In class lease examples with ifrs f08

Acct. 414 – Journal Entry Examples: Leases Prof. Teresa Gordon

Introduction

ACCOUNTING FOR LEASESFASB 13 (as amended)

Synopsis:A lease that transfers substantially all of the benefits and risks of ownership should be accounted for as the acquisition of an asset and the incurrence of an obligation by the lessee and as a sale or financing by the lessor.

The chart below includes the BASIC criteria you must learn to classify leases. We will also do more complicated examples that will require FARS research.

U.S. GAAPCRITERIA FOR CAPITALIZATION:

FOR LESSEE AND LESSOR: (must meet at least one)

A1 - TITLE TRANSFERS. The lease transfers ownership of the property to the lessee by the end of the lease term.

A2 - BARGAIN PURCHASE OPTION. The lease contains an option to purchase the leased property at a bargain price.

A3 – ECONOMIC LIFE. The lease term is equal to or greater than 75% of the estimated economic life of the leased property.

A4 – RECOVERY OF INVESTMENT. The present value of the minimum lease payments equals or exceeds 90% of the fair value of the leased property less any investment tax credit retained by the lessor.

FOR LESSOR ONLY: (must meet both)

B1 - COLLECTIBILITY. Collectibility of the minimum lease payments is reasonably predictable.

B2 - NO UNCERTAINTIES. No important uncertainties surround the amount of unreimburseable costs yet to be incurred by the lessor under the lease.

We will work through a variety of examples. In some cases, we will classify the lease and do journal entries. Those examples are contained in this file. In other cases, we will just classify the lease. These classification examples are generally in the PowerPoint lecture slides and not included in this file. We will not necessarily work examples in numeric order but you can find all the solutions on the course web page.

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Introductory Examples – Lease 1A – Operating Lease

To illustrate accounting for lease transactions, we will use a simple case involving three parties:1. Farview Farms needs a small tractor (Model SX). These tractors have an expected useful life of six years with

no salvage value.2. Idaho First Bank & Trust which is currently charging 12% interest on long-term equipment loans.3. Troy Tractors, Inc., which manufactures the Model SX tractor at a cost of $40,000 and then sells them for

$50,000. It also has a few units for trial use which rent for $500 per week.

If Farview Farms rents a tractor for one week from Troy Tractors, the journal entries would follow the usual pattern for a rental:

Farview Farms Debit Credit

Rent expense

Cash

Troy Tractors Debit Credit

Cash

Rental Income

Depreciation expense

Accumulated depreciation

Comments --An operating lease is, in essence, a rental agreement. The lessor retains the risks and benefits of ownership.

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Installment Purchase Arrangement

SITUATION 1B: PURCHASE WITH LONG-TERM BANK FINANCING

Assume Farview Farms decides to purchase the tractor and borrows the full purchase price of $50,000 from Idaho First Bank & Trust at 12% interest on the unpaid balance of the loan. The borrower agrees to make annual payments of $10,000 for five years. Again, the journal entries follow the normal pattern:


Cash

Note Payable to Bank

Equipment

Cash (to Troy Tractors)

At year end:



Interest expense

Interest payable


Cash

Sales

Cost of goods sold

Inventory

Idaho First Bank & Trust Debit Credit

Note Receivable

Cash

At year end

Interest receivable

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Interest revenue

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SITUATION 1C - DIRECT FINANCING LEASEFor various reasons either (or both) Farview Farms and Idaho First Bank & Trust might prefer a lease

arrangement to an outright purchase/long-term loan. Assume that the bank agrees to purchase the tractor from Troy Tractors for $50,000. It then computes the payment on the lease required for it to earn its desired rate of 12% interest if the lease is written for five years with the first payment coming at the end of the first year (after harvest). [PVA = 50,000, n = 5, i = 12%, pymt = 13,871]. The lease agreement specifies that Farview Farms gets to keep the tractor at the end of the lease. ----------------------------------------------------------------- DATE LEASE INTEREST REDUCTION LEASE PAYMENT LEASE RECBL/LIAB 50,001.85 RECBL/LIAB BALANCE ----------------------------------------------------------------- 0 01/01/12 0.00 0.00 0.00 50,000.00 1 12/31/12 13,871.00 6,000.00 7,871.00 42,129.00 2 12/31/13 13,871.00 5,055.48 8,815.52 33,313.48 3 12/31/14 13,871.00 3,997.62 9,873.38 23,440.10 4 12/31/15 13,871.00 2,812.81 11,058.19 12,381.91 5 12/31/16 13,871.00 1,489.09 12,381.91 0.00


Farm Equipment

Lease obligation

At year end:



Interest expense

Lease obligation

Cash


Cash

Sales

Cost of goods sold

Inventory


Equipment held for lease

Cash

Net investment in lease

Equipment held for lease

Cash

Interest revenue


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SITUATION 1D - SALES TYPE LEASEFarview Farms may also be able to arrange a similar or better lease arrangement with the

manufacturer of the Model SX tractor. We will assume that the lease terms are the same for purposes of illustration.

NOTE: The first step in doing lease accounting involves finding the present value of the cash flows that are transferred between the lessee and lessor. This "present value of the minimum lease payments" [PVMLP] will give you the SALES amount for the lessor (assuming a sales-type lease) and the ASSET amount for the lessee.

COMPUTE PVMLP: [n = 5, i = 12%, pymt = 13,871]


Farm Equipment

Lease obligation

At year end:



Interest expense

Lease obligation

Cash



Sales

Cost of goods sold

Inventory

At year end:

Cash

Interest revenue


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Introductory Example – Lease 1E - BARGAIN PURCHASE OPTION

1. Inception date: 1/1/12 7. First payment due on 12/31/122. Lessor: Troy Tractors Inc.

8. Lessee: Farview Farms

3. Fair value of tractor at 1/1/12: $50,0009. Incremental borrowing rate (lessee): 12%

4. Cost to manufacture tractor: $40,00010. Implicit interest rate (known to lessee): 12%

5. Estimated fair value at end of lease is $10,00011. Option to buy at end of lease term for $5,000

6. Fixed non-cancelable lease term: 5 years.12. Estimated useful life of tractor: 8 years

To earn its desired return of 12%, at what amount should Troy Tractors set the annual payments?

Construct an amortization table and prepare the journal entries for both parties:Date Payment Interest "Principal" Balance

0

1

2

3

4

5


At inception:Farm Equipment

Lease liabilityAt year end:Interest expenseLease liability

Cash

Depreciation expenseAccumulated depreciation


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At inception:Lease Receivable

SalesCost of Goods Sold

InventoryAt year end:Cash

Lease ReceivableInterest revenue

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Introductory Example – Lease 1F - ANNUITY DUEAssume that Troy Tractors and Farview Farms sign a lease agreement on a SX Tractor with

the following terms:

1. Inception date: 1/1/12 6. Lessee: Farview Farms2. Lessor: Troy Tractors Inc. 7. Fixed non-cancelable lease term: 6 years.

3. Fair value of tractor at 1/1/12: $50,000 8. Option to buy at end of lease term for $2,000

4. Estimated fair value at end of lease is $10,000 9. Estimated useful life of tractor: 8 years

5. First payment due on 1/1/12 10. Desired rate of return for lessor and incremental borrowing rate for lessee: 12%

With these lease terms, how much should Troy Tractors ask for the annual payments?

Construct an amortization table and prepare the journal entries for both parties:Date Payment Interest "Principal" Balance

0

1

2

3

4

5

6


At inception:Farm Equipment

Lease liabilityCash

At year end:Interest expense

Lease liability

Depreciation expenseAccumulated depreciation

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Troy Tractors Debit CreditAt inception:CashLease Receivable

SalesCost of Goods Sold

InventoryAt year end:Lease Receivable

Interest revenue

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International Financial Reporting Standards (IFRS)Leases (IAS17)

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership.Classification depends on the substance of the transaction rather than the form of the contract. Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are:

a) the lease transfers ownership of the asset to the lessee by the end of the lease term.b) the lessee has the option to purchase the asset at a price that is expected to be sufficiently

lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised.

c) the lease term is for the major part of the economic life of the asset even if title is not transferred.

d) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset.

e) the leased assets are of such a specialized nature that only the lessee can use them without major modifications.

Other indications that it is a finance lease include: a) if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are

borne by the lessee.b) gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for

example, in the form of a rent rebate equalling most of the sales proceeds at the end of the lease)

c) the lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.

The examples and indicators (above) are not always conclusive. If it is clear from other features that the lease does not transfer substantially all risks and rewards incidental to ownership, the lease is classified as an operating lease.

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http://eifrs.iasb.org/eifrs/stdcontent/A_Guide_through_IFRSs__2007/IAS17c_2005-08-18_en-3.html#SL145281

http://eifrs.iasb.org/eifrs/stdcontent/A_Guide_through_IFRSs__2007/IAS17c_2005-08-18_en-3.html#SL145279


Lease Example #3

On January 1, 2012, Andrewson Consulting and Sun Computers sign a lease with the following terms:

1. Term: 3 years 2. Payments of $47,523 3. Implicit interest rate (known to lessee) 10% 4. Lessor retains ownership of asset at end of lease 5. Fair value of asset $130,000 6. Cost of asset $100,000 7. Incremental borrowing rate: 15% 8. First payment due 1/1/12 9. Estimated useful life of asset: 4 years 10. No collection or cost uncertainties for lessor

FIND PRESENT VALUE OF MINIMUM LEASE PAYMENTS:

Type of lease forLessor Lessee

US GAAP

IFRS

Date Lease Payment Interest Principal Balance1/01/12 130,000

0 1/01/12 47,523 0 47,523 82,477 1 1/01/13 47,523 8,248 39,275 43,202 2 1/01/14 47,523 4,320 43,203 0

142,569 12,568 130,001 0

Lessee Debit Credit Lessor Debit Credit

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Lease Example #5

On March 30, 2012, Genessee Engineering, Inc. and Idaho First Bank sign a lease with the following terms:

1. Inception of lease: March 30, 2012 8. Payments of ______________ 2. Term: 3 years 9. Est. fair value of asset at end of lease $5,000 3. Implicit interest rate (not known to lessee) 10% 10. Cost of asset $100,000 4. Fair value of asset $100,000 11. First payment due 3/30/12 5. Incremental borrowing rate: 12% 12. No collection or cost uncertainties for lessor 6. Estimated useful life of asset: 5 years 13. Both parties have calendar-year fiscal years. 7. Purchase option at end of lease: $2,500

FIND THE PAYMENT WHICH IDAHO FIRST BANK SHOULD ASK TO EARN THE IMPLICIT INTEREST RATE LISTED ABOVE:

PVMLP for Lessee:

PVMLP for Lessor:


US GAAP

IFRSExplain:

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Example 5 – Lessee Accounting (Capital Lease with BPO)

On March 30, 2012, Genessee Engineering, Inc. and Idaho First Bank sign a lease with the following terms:

1. Term: 3 years 2. Payments of 35,869 3. Implicit interest rate (not known to lessee) 10% 4. Est. fair value of asset at end of lease $5,000 5. Fair value of asset $100,000 6. Cost of asset $100,000 7. Incremental borrowing rate: 12% 8. First payment due 3/30/12 9. Estimated useful life of asset: 5 years 10. No collection or cost uncertainties for lessor11. Purchase option at end of lease: $2,500 12. Both parties have calendar-year fiscal years.

Date Lease Payment

Interest Principal Balance

03/30/12 98,270 0 03/30/12 35,869 0 35,869 62,401 1 03/30/13 35,869 7,488 28,381 34,020 2 03/30/14 35,869 4,082 31,787 2,234 3 03/30/15 2,500 266 2,234 0

Genessee Engineering Inc. Debit Credit

3/30/12 Leased Asset

Lease obligation

Cash 35,869

12/31/12 Depreciation expense


Interest expense

Interest payable

3/30/13 Interest expense

Interest payable

Lease obligation

Cash 35,869



Interest expense

Interest payable

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Lease #5 Genessee Engineering Inc. Debit Credit


Interest payable

Lease obligation

Cash 35,869



Interest expense

Interest payable


Interest payable

Lease obligation

Cash 2,500






Accumulated depreciationAcc'd Depreciation Lease Liability

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Example 5 – Lessor Accounting (Direct Financing Lease with BPO)

Date Lease Payment


03/30/12 100,000 0 03/30/12 35,869 0 35,869 64,131 1 03/30/13 35,869 6,413 29,456 34,675 2 03/30/14 35,869 3,468 32,401 2,274 3 03/30/15 2,500 226 2,274 0

110,107 10,107 100,000


03/30/12 Cash 35,869


Equipment purchased for lease

12/31/12 Interest receivable

Interest revenue

3/30/13 Cash 35,869

Interest receivable

Interest revenue



Interest revenue

3/30/14 Cash 35,869

Interest receivable

Interest revenue



Interest revenue

12/31/15 Cash 2,500

Interest receivable

Interest revenue


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Example 5 – FASB Style J E s - Lessor Date Lease

PaymentInterest Principal Balance

03/30/12 100,000 0 03/30/12 35,869 0 35,869 64,131 1 03/30/13 35,869 6,413 29,456 34,675 2 03/30/14 35,869 3,468 32,401 2,274 3 03/30/15 2,500 226 2,274 0

110,107 10,107 100,000


3/30/12 Lease Payments Receivable (or Gross investment in lease)

110,107

Equipment purchased for lease

Unearned interest revenue

Cash 35,869

Lease Payments Receivable (or Gross investment in lease)

12/31/12 Unearned interest revenue

Interest revenue

3/30/13 Cash 35,869

Unearned interest revenue

Interest revenue

Lease Payments Receivable (or Gross investment in lease)

12/31/13

3/30/14

12/31/14

3/30/15

Continue as above for the following dates

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COMMENTS ON APPLYING CRITERIA (US GAAP)

LEASE TERM: Always ends at a bargain purchase option (including ordinary renewal periods up to BPO).

Includes renewal periodsunder bargain renewal optionsif there is a penalty large enough to assure renewalif renewal or extensions is at option of lessorduring which lessee guarantees lessor's debt related to property during which there is a loan from lessee to the lessor

Lease must be cancelable only under remote contingency, with permission of lessor, or if lessee enters into new lease with lessor, or with there is a large penalty for cancellation that makes cancellation unlikely.

MINIMUM LEASE PAYMENTS:Excludes contingent rentalsExcludes executory costs paid by lessor:

maintenanceproperty taxesinsurance

Excludes all rental payments past date of bargain purchase optionIncludes all rental payments up to date of bargain purchase optionIncludes bargain purchase optionIncludes renewal penalties not large enough to assure continuation of leaseIncludes rents during renewal periods covered by:

bargain renewal optionsnonrenewal penalty large enough to assure continuation of lease

Includes guaranteed residual value of property -If guaranteed by lessee If guaranteed by third party, only lessor includes as part of minimum lease payments

Note:Never record the leased asset at more than its fair value!The asset should be recorded at the lower of the PVMLP or the FMV.

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Lease Example #7

On January 1, 2012, Harris Manufacturing (lessee) and Accel Engines sign a lease with the following terms:

1. Term: 4 years 2. Payments of $84,079 3. Implicit interest rate (known to lessee) 10% 4. Lessor retains ownership of asset at end of lease 5. Fair value of asset $300,000 6. Cost of asset $250,000 7. Incremental borrowing rate: 12% 8. First payment due 1/1/12 9. Estimated useful life of asset: 6 years 10. No collection or cost uncertainties for lessor10. Est. fair value of asset at end of lease: $10,000 11. The residual value is NOT guaranteed by lessee

PVMLP for Lessee: PVMLP for Lessor:


US GAAP

IFRSExplain:

Lessee Lessor

DateLease


Lease Payment


01/01/12 293,171 300,000 0 01/01/12 84,079 0 84,079 209,092 84,079 0 84,079 215,921 1 01/01/13 84,079 20,909 63,170 145,922 84,079 21,593 62,486 153,435 2 01/01/14 84,079 14,592 69,487 76,435 84,079 15,344 68,735 84,700 3 01/01/15 84,079 7,644 76,435 0 84,079 8,470 75,609 9,091

10,000 909 9,091 0

Lessee – Harris Manufacturing Debit Credit

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Lease # 7 - Lessor Accounting for Sales-Type Lease when there is an Unguaranteed Residual Value

DateLease


01/01/12 300,000 0 01/01/12 84,079 0 84,079 215,921 1 01/01/13 84,079 21,593 62,486 153,435 2 01/01/14 84,079 15,344 68,735 84,700 3 01/01/15 84,079 8,470 75,609 9,091 4 01/01/16 10,000 909 9,091 0

Totals 346,316 46,316 300,000 0

Lessor – Accel Engines Debit Credit

1/1/12

Net Investment in Lease (PVMLP + PV of Unguaranteed RV)

Cost of Sales (Cost of asset - PV of Unguaranteed RV)

Inventory/Equipment (Cost of asset)

Sales Revenue (PVMLP)

Cash

Net Investment in Lease

12/31/12

Interest receivable

Interest Revenue

1/1/13

Cash

Interest ReceivableNet Investment in Lease

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UNGUARANTEED RESIDUAL VALUES - JOURNAL ENTRY FORMAT FOR LESSOR (As illustrated by FASB -- use of Gross rather than Net investment in lease is optional. Net investment in lease = GIIL - unearned income)

DIRECT FINANCING LEASE:Gross Investment in Lease (MLP + Unguaranteed Residual Value + initial direct costs)

Equipment (Cost or carrying amount)

Unearned Income (GIIL - cost or carrying amount)

SALES TYPE LEASE:Gross Investment in Lease (MLP + Unguaranteed Residual Value)

Cost of Sales (Cost of asset - PV of Unguaranteed Residual Value)

Inventory/Equipment (Cost of asset)

Unearned Income (GIIL -PVMLP)

Sales Revenue (PVMLP)

Where MLP = minimum lease payments exclusive of executory costs paid by the lessor

GIIL = gross investment in lease

PVMLP = present value of MLP

The “easier” method:

DIRECT FINANCING LEASE:Net Investment in Lease (PVMLP + PV of Unguaranteed Residual Value + initial direct costs)

Equipment (Cost or carrying amount)

SALES TYPE LEASE:Net Investment in Lease (PVMLP + PV of Unguaranteed Residual Value)

Cost of Sales (Cost of asset - PV of Unguaranteed Residual Value)

Inventory/Equipment (Cost of asset)Sales Revenue (PVMLP)

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Lease Example #9

On January 1, 2012, Hamford Ritz Inc. and Cisco Leasing sign a lease with the following terms:

1. Term: 4 years 2. Payments of $81,140 3. Implicit interest rate (not known to lessee) 10% 4. Lessor retains ownership of asset at end of lease 5. Fair value of asset $300,000 6. Cost of asset $300,000 7. Incremental borrowing rate: 12% 8. First payment due 1/1/12 9. Estimated useful life of asset: 5 years 10. No collection or cost uncertainties for lessor11. Est. fair value of asset at end of lease: $25,000 12. The residual value is NOT guaranteed by lessee13. The lessor incurred initial direct costs of $1,848

related to the lease



US GAAP

IFRSExplain:

LesseeDate Lease Payment Interest Principal Balance

01/01/12 12% 276,026 0 01/01/12 81,140 0 81,140 194,886 1 01/01/13 81,140 23,386 57,754 137,131 2 01/01/14 81,140 16,456 64,685 72,447 3 01/01/15 81,140 8,694 72,447 0

Hamford Ritz Inc. (Lessee) Debit Credit

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Lease Example #9 – Lessor Accounting for Initial Direct Costs with a Direct Financing Lease

How to arrive at adjusted interest rate:

Date Lease Payment Interest Principal Balance01/01/12 9.56% 301,848

0 01/01/12 81,140 0 81,140 220,708 1 01/01/13 81,140 21,100 60,040 160,667 2 01/01/14 81,140 15,360 65,780 94,887 3 01/01/15 81,140 9,072 72,069 22,818 4 01/01/16 25,000 2,182 22,818 0

Cisco Leasing Co. (Lessor) Debit Credit

1/1/12 Initial Direct Costs – Leases 1,848

Cash 1,848

Equipment held for lease 300,000

Cash 300,00

1/1/12 Net investment in lease

Equipment purchased for lease 300,000

Initial direct costs - leases 1,848

Cash 81,140



Interest revenue

1/1/13 Cash 81,140


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Interest revenue

1/1/16 Used Equipment


Loss on Leased Asset

The last “payment” the lessor will receive is the returned equipment. It should be recorded at the lower of fair value or original estimated residual value. In other words, it may be necessary to record a loss. Lessors are supposed to evaluate the residual values at each balance sheet date and recognize any losses in anticipated value.

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Lease Example #10

On May 1, 2012, SlumberJay, Inc. and Omaha Oscillators, Inc. sign a lease with the following terms:

1. Term: 4 years 2. Payments of $82,434 3. Implicit interest rate (NOT known to lessee) 10% 4. Lessor retains ownership of asset at end of lease 5. Fair value of asset $270,000 6. Cost of asset $250,000 7. Incremental borrowing rate: 12% 8. First payment due 5/1/12 9. Estimated useful life of asset: 4 years 10. There are collection uncertainties for lessor10. Est. fair value of asset at end of lease: $0 11. The payments include $5,000 for insurance to be

paid by the lessor12. Initial direct costs incurred by lessor $1,000



US GAAPIFRS

Date Lease Payment Interest Principal Balance05/01/12 270,000

0 05/01/12 77,434 0 77,434 192,566 1 05/01/13 77,434 19,257 58,177 134,389 2 05/01/14 77,434 13,439 63,995 70,394 3 05/01/15 77,434 7,040 70,394 0

Lessor – Omaha Oscillators, Inc. Debit Credit

05/01/12 Initial direct costs – deferredCash

05/01/12 Cash 82,434 Unearned rental incomePrepaid Insurance

12/31/12 Rental costsInitial direct costs - deferred

Insurance expensePrepaid insurance

Unearned rental incomeRental income

Depreciation expenseAccumulated Depreciation

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Lessor – Omaha Oscillators, Inc. Debit Credit

05/01/13 Cash 82,434 Unearned rental incomePrepaid Insurance

12/31/13 Rental costsInitial direct costs - deferred


Unearned rental incomeRental income

Depreciation expenseAccumulated Depreciation

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Lease Example #10 - LesseeDate Lease Payment Interest Principal Balance05/01/12 263,417

0 05/01/12 77,434 0 77,434 185,983 1 05/01/13 77,434 22,318 55,116 130,867 2 05/01/14 77,434 15,704 61,730 69,137 3 05/01/15 77,434 8,296 69,138 0

SlumberJay, Inc. - Lessee debit credit05/01/12 Leased Asset

Prepaid Insurance Lease ObligationCash 82,434

12/31/12 Depreciation ExpenseAccumulated Depreciation


Interest ExpenseInterest Payable

05/01/13 Lease ObligationInterest Payable

Insurance expenseCash 82,434

12/31/13 Depreciation ExpenseAccumulated Depreciation


Interest ExpenseInterest Payable

01/01/14 Lease ObligationInterest Payable

Prepaid Insurance Cash 82,434

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Lease Example #11

On June 1, 2012, Fantasia Funnels, Inc. and Idaho First Bank sign a lease with the following terms:

1. Term: 4 years 2. Payments of $61,924 3. Interest rate used to compute payments = 12% 4. Cost of asset $200,000 5. Fair value of asset $200,000 6. First payment due 6/1/12 7. Incremental borrowing rate: 14%

(Lessee does not know implicit interest rate) 8. The lessee can purchase asset for $10,000 at end

of lease, otherwise, asset is returned to lessor. 9. Estimated useful life of asset: 6 years 10. The payments include $5,000 for maintenance.11. Est. fair value of asset at end of lease: $10,000 12. No collection or cost uncertainties for lessor13. Initial direct costs to arrange lease: $3,000



US GAAPIFRSExplain:

Lessee’s Amortization ScheduleDate Lease Payment Interest Principal Balance

06/01/12 14% 189,081 0 06/01/12 56,924 0 56,924 132,157 1 06/01/13 56,924 18,502 38,422 93,735 2 06/01/14 56,924 13,123 43,801 49,933 3 06/01/15 56,924 6,991 49,933 0

Fantasia Funnels Inc. (Lessee) Debit Credit

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Lease Example #11

DateLease


6/01/12 203,000

0 6/01/12 56,924

1 6/01/13 56,924

2 6/01/14 56,924

3 6/01/15 56,924

4 6/01/16 10,000Note: This problem is similar to Lease #9. It requires you to compute a new interest rate for the lessor so that the initial direct costs are amortized over the life of the lease. Note that the residual value MUST be included because the asset’s value at the end of the lease is important to the lessor since there is no title transfer or bargain purchase option.

Remember that the lessor’s amortization table includes residual values (whether or not they are guaranteed) if the lessor expects the leased asset to be returned at end of lease (in other words, no title transfer and no bargain purchase option).

Idaho First Bank. (Lessor) Debit Credit

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LEASE Example #12

On August 1, 2012, Hells Gate Jet Boats and Washington Leasing Co. sign a lease with the following terms:

1. Term: 4 years with possible renewal (see #11) 2. Payments of $49,523 3. Implicit interest rate (NOT known to lessee) 10% 4. Lessor retains ownership of asset at end of lease 5. Fair value of asset $200,000 6. Cost of asset $200,000 7. Incremental borrowing rate: 14% 8. First payment due 8/1/12 9. Estimated useful life of asset: 6 years 10. No collection or cost uncertainties for lessor11. At the end of the lease, HGJB can renew for one

more year at same annual amount of $49,523. This is certainly no bargain. There is a $15,000 penalty for non-renewal of the lease. However, this amount is probably not large enough to assure that HGJB will renew.

12. The residual value is NOT guaranteed by lessee, asset is expected to be worth $25,000 at end of 4 years, and $15,000 at end of 5 years.

WHAT ARE THE MINIMUM LEASE PAYMENTS? FIND PRESENT VALUE:

LESSOR - Washington Leasing Co.

Date Payment Interest "Principal" Balance

0

1

2

3

4

5

Lessor - Washington Leasing Co. Debit Credit

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Lease Example 12 (continued)

On August 1, 2012, Hells Gate Jet Boats and Washington Leasing Co. sign a lease with the following terms:

1. Term: 4 years with possible renewal (see #11) 2. Payments of $49,523 3. Implicit interest rate (NOT known to lessee) 10% 4. Lessor retains ownership of asset at end of lease 5. Fair value of asset $200,000 6. Cost of asset $200,000 7. Incremental borrowing rate: 14% 8. First payment due 8/1/12 9. Estimated useful life of asset: 6 years 10. No collection or cost uncertainties for lessor11. At the end of the lease, HGJB can renew for one

more year at same annual amount of $49,523. This is certainly no bargain. There is a $15,000 penalty for non-renewal of the lease. However, this amount is probably not large enough to assure that HGJB will renew.

12. The residual value is NOT guaranteed by lessee, asset is expected to be worth $25,000 at end of 4 years, and $15,000 at end of 5 years.

WHAT ARE THE MINIMUM LEASE PAYMENTS? FIND PRESENT VALUE:

LESSEE - Hells Gate Jet Boats


0

1

2

3

4

5

Lessee - Hells Gate Jet Boats Debit Credit

Lease #12 – continued

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What if the lessee decided that the penalty was large enough that they would renew the lease? How would you classify the lease in this situation?

LESSEE - Hells Gate Jet Boats


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Lessee - Hells Gate Jet Boats Debit Credit

Note that the implicit interest rate for the lessor would also have to be re-computed if the lessor also decided that the penalty was going to be large enough. A new table would be required. It would still be direct financing lease since lease term would exceed 75% of economic life.

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LEASE Example #13

On October 1, 2012, Knightco (lessee) and Jack Dear Corp. sign a lease with the following terms:

1. Term: 4 years, with possible renewal (see #11) 2. Payments of $68,565 3. Implicit interest rate (NOT known to lessee) 10% 4. Lessor retains title to the asset at end of lease 5. Fair value of asset $260,000 6. Cost of asset $200,000 7. Incremental borrowing rate: 12% 8. First payment due 10/1/12 9. Estimated useful life of asset: 6 years 10. No collection or cost uncertainties for lessor11. Lease can be renewed for one more year at

$17,000. The actual value is probably $25,000.12. Est. fair value of asset at end of original lease term is

$35,000. It should be worth $15,000 at the end of 5 years.13. There are no guarantees of residual value

LESSOR AMORTIZATION TABLE


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LESSEE AMORTIZATION TABLE


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Lease #13

Lessee – Knightco Inc. Debit Credit

Lessor – Jack Dear Corp. Debit Credit

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In class lease examples with ifrs f08

Economy & Finance

lease term

lease arrangement

operating lease

lease agreement

lease transactions

minimum lease payments

lease transfers ownership

c direct financing lease