of annual lease
obligation)
21–67
PROBLEM 21-15
Memorandum Prepared by: (Your Initials)
Date:
HOCKNEY, INC.
December 31, 2012
Reclassification of Leased Auto
As a Capital Lease
Examining the noncancelable lease agreement entered into with Crown New
and Used Cars on January 1, 2012, I determined that the automobile should
be capitalized because its lease term (4 years) is greater than 75% of its
useful life (5 years).
To account for the first year’s payments as well as to reverse the original
entries, I advised the client to make the following entry:
Lease Liability ………………………………………………………. 2,317
Interest Expense (8% X $11,540) ……………………………. 923
Rent Expense …………………………………………………. 3,240
PROBLEM 21-15 (Continued)
Finally, this vehicle must be depreciated over its lease term. Using straight–
21–69
PROBLEM 21-16
(a) The lease agreement satisfies both the 75% of useful life and 90% of
fair value requirements, collectibility is reasonably predictable, and there
(b) January 1, 2012
Lessee:
Leased Equipment ………………………………………….. 220,404
Lease Liability ………………………………………….. 220,404
($30,300 X 6.99525 = $211,956)
($20,000 X .42241 = 8,448)
= $220,404)
December 31, 2012
Lessee:
Interest Expense …………………………………………….. 17,109
Interest Payable
[($220,404 – $30,300) X .09] ……………………. 17,109
PROBLEM 21-16 (Continued)
December 31, 2012
Lessor:
Interest Receivable …………………………………………… 17,109
Interest Revenue …………………………..……………. 17,109
(c) (1) and (2) are both $211,956, as the lessee has no obligation to pay the
residual value.
21–71
TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 21-1 (Time 15–25 minutes)
Purpose—to provide the student with an understanding of the theoretical reasons for requiring certain
leases to be capitalized by the lessee and how a capital lease is recorded at its inception and how the
amount to be recorded is determined. The student explains how to determine the lessee’s expenses
during the first year and how the lessee will report the lease on the balance sheet at the end of the
first year.
CA 21-2 (Time 25–35 minutes)
Purpose—to provide an understanding of the factors underlying the accounting for a leasing arrangement
from the point of view of both the lessee and lessor. The student is required to determine the classifica–
tion of this leasing arrangement, the appropriate accounting treatment which should be accorded this
lease, and the financial statement disclosure requirements for both the lessee and lessor.
CA 21-3 (Time 20–30 minutes)
Purpose—to provide the student with an understanding of the classification of three leases. The student
determines how the lessee should classify each lease, what amount should be recorded as a liability at
the inception of each lease, and how the lessee should record each minimum lease payment for each
lease.
CA 21-4 (Time 15–25 minutes)
Purpose—to provide the student with an assignment to describe: (a) the accounting for a capital lease
both at inception and during the first year and (b) the accounting for an operating lease. The student is
also required to compare and contrast a sales-type lease with a direct-financing lease.
CA 21-5 (Time 30–35 minutes)
Purpose—to provide the student with a lease situation containing a bargain-purchase option and both
an implicit rate and a stated interest rate between which the student must choose. The student is
required to compute the appropriate amount at which to capitalize the lease and, in a second requirement,
given different interest rates, to prepare the balance sheet and income statement presentation of this
lease by the lessee.
CA 21-6 (Time 20–25 minutes)
Purpose—to provide the student with a lease arrangement with a bargain-purchase option in order to
examine the ethical issues of lease accounting.
*CA 21-7 (Time 15–25 minutes)
Purpose—to provide the student with an assignment to discuss the theoretical justification for lease
capitalization. In addition, the student is required to discuss the accounting issues related to a sale-
leaseback.
*CA 21-8 (Time 20–25 minutes)
Purpose—to provide the student with a sale-leaseback situation to which lease capitalization criteria
need to be applied, as well as disclosures discussed and the sale accounted for.
SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 21-1
(a) When a lease transfers substantially all of the benefits and risks incident to the ownership of
property to the lessee, it should be capitalized by the lessee. The economic effect of such a lease
on the lessee is similar, in many respects, to that of an installment purchase.
(c) Evans will incur interest expense equal to the interest rate used to capitalize the lease at its
inception multiplied by the appropriate net carrying value of the liability at the beginning of the
period.
CA 21-2
(a) (1) Because the present value of the minimum lease payments is greater than 90 percent of
the fair value of the asset at the inception of the lease, Sylvan should record this as a
capital lease.
(2) Since the given facts state that Sylvan (lessee) does not have access to information that
would enable determination of Breton Leasing Corporation’s (lessor) implicit rate for this
(3) The amount recorded as an asset on Sylvan’s books should be shown in the fixed assets
section of the balance sheet as “Leased Equipment” or another similar title. Of course, at
the same time as the asset is recorded, a corresponding liability (“Lease Liability” or similar
21–73
CA 21-2 (Continued)
represents a fixed interest rate applied to the declining balance of the debt. Executory costs
(such as insurance, maintenance, or taxes) paid by Sylvan are charged to an appropriate
expense, accrual, or deferral account as incurred or paid.
(4) For this lease, Sylvan must disclose the future minimum lease payments in the aggregate
and for each of the succeeding fiscal years (not to exceed five), with a separate deduction
for the total amount for imputed interest necessary to reduce the net minimum lease
(2) Breton should record a Lease Receivable for the present value of the minimum lease
payments and the present value of the residual value. It should also remove the machine
from the books by a credit to the applicable asset account.
(3) During the life of the lease, Breton will record payments received as a reduction in the
receivable. Interest is recognized as interest revenue earned by applying the implicit
(4) Breton must make the following disclosures with respect to this lease:
(a) The components of the lease receivable in direct-financing leases, which are (1) the
CA 21-3
(a) A lease should be classified as a capital lease when it transfers substantially all of the benefits
and risks inherent to the ownership of property by meeting any one of the four criteria established
by GAAP for classifying a lease as a capital lease.
CA 21-3 (Continued)
(b) For Lease L, Santiago Company should record as a liability at the inception of the lease an
amount equal to the present value at the beginning of the lease term of the minimum lease
payments during the lease term. This amount excludes that portion of the payments representing
(c) For Lease L, Santiago Company should allocate each minimum lease payment between a reduc-
tion of the liability and interest expense so as to produce a constant periodic rate of interest on
the remaining balance of the liability.
CA 21-4
Part 1
(a) A lessee would account for a capital lease as an asset and an obligation at the inception of the
lease. Rental payments during the year would be allocated between a reduction in the liability
and interest expense. The asset would be amortized in a manner consistent with the lessee’s
normal depreciation policy for owned assets, except that in some circumstances, the period of
amortization would be the lease term.
Part 2
(a) The lease receivable in the lease is the same for both a sales-type and a direct-financing lease.
The lease receivable is the present value of the minimum lease payments (net of amounts, if any,
21–75
CA 21-4 (Continued)
(c) In a sales-type lease, the excess of the sales price over the carrying amount of the leased
CA 21-5
(a) The appropriate amount for the leased aircraft on Albertsen Corporation’s balance sheet after the
lease is signed is $1,000,000, the fair value of the plane. In this case, fair market value is less
than the present value of the net rental payments plus purchase option ($1,022,226). When this
occurs, the asset is recorded at the fair value.
The following items relating to the leased aircraft will be reflected on Albertsen Corporation’s
income statement:
Depreciation expense (Note A) ……………………………………………………. $61,667
Interest expense …………………………..…………………………………………… 77,600
Maintenance expense ………………………………………………………………… 6,900
Insurance and property tax expense …………………………………………….. 4,000
CA 21-5 (Continued)
Computations
Depreciation expense:
Capitalized amount ………………………………………………………….. $1,000,000
Less: Salvage value ………………………………………………………… 75,000
$ 925,000
CA 21-6
(a) The ethical issues are fairness and integrity of financial reporting versus profits and possibly
misleading financial statements. On one hand, if Buchanan can substantiate her position, it is
possible that the agreement should be considered an operating lease. On the other hand, if
Buchanan cannot or will not provide substantiation, she would appear to be trying to manipulate
the financial statements for some reason, possibly debt covenants or minimum levels of certain
ratios.
*CA 21-7
(a) The economic effect of a long-term capital lease on the lessee is similar to that of an installment
purchase. Such a lease transfers substantially all of the benefits and risks incident to the ownership
of property to the lessee. Therefore, the lease should be capitalized.
21–77
*CA 21-7 (Continued)
(2) Perriman should account for the leaseback portion of the sale-leaseback transaction at
January 1, 2012, by recording both an asset and a liability at an amount equal to the
present value at the beginning of the lease term of minimum lease payments during the
lease term, excluding any portion of the payments representing executory costs, together
with any profit. However, if the present value exceeds the fair value of the leased equipment
at January 1, 2012, the amount recorded for the asset and liability should be the equipment’s
fair value.
*CA 21-8
(a) (1) Comparisons of an equipment’s fair value to its lease payments’ present value, and of its
useful life to the lease term, are used to determine whether the lease is equivalent to an
installment sale and is therefore a capital lease.
(b) Shellhammer should account for the sale portion of the sale-leaseback transaction at December
31, 2012, by increasing cash for the sale price, decreasing equipment by the carrying amount,
and recognizing a loss for the excess of the equipment’s carrying amount over its sale price.
21–78
FINANCIAL REPORTING PROBLEM
(a) In P&G’s Management’s Discussion and Analysis (under Contractual
Commitments), both capital leases and operating leases are disclosed.
(c) P&G disclosed future minimum rental commitments under noncancelable
operating leases in excess of one year as of June 30, 2009, of:
2010—$305 million
2011—$272 million
21–79
COMPARATIVE ANALYSIS CASE
(a) Southwest uses both capital leases and long-term operating leases.
Southwest primarily leases aircraft and terminal space.
(c) Future minimum commitments under noncancelable leases are set forth
below (in millions):
Capital
Operating
2010 …………………………………………….
$15
$ 414
2011 …………………………………………….
12
379
2012 …………………………………………….
—
333
2013 …………………………………………….
—
254
2014 …………………………………………….
—
222
Later years …………………………………..
—
1,032
$27
$2,634
(f) The main difference between Southwest and UAL is that UAL is leasing
more types of assets compared to Southwest. In addition to aircraft and
terminal space, UAL is leasing aircraft hangars, maintenance facilities,