21–80
FINANCIAL STATEMENT ANALYSIS CASE
(a) The total obligations under capital leases at 12/26/2009 for Tasty Baking
Company is $2,306,000 (the present value of the future lease payments).
1. The estimated life of the asset and the lease term may be different.
If the asset is being depreciated over the economic life, but the
obligation is reduced over the lease term, a difference will result.
2. The asset and the reduction of the obligation are independent ac–
counting processes during the term of the lease. The lessee should
depreciate the leased asset by applying conventional depreciation
methods: straight-line, sum-of-the-years’ digits, declining balance,
units of production, etc. The reduction of the liability is based on
payment schedules, interest rates, length of lease, etc.
21–81
FINANCIAL STATEMENT ANALYSIS CASE (Continued)
Total operating lease payments due ………………………….. $178,411,000
Less estimated interest …………………………………………….. 19,089,977
Estimated present value of net operating
lease payments …………………………..………………………… $159,321,023
21–82
ACCOUNTING, ANALYSIS, AND PRINCIPLES
Accounting
There are four lease capitalization criteria. They are (1) transfer of title,
(2) bargain-purchase option, (3) lease term is a 75% or more of the
economic life of the leased asset, and (4) the present value of the minimum
Minimum lease payments
= rental payments – executory costs
= $3,557.25 – $500 = $3,057.25.
21–83
ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued)
Analysis
When companies structure leases to avoid capitalization, both the leased
assets and the obligation for the noncancelable lease payments are “off–
Principles
The element of the fundamental quality of faithful representation. The lease
criteria are designed to report leases according to their economic
substance. Thus, if through a lease arrangement a company controls the
PROFESSIONAL RESEARCH
(a) According to FASB ASC 840-10–10-1 the objective of the lease
(b) According to the Glossary at FASB ASC 840–10–20, “substantially all”
relates to the concepts underlying the lease classification criteria. A 90
percent recovery test in the minimum-lease-payments criterion in
use of the property sold.
(c) Lease Term (Codification String: Broad Transactions > 840 Leases > 10
Overall > 20 Glossary)
The lease term is the fixed noncancelable lease term plus all of the
following, except as noted in the following paragraph:
a. All periods, if any, covered by bargain renewal options.
21–85
PROFESSIONAL RESEARCH (Continued)
(2) A loan from the lessee to the lessor directly or indirectly related
to the leased property is expected to be outstanding.
The lease term shall not be assumed to extend beyond the date a
bargain purchase option becomes exercisable.
21–86
PROFESSIONAL SIMULATION 1
Resources
Note: This lease is a capital lease to the lessee because the lease term
(six years) exceeds 75% of the economic life of the asset (six years). Also, the
present value of the minimum lease payments exceeds 90% of the fair
value of the asset.
$ 81,365 Annual rental payment
X 4.60478 PV of an annuity due of 1 for n = 6, i = 12%
$ 374,668 PV of periodic rental payments
21–87
PROFESSIONAL SIMULATION 1 (Continued)
Journal Entries
During 2012
Executory Costs ……………………………………………………. 4,000
Cash …………………………..………………………………….. 4,000
January 1, 2013
Interest Payable …………………………………………………….. 38,236
Interest Expense …………………………………………….. 38,236
Interest Expense …………………………………………………… 38,236
Lease Liability ………………………………………………………. 43,129
Cash …………………………..………………………………….. 81,365
21–88
PROFESSIONAL SIMULATION 1 (Continued)
(Note to instructor: The guaranteed residual value was subtracted for
purposes of determining the depreciable base. The reason is that at the
21–89
PROFESSIONAL SIMULATION 2
Explanation
This is a capital lease to Dexter Labs since the lease term (5 years) is
greater than 75% of the economic life (6 years) of the leased asset. The
lease term is 831/3% (5 ÷ 6) of the asset’s economic life.
Measurement
Journal Entries
1/1/12 Leased Equipment ………………………………….. 36,144
Lease Liability ………………………………….. 36,144
Lease Liability ………………………………………… 8,668
Cash ………………………………………………… 8,668
Interest Expense …………………………………….. 2,748
Interest Payable
[($36,144 – $8,668) X .10] ……………….. 2,748
21–90
IFRS CONCEPTS AND APPLICATION
IFRS21-1
The IFRS leasing standard is IAS 17, first issued in 1982. This standard is
the subject of only three interpretations.
IFRS21-2
IFRS21-3
Lease accounting is one of the areas identified in the IASB/FASB
Memorandum of Understanding and also a topic recommended by the SEC
in its off-balance-sheet study for standard-setting attention. The joint
IFRS21-4
Under the operating method, each rental receipt of the lessor is recorded
as rental revenue on the use of an item carried as a fixed asset. The fixed
21–91
IFRS21-5
If the lease transaction satisfies the necessary criteria to be classified as a
direct-financing lease, the lessor records a “lease receivable” for the
IFRS21-6
From the standpoint of the lessor, leases may be classified for accounting
purposes as: (a) operating leases, (b) direct-financing leases, and (c) sales-
type leases.
From the standpoint of lessors, leases are classified as finance leases if
they meet one or more of the following four criteria:
1. The lease transfers ownership of the property to the lessee,
Finance leases are classified as direct-financing leases or sales-type
leases. All other leases are classified as operating leases. The distinction
IFRS21-7
Interest Expense …………………………………………………… 29,530
Interest Payable [($300,000 – $53,920) X 12%] …… 29,530
21–92
IFRS21-8
Interest Payable [($300,000 – $53,920) X 12%] ………… 29,530
Lease Liability ………………………………………………………. 24,390
Cash ……………………………………………………………… 53,920
IFRS21-9
(a) To Brecker, the lessee, this lease is a finance lease because the terms
satisfy the following criteria:
(b) The minimum lease payments in the case of a guaranteed residual
value by the lessee include the guaranteed residual value. The present
value therefore is:
Monthly payment of $250 for 50 months ……….. $ 9,800
Residual value of $1,180 ………………………………. 715
Present value of minimum lease payments …… $10,515
21–93
IFRS21-10
(a) The lease agreement has a bargain-purchase option and thus meets
the criteria to be classified as a finance lease from the viewpoint of the
lessee. Also, the present value of the minimum lease payments exceeds
90% of the fair value of the asset.
(c) Computation of lease liability:
$18,829.49 Annual rental payment
X 4.16986 PV of annuity due of 1 for n = 5, i = 10%
$78,516.34 PV of periodic rental payments
21–94
IFRS21-10 (Continued)
GILL COMPANY (Lessee)
Lease Amortization Schedule
Date
Interest
(10%) on
Liability
Reduction
of Lease
Liability
Lease
Liability
5/1/12
$81,000.00
5/1/12
$18,829.49
62,170.51
*Rounding error is 20 cents.
(d) 5/1/12 Leased Equipment ……………………….. 81,000.00
Lease Liability ……………………….. 81,000.00
Lease Liability ……………………………… 18,829.49
Cash …………………………………….. 18,829.49
1/1/13 Interest Payable ……………………………. 4,144.70
Interest Expense ……………………. 4,144.70
5/1/13
5/1/14
35,684.39
5/1/15
20,423.34
5/1/16
4/30/17
4,000.00
3,636.18
$98,147.45
$81,000.00
21–95
IFRS21-10 (Continued)
12/31/13 Interest Expense ……………………….. 3,303.87
Interest Payable ………………….. 3,303.87
($4,955.81 X 8/12 =
($3,303.87)
IFRS21-11
Note: The lease agreement has a bargain-purchase option. The lease,
therefore, qualifies as a finance lease from the viewpoint of the lessor.
(a) The lease receivable is computed as follows:
$18,829.49 Annual rental payment
X 4.16986 PV of annuity due of 1 for n = 5, i = 10%
$78,516.34 PV of periodic rental payments
21–96
IFRS21-11 (Continued)
$78,516.34 PV of periodic rental payments
+ 2,483.68 PV of bargain-purchase option
$81,000.00* Lease receivable at inception
*Rounded
(b) LENNOX LEASING COMPANY (Lessor)
Lease Amortization Schedule
Annual Lease
Payment Plus
Interest (10%)
on Lease
Recovery
of Lease
Lease
*Rounding error is 20 cents.
(c) 5/1/12 Lease Receivable …………………. 81,000.00
Cost of Goods Sold ………………. 65,000.00
Sales Revenue ………………. 81,000.00
Inventory ………………………. 65,000.00
21–97
IFRS21-11 (Continued)
5/1/13 Cash ……………………………………. 18,829.49
Lease Receivable ………….. 12,612.44
Interest Receivable ………… 4,144.70
Interest Revenue …………… 2,072.35
($6,217.05 – $4,144.70)
12/31/14 Interest Receivable ………………. 2,378.96
Interest Revenue …………… 2,378.96
($3,568.44 X 8/12 =
($2,378.96)
IFRS21-12
(a) According to IAS 17, paragraph 7, “The classification of leases adopted
in this Standard is based on the extent to which risks and rewards
incidental to ownership of a leased asset lie with the lessor or the
lessee. Risks include the possibilities of losses from idle capacity or
21–98
IFRS21-12 (Continued)
(b) IAS 17 does not define “substantially all.”
(c) IAS 17 does not name other considerations in determining “lease term,”
IFRS21-13
(a) M&S uses both finance leases and operating leases.
(b) M&S reported finance leases of £89.8 million (net of interest of £76.2
million) in total, and £13.7 million for less than 1 year, £26.7 million for
more than 1 year and less than 5 years, and £49.4 million for more than
5 years.