CHAPTER 21

Accounting for Leases

LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the environment 3. Explain the accounting for
related to leasing transactions. leases by lessors.
2. Explain the accounting for 4. Discuss the accounting and
leases by lessees. reporting for special features
of lease arrangements.

21-1
 PREVIEW OF CHAPTER 21

Intermediate Accounting
IFRS 3rd Edition
Kieso ● Weygandt ● Warfield
21-2
 Jawaban Post-Review Test: Investment in Equity

1. A 6. C 11. A

2. C 7. C 12. B

3. A 8. A 13. B

4. C 9. D 14. C

5. B 10. A 15. A

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 LEARNING OBJECTIVE 3
Lessor Accounting Explain the accounting for
leases by lessors.

Economics of Leasing
Lessor determines the amount of the rental payment, not
the lessee.
 Determines payment using rate of return (implicit rate).
 Considers credit standing of lessee.
 Length of the lease.
 Status of the residual value (guaranteed versus
unguaranteed).

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 Lessor Accounting

Economics of Leasing
In Examples 1 and 2, CNH determined the implicit rate to be 4
percent, the fair value of the equipment to be €100,000, and the
residual value to be $5,000. CNH then computes the lease
payment as shown.

Fair value of leased equipment €100,000.00

Less: Present value of the residual value
(€5,000 × .82193 (PVF 5,4%)) 4,109.65
Amount to be recovered by lessor through
lease payments € 95,890.35
Five beginning-of-year lease payments to earn a
4% return (€95,890.35 ÷ 4.62990) (PVF-AD 5,4%)) € 20,711.11
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 Classification of Leases by the Lessor

For accounting purposes, the lessor classifies leases as a

 Finance lease or an,
 Operating lease.
For a finance lease, it must be non-cancelable and meet at least
one of five tests in Illustration 21.18.

To meet one of these five tests, the lessor must transfer

control of a substantial portion of the underlying asset to the
lessee or provide ownership of the underlying asset to the lessee.

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 For a finance lease,
• must be non-
cancelable and
• meet at least one
of the five tests.

ILLUSTRATION 21.218
Lease Classification Tests
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 Classification of Leases by the Lessor

Transfer of Ownership Test

 If the lease transfers ownership of the asset to the lessee, it
is a finance lease.

Purchase Option Test

 The lease purchase option allows the lessee to
purchase the property for a price that is significantly
lower than the underlying asset’s expected fair value
at the date the option becomes exercisable (bargain
purchase option).

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 Classification of Leases by the Lessor

Lease Term Test

 When the lease term is a major part of the remaining
economic life of the leased asset, companies should use the
finance method.
 Guideline: If the lease term is 75 percent or greater of the
economic life of the leased asset, the lease meets the lease
term test.

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 Classification of Leases by the Lessor

Present Value Test

 If the present value of the lease payments is
reasonably close to the fair value of the asset, the
lessee should use the finance method.
 Guideline: if the present value of the lease payments
equals or exceeds 90 percent of the fair value of the
asset, then a lessee should use the finance method.

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 Classification of Leases by the Lessor

Lease Payments
Generally include:

1. Fixed payments.

2. Variable payments.

3. Residual values (guaranteed or not).

4. Payments the lessee is reasonably certain to exercise.

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 Classification of Leases by the Lessor

Discount Rate
 Implicit rate should be used to determine the present
value of the payments.
 Defined as the discount rate that, at commencement
of the lease, causes the present value of the lease
payments and unguaranteed residual value to be
equal to the fair value of the leased asset.

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 Alternative Use Test

If at the end of the lease term the lessor does not have an
alternative use for the asset, the lessee classifies the lease
as a finance lease.

The assumption is that the lessee uses all the benefits from
the leased asset and therefore the lessee has essentially
purchased the asset.

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 Classification of Leases by the Lessor

Accounting Measurement and Presentation

For a sales-type lease,
 the lessor accounts for the lease in a manner similar to the
sale of an asset.
 the lessor generally records a Lease Receivable and
eliminates the leased asset.
 the lease receivable is computed as shown.

21-14 ILLUSTRATION 21.19 LO 3

 Finance (Sales-Type) Lease Example

Illustration: CNH Financial Services Corp. (a subsidiary of CNH) and Ivanhoe

Construction sign a lease agreement dated January 1, 2019, that calls for CNH
to lease a backhoe to Ivanhoe beginning January 1, 2019. The terms and
provisions of the lease agreement, and other pertinent data, are as follows.
• The term of the lease is five years. The lease agreement is non-cancelable,
requiring equal rental payments at the beginning of each year (annuity-due
basis).
• The backhoe has a fair value at the commencement of the lease of €100,000,
an estimated economic life of five years, and a guaranteed residual value of
€5,000 (which is less than the expected residual value of the backhoe at the
end of the lease). Further, assume the underlying asset (the backhoe) has an
€85,000 cost to the dealer, CNH.
• The lease contains no renewal options. The backhoe reverts to CNH at the
termination of the lease.
• Collectibility of payments by CNH is probable.
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 Finance (Sales-Type) Lease Example

Illustration: CNH Financial Services Corp. (a subsidiary of CNH) and Ivanhoe

Construction sign a lease agreement dated January 1, 2019, that calls for CNH
to lease a backhoe to Ivanhoe beginning January 1, 2019. The terms and
provisions of the lease agreement, and other pertinent data, are as follows.
• CNH sets the annual rental payment to earn a rate of return of 4 percent per
year (implicit rate) on its investment as shown in Illustration 21.20.

ILLUSTRATION 21.20
Lease Payment Calculation

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 Finance (Sales-Type) Lease Example

The lease meets the criteria for classification as a finance

(sales-type) lease because
1. Lease term is equal to the economic life of the asset.

2. Present value of the lease payments is €100,000*, which is

100% (greater than or equal to 90%) of the fair value of the
backhoe.

That is, Ivanhoe will consume substantially the entire

underlying asset over the lease term.

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 Finance (Sales-Type) Lease Example

CNH computes the lease receivable as shown. ILLUSTRATION 21.22

Lease Receivable Calculation

The journal entries on January 1, 2019, are as follows.

Lease Receivable 100,000
Sales Revenue 100,000
Cost of Goods Sold 85,000
Inventory 85,000
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 Finance (Sales-Type) Lease Example

ILLUSTRATION 21.23
Lease Amortization Schedule

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 ILLUSTRATION 21.23

On January 1, 2019, CNH records receipt of the first year’s lease

payment as follows.
Ivanhoe records accrued interest on December 31, 2019
Cash 20,711.11
Lease Receivable 20,711.11
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 ILLUSTRATION 21.23

On December 31, 2019, CNH recognizes the interest revenue on the

lease receivable during the first year through the following entry.

Lease Receivable 3,171.56

Interest Revenue 3,171.56
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 Finance (Sales-Type) Lease Example

The balance sheet as it relates to lease transactions at December

31, 2019.

ILLUSTRATION 21.24
Balance Sheet
Presentation

On its December 31, 2019, income statement, CNH reports,

ILLUSTRATION 21.25
Income Statement
presentation

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 ILLUSTRATION 21.23

The following entries record receipt of the second year’s lease

payment and recognition of the interest revenue in 2020.

Jan. 1 Cash 20,711.11

Lease Receivable 20,711.11
Ivanhoe records accrued interest on December 31, 2019
Dec. 31 Lease Receivable 2,469.97
Interest Revenue 2,469.97
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 ILLUSTRATION 21.23

CNH makes the following entry on December 31, 2023.

Ivanhoe records accrued

Lease Receivable interest on December 31, 2019
192.19
Lease Revenue 192.19

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 ILLUSTRATION 21.23

At January 1, 2024, when the leased asset is returned to CNH.

Inventory 5,000
Lease Receivable 5,000

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 Classification of Leases by the Lessor

Accounting Measurement and Presentation

For a sales-type lease,
 the lessor accounts for the lease in a manner similar to the
sale of an asset.
 the lessor generally records a Lease Receivable and
eliminates the leased asset.
 the lease receivable is computed as shown.

21-26 ILLUSTRATION 21.19 LO 3

 Lessor—Guaranteed Residual Value

In the Ivanhoe/CNH example, Ivanhoe guaranteed a residual value of

€5,000. In computing the amount to be recovered from the rental
payments, the present value of the residual value was subtracted from
the fair value of the backhoe to arrive at the amount to be recovered
by the lessor. Illustration 21.26 shows this computation.
ILLUSTRATION 21.26

Computation is same whether residual value is guaranteed or

unguaranteed.
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 Lessor—Unguaranteed Residual Value

In this case, there is less certainty that the unguaranteed residual

portion of the asset has been “sold.”
 The lessor recognizes sales revenue and cost of goods sold
only for the portion of the asset for which recovery is assured.
 Both sales revenue and cost of goods sold are reduced by the
present value of the unguaranteed residual value.
 The gross profit computed will still be the same amount as
when a guaranteed residual value exists.

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 Lessor—Unguaranteed Residual Value

To compare a sales-type lease with a guaranteed residual value

to one with an unguaranteed residual value, assume the same
facts as in the CNH/Ivanhoe lease situation. That is:

1. The sales price is €100,000.

2. The expected residual value is €5,000 (the present value of

which is €4,109.65).

3. The leased equipment has an €85,000 cost to the dealer,

CNH.

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 Lessor—Unguaranteed Residual Value

Computation of Lease Amounts by CNH

Financial—Sales-Type Lease

ILLUSTRATION 21.27
Computation of Lease Amounts by CNH—Sales-Type Lease

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 ILLUSTRATION 21.28
21-31 Entries for Guaranteed and Unguaranteed Residual Values — Sales-Type Lease LO 3
 Lessor Accounting for Operating Leases

The following data relates to a lease agreement between Hathaway Disposal

Ltd. and M&S for the use of one of Hathaway’s standard cardboard
compactors. Information relevant to the lease is as follows.
• The term of the lease is three years. The lease agreement is non-
cancelable, requiring three annual rental payments of £17,620.08, with the
first payment on January 1, 2019 (annuity-due basis).
• The compactor has a cost and fair value at commencement of the lease of
£60,000, an estimated economic life of five years, and a residual value at
the end of the lease of £12,000 (unguaranteed).
• The lease contains no renewal options. The compactor reverts to
Hathaway at the termination of the lease.
• The implicit rate of the lessor is known by M&S. Traylor’s incremental
borrowing rate is 6 percent. Hathaway sets the annual rental rate to earn a
rate of return of 6 percent per year (implicit rate) on its investment.
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 Lessor Accounting for Operating Leases

Hathaway classifies the lease as an operating lease because none of

the finance lease tests are met.

ILLUSTRATION 21.30
Lease Classification Tests
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 Lessor Accounting for Operating Leases

Under the operating method, Hathawary (the lessor)

 continues to recognize the asset on its statement of
financial position and recognizes lease revenue (generally
on a straight-line basis) in each period.
 continues to depreciate the leased asset.

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 Lessor Accounting for Operating Leases

To illustrate the operating method for the Hathaway/M&S lease,

Hathaway records the lease payment on a straight-line basis on
January 1, 2019, 2020, and 2021, as follows.

Cash 17,620.08
Unearned Lease Revenue 17,620.08

On December 31, 2019, 2020, and 2021, Hathaway records the

recognition of the revenue each period as follows.

Unearned Lease Revenue 17,620.08

Lease Revenue 17,620.08

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 Lessor Accounting for Operating Leases

Hathaway also records depreciation expense on the leased

equipment (assuming double-declining-balance, given a cost basis
of £60,000, and a five-year economic life), as follows.

Depreciation Expense (£60,000 × 40%) 24,000.00

Accumulated Depreciation—Equipment 24,000.00

Hathaway records other costs related to the lease arrangement,

such as insurance, maintenance, and taxes in the period incurred.

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 Special Lease Accounting Problems

Presentation, Disclosure, and Analysis

Presentation
Summary of how the lessee reports the information related to
finance and operating leases in the financial statements.

ILLUSTRATION 21.35
Presentation in Financial Statements—Lessee

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 Presentation, Disclosure, and Analysis

Presentation
Summary of how the lessor reports the information related to
sales-type and operating leases in the financial statements.

ILLUSTRATION 21.36
Presentation in Financial Statements—Lessor

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 Presentation, Disclosure, and Analysis

Disclosure
Lessees and lessors must also provide additional qualitative and
quantitative disclosures to help financial statement users assess
the amount, timing, and uncertainty of future cash flows. Qualitative
disclosures to be provided by both lessees and lessors are
summarized as shown.

ILLUSTRATION 21.37
Qualitative Lease Disclosures

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 Presentation, Disclosure, and Analysis

Disclosure
This illustration presents the type of quantitative information that
should be disclosed for the lessee.

ILLUSTRATION 21.38
Lessee Quantitative Disclosures

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 Presentation, Disclosure, and Analysis

Disclosure
This illustration presents the type of quantitative information that
should be disclosed for the lessor.

ILLUSTRATION 21.40
Lessor Quantitative Disclosures

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 Presentation, Disclosure, and Analysis

Analysis
With the increase in the assets and liabilities, a number of financial
metrics used to measure the profitability and solvency of
companies will change.
• Return on assets will decrease.
• Earnings before interest, taxes, and depreciation and
amortization (EBIDTA), which likely will require some
adjustments as companies depreciate right-of-use assets and
record interest expense.
• Debt to equity ratio will increase, and the interest coverage ratio
will decrease.
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 APPENDIX 21A Sale-Leasebacks

LEARNING OBJECTIVE 5
Describe the lessee’s accounting for sale-leaseback transactions.

A company (the seller-lessee) transfers an asset to another

company (the buyer-lessor) and then leases that asset back from
the buyer-lessor.
ILLUSTRATION 21A.1
Sale-Leaseback

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 APPENDIX 21A Sale-Leasebacks

Why do companies like Darden Restaurants engage in sale-

leaseback transactions?
1. Darden can use the cash that otherwise would be tied up in
property to expand its operations. At the same time, it continues
to use the property through the lease term.

2. Darden can structure the lease arrangement so issues such

as repurchase provisions, refinancing issues, and conventional
financing costs are minimized.

3. Darden may receive a tax advantage in that entire rental

payments are tax-deductible, whereas under a conventional
financing, only interest and depreciation can be deducted.

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 APPENDIX 21A Sale-Leasebacks

The advantages to Golden Gate Capital (buyer-lessor):

 It generally can earn a higher rate of return under a sale-
leaseback than under traditional financing.
 During the lease term, Golden Gate is protected from a
downturn in the real estate market and may have an inflation
hedge, provided the property appreciates in value.

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 APPENDIX 21A Sale-Leasebacks

Accounting Issues In Sale-Leaseback

Transactions
The accounting issue is whether the transaction is a sale or
a financing.
 If control has passed from seller to buyer, then a sale has
occurred.
 If control has not passed from seller to buyer, the
transaction is recorded as a financing (often referred to
as a failed sale).

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 APPENDIX 21A Sale-Leasebacks

Sale Transaction
In a sale, gain or loss recognition is appropriate. Darden
then records the transaction as follows.
1. Increases cash and reduces the carrying value of the
asset to zero (referred to as derecognizing the asset).

2. Recognizes a gain or loss as appropriate.

3. Accounts for the leaseback in accordance with lease

accounting guidance used in this chapter.

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 APPENDIX 21A Sale-Leasebacks

Sale Transaction
For example, assume that Stora Enso (FIN) sells one of its
buildings having a carrying value of €580,000 (building
€800,000 less accumulated depreciation €220,000) to
Deutsche Bank (DEU) for €623,110. It then leases the
building back from Deutsche Bank for €50,000 a year, for eight
of the building’s 15 years of remaining economic life. Assume
that the present value of these lease payments is equal to
€310,000, such that the lease is classified as an operating
lease by Deutsche Bank.

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 APPENDIX 21A Sale-Leasebacks

Sale Transaction
Stora Enso makes the following entries to record the sale-
leaseback.

Cash 623,110
Accumulated Depreciation—Buildings 220,000
Buildings 800,000
Gain on Disposal of Plant Assets 43,110
(€623,110 − €580,000)

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 APPENDIX 21A Sale-Leasebacks

Sale Transaction
In addition, Stora Enso makes an entry to record the operating
lease from Deutsche Bank as follows.

Right-of-Use Asset 310,000

Lease Liability 310,000

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 APPENDIX 21A Sale-Leasebacks

Financing Transaction (Failed Sale)

Stora Enso does not record a sale in the above transaction if the
lease from Deutsche Bank is classified as a finance lease. In a
financing (failed sale), Scott:
 Does not reduce the carrying value of the building.
 Depreciate the building as if it was the legal owner.
 Recognizes the sale proceeds from Deutsche Bank as a
financial liability.

The entry to record the financing is as follows.

Cash 623,110
Notes Payable 623,110
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 APPENDIX 21A Sale-Leasebacks

Sale-Leaseback Example
Japan Airlines (JAL) (JPN) on January 1, 2019, sells a used Boeing 757 having a
carrying amount on its books of $30,000,000 to CitiCapital for $33,000,000. JAL
immediately leases the aircraft back under the following conditions:
• The term of the lease is 7 (seven) years. The lease agreement is non-
cancelable, requiring equal rental payments of $4,881,448 at the end of
each year (ordinary annuity basis), beginning December 31, 2019.
• The lease contains no renewal or purchase options. The plane reverts to
CitiCapital at the termination of the lease.
• The aircraft has a fair value of $33,000,000 on January 1, 2019, and an
estimated remaining economic life of 10 (ten) years. The residual value
(unguaranteed) at the end of the lease is $13,000,000.
• The annual payments assure the lessor an 8 percent return (which is the
same as JAL’s incremental borrowing rate).
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 Sale-Leaseback Example
Applying the classification tests, the lease-back of the airplane is
classified as an operating lease because none of the sales-type
lease criteria are met, as indicated in Illustration 21A.3.

ILLUSTRATION 21A.3
Lease Classification Tests
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 Sale-Leaseback Example
This arrangement is accounted for as a sale because the
leaseback does not transfer control of the asset back to JAL; only
the right-of-use for seven years is granted through the lease.

Partial Lease Amortization Schedule

ILLUSTRATION 21A.4
Comparative Entries for Sale-Leaseback for Lessee and Lessor

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ILLUSTRATION 21A.4
Comparative Entries for Sale-Leaseback for Lessee and Lessor

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 APPENDIX 21B DIRECT FINANCING LEASE (LESSOR)

LEARNING OBJECTIVE 6
Apply lessee and lessor accounting to finance and operating leases.

Lease Terms: Scenario 1

Parker Shipping Ltd. (lessee) leases a standard hydraulic lift from
Stoughton Trailers AG (the lessor). The lease, signed on January 1, 2019,
specifies that Stoughton grants right-of-use of the lift to Parker.

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 Lease Terms: Scenario 1

The lease terms are as follows:

• Lease is non-cancelable, term of four years, equal rental payments
of €11,182.24 at the beginning of each year (annuity-due).
• Lift has a fair value of €40,000, economic life of four years, and no
residual value.
• Cost of lift on Stoughton’s books is €30,000.
• No renewal options. Lift reverts to Stoughton. Implicit rate of lessor
is 8 percent and is known by Parker. ILLUSTRATION 21B.1
Lease Payment Calculation

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 Lease Terms: Scenario 1

Stoughton (lessor) evaluates the lease classification tests as

indicated.

ILLUSTRATION 21B.2
Lease Classification Tests
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 Lease Terms: Scenario 1

Lessee/Lessor Accounting

*Rounded by €0.06.
ILLUSTRATION 21B.3
Lease Liability Amortization Schedule

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 Scenario 1

ILLUSTRATION 21B.4
Lessee/Lessor Entries for Finance/Sales-Type Lease
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 Scenario 1

ILLUSTRATION 21B.4
Lessee/Lessor Entries for Finance/Sales-Type Lease

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 Scenario 1

ILLUSTRATION 21B.4
Lessee/Lessor Entries for Finance/Sales-Type Lease

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 Lease Terms: Scenario 2

The lease terms are as follows:

• Lease is non-cancelable, term of four years, equal rental payments
of €9,538.39 at the beginning of each year (annuity-due).
• Lift has a fair value of €40,000, economic life of six years, and
residual value of €80,000 (unguaranteed).
• Cost of lift on Stoughton’s books is €30,000.
• No renewal options. Lift reverts to Stoughton. Implicit rate of lessor
is 8 percent and is known by Parker. ILLUSTRATION 21B.5
Lease Payment Calculation

21-68
 Lease Terms: Scenario 2

Stoughton (lessor) evaluates the lease classification tests as

indicated.

ILLUSTRATION 21B.6
Lease Classification Tests
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 Lease Terms: Scenario 2

Lessee Accounting
Parker makes the following entry to record this lease and the first
payment.
January 1, 2019

Right-of-Use Asset 34,119.76

Lease Liability 34,119.76

Lease Liability 9,538.39

Cash 9,538.39

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 Lease Terms: Scenario 2

Lessee Accounting

*Rounded by €0.02.
ILLUSTRATION 21B.7
Lease Amortization Schedule—Lessee

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 Scenario 2

ILLUSTRATION 21B.8
Lessee Entries for Finance Lease

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 Scenario 2

ILLUSTRATION 21B.8
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Lessee Entries for Finance Lease
LO 6
 Scenario 2

ILLUSTRATION 21B.8
Lessee Entries for Finance Lease

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 Scenario 2

ILLUSTRATION 21B.8
Lessee Entries for Finance Lease

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 Scenario 2

Lessor Accounting—Operating Lease

Stoughton classifies the lease as an operating lease because none
of the sales-type lease criteria are met.

ILLUSTRATION 21B.9
Lessor Entries for Operating Lease
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 PR

E 21 – 12
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 Copyright

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