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Intermediate Accounting, Tenth Canadian Edition

CHAPTER 20
LEASES
ASSIGNMENT CLASSIFICATION TABLE
Topics

Brief
Exercises Exercises Problems

*1. Rationale for leasing.

Writing
Assignments
2, 3, 4

*2. Lessees: classification 1, 2, 3, 4,


of leases; accounting
5, 6, 7, 8,
by lessees.
9, 11

1, 2, 3, 4,
5, 6, 7, 8,
9, 10, 11,
12, 13, 14,
15, 16, 17,
18, 19, 21

1, 2, 3, 5, 1, 2
6, 7, 10,
11, 12, 14,
15, 16, 17,
18, 20

*3. Disclosure of leases.

4, 8, 9, 15 3, 5, 6, 7,
8, 10, 11,
12, 18, 20

*4. Lessors: classification


of leases; accounting
by lessors.

10, 12, 13, 6, 7, 10,


14, 15, 16, 11, 14, 15,
17
16, 17, 18,
19, 20, 21

3, 4, 5, 6, 3, 6
9, 10, 11,
13, 15, 16,
18, 20

5. Differences between
IFRS and ASPE

1, 2

6, 10, 11

6, 7, 8, 9,
14, 16

*5. Sale and leaseback.

18, 19

22, 23, 24 22, 23

*6. Real estate leases.

19, 20

25

22

*7. Contract-based
22, 23
13
19, 20
approach
*This material is dealt with in an Appendix to the chapter.

NOTE: If your students are solving the end-of-chapter material using a financial
calculator or an Excel spreadsheet as opposed to the PV tables, please note that
there will be a difference in amounts. Excel and financial calculators yield a more
precise result as opposed to PV tables. The amounts used for the preparation of
journal entries in solutions have been prepared from the results of calculations
arrived at using the PV tables.
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ASSIGNMENT CHARACTERISTICS TABLE


Item

Description

E20-1

Lessee entries; capital lease with


unguaranteed residual value.
Lessee Entries; operating lease; comparison
Lessee calculations and entries; capital lease
with guaranteed residual value.
Lessee entries; capital lease with executory
costs and unguaranteed residual values.
Lessee entries; capital lease with executory
costs and unguaranteed residual, lease and
fiscal year differ.
Type of lease; Lessee entries with bargain
purchase option.
Lessor entries with bargain purchase option.
Lessee calculations and entries; capital lease
disclosure.
Amortization schedule and journal entries for
lessee.
Capital lease payment; Lessee-lessor entries;
capital/sales-type lease.
Type of lease; amortization schedule.
Operating lease versus capital lease.
IFRS compared to contract based approach
Calculation of rental; journal entries for lessor.
IFRS compared to contract based approach
Lessor entries, determine type of lease, capital
lease payments.
Lessor entries; capital lease with option to
purchase; lessee capitalizable amount.
Lessor entries; disclosure, direct financing with
unguaranteed residual
Accounting for an operating lease and
disclosure: lessee and lessor
Accounting for an operating lease.
Lessor entries; sales-type lease.
Operating lease for lessee and lessor.
Lessee-lessor, sale-leaseback.
Land lease; lessee and lessor.
Sale and leaseback; lessee and lessor entries.
Real estate lease.

E20-2
E20-3
E20-4
E20-5
E20-6
E20-7
E20-8
E20-9
E20-10
E20-11
E20-12
E20-13
E20-14
E20-15
E20-16
E20-17
E20-18
E20-19
E20-20
E20-21
*E20-22
*E20-23
*E20-24
*E20-25

Level of
Time
Difficulty (minutes)
Moderate

15-20

Moderate
Moderate

20-25
20-25

Moderate

20-30

Moderate

25-35

Moderate

20-30

Moderate

20-30

Moderate

20-30

Moderate

20-25

Simple
Moderate
Moderate
Moderate
Moderate
Moderate

15-20
25-35
30-35
15-25
20-30
20-25

Moderate

25-35

Moderate

25-35

Simple

15-20

Simple
Moderate
Simple
Moderate
Moderate
Moderate
Moderate

10-20
15-20
15-20
20-30
15-20
20-30
20-25

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ASSIGNMENT CHARACTERISTICS TABLE (Continued)


Item
P20-1
P20-2
P20-3
P20-4
P20-5
P20-6
P20-7
P20-8
P20-9
P20-10
P20-11
P20-12
P20-13
P20-14
P20-15

P20-16
P20-17
P20-18
P20-19
P20-20

Description
Operating and capital lease alternatives,
statement disclosurelessee and rationale.
Leasing alternative comparisonlessee,
comparison including cash flows.
Lessee entries and statement of financial
position, income and cash flow presentation;
capital lease.
Lessor entries and statement of financial
position, income and cash flow presentation;
direct financing lease.
Capital lease to lessee and operating lease to
lessor; entries and financial statements.
Operating lease; lessee-lessor entries.
Capital lease, lessee with bargain purchase
option.
Statement of financial position and income
statement disclosurelessee.
Statement of financial position and income
statement disclosurelessor.
Basic lessee accounting with difficult PV
calculation.
Lessee-lessor entries; statement of financial
position and cash flow presentation; sales-type
lease.
Lessee entries and statement of financial
position and cash flow presentation; capital
and operating lease.
Lessor calculations and entries; sales-type
lease with unguaranteed residual value.
Lessee calculations and entries; capital lease
with guaranteed and unguaranteed residual
value and bargain option.
Lessor calculations and entries; sales-type
lease with guaranteed and unguaranteed
residual value, with disclosure, depreciation
calculations for lessee.
Lessee-lessor accounting for residual value.
Contrasting capital and operating lease choice
Lease accounting and reporting operating
lease to lessee and capital lease to lessor.
Contract-based approach, including revision of
estimates for guaranteed residual value.
Lease vs. purchase including financing,
options to purchase, contract-based approach
and summarieslessee

Level of
Time
Difficulty (minutes)
Complex
45-50
Moderate

45-50

Moderate

45-50

Moderate

40-45

Complex

40-45

Simple
Moderate

20-30
30-35

Moderate

30-40

Moderate

30-40

Moderate

40-50

Moderate

35-45

Moderate

25-35

Complex

35-45

Complex

40-50

Complex

40-45

Complex
Moderate
Complex

30-40
30-35
40-45

Moderate

30-35

Complex

50-80

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ASSIGNMENT CHARACTERISTICS TABLE (Continued)


Item
P20-21
*P20-22
*P20-23

Description
Lessor of P20-20
Sale and leaseback arrangement
Sale and leaseback of real estate

Level of
Time
Difficulty (minutes)
Moderate
20-25
Complex
40-45
Complex
40-45

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SOLUTIONS TO BRIEF EXERCISES


BRIEF EXERCISE 20-1
The lease does not meet the transfer of ownership test, (the
bargain purchase test), or the economic life test [(5 years 8
years) < 75%] used for ASPE. However, it does pass the
recovery of investment test. The present value of the minimum
lease payments ($32,000 X 4.31213 = $137,988) (or using the
alternatives below) is greater than 90% of the fair value of the
asset (90% X $140,000 = $126,000). Therefore, Piper should
classify the lease as a capital lease.
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
8%
N
5
PMT
$ (32,000)
FV
$0
Type
1

Yields $137,988

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 20-2


(a) IFRS
The lease does not meet the transfer of ownership test (there is
no transfer of ownership or bargain purchase option), however
the lease term is for the major part of the economic life of the
leased asset [(5 years 8 years) = 63%]. In addition, the present
value of minimum lease payments may be considered to
represent substantially all of the fair value of the leased asset
[($215,606.50 $250,000) = 86%]. Therefore, Blane should
classify the lease as a finance lease.
(b) ASPE
The lease does not meet the transfer of ownership test, (there is
no bargain purchase option or transfer of ownership), or the
economic life test [(5 years 8 years) < 75%], or the recovery of
investment test [($215,606.50 $250,000) < 90%] used for ASPE.
Therefore, Blane should classify the lease as an operating lease.

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 20-3


(a) IFRS
For finance leases, the lessee uses the rate implicit in the lease
whenever it can be reasonably determined; otherwise the
incremental borrowing rate is used. In this case, the rate implicit
in the lease is 9%.
Using Table A-5 Present Value of an annuity due, 6 periods at
9% of 4.88965, the capitalized amount of the leased asset =
$30,000 X 4.88965 = $146,689.50.
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
9%
N
6
PMT
$ (30,000)
FV
$0
Type
1

Yields $146,689.54

(b) ASPE
For capital leases, the lessee uses the lower of the lessees
incremental borrowing rate and the rate implicit in the lease. In
this case, the lower of the lessees incremental borrowing rate
and the rate implicit in the lease is 8%.
Using Table A-5 Present Value of an annuity due, 6 periods at
8% of 4.99271, the capitalized amount of the leased asset =
$30,000 X 4.99271 = $149,781.30.

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 20-3 (Continued)


(b) (Continued)
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
8%
N
6
PMT
$ (30,000)
FV
$0
Type
1

Yields $149,781.30

BRIEF EXERCISE 20-4


Equipment under Lease ..................................
Obligations under Lease .........................

112,400
112,400

(Using Table A-5 Present Value of an annuity due and 5 periods


at 6% of 4.46511, present value of minimum lease payments =
$25,173 X 4.46511= $112,400.21.)
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? Yields $112,400.10
I
6%
N
5
PMT
$ (25,173)
FV
$0
Type
1
Obligations under Lease.................................
Cash..........................................................

25,173
25,173

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 20-5


Using Excel or a financial calculator solve the payment amount:
Excel formula =PMT(rate,nper,pv,fv,type)
Using a financial calculator
PV
$ 112,400
RATE
6%
NPR
5
PMT
?
FV
$0
Type
1

Yields $25,173

Using Table A-5 Present Value of an annuity due, 5 periods at


6% of 4.46511, payment = $112,400 / 4.46511= $25,172.95.

BRIEF EXERCISE 20-6


Interest Expense ................................................
Interest Payable
[($150,000 $25,561) X 10% X 8/12]....

8,296

Depreciation Expense ........................................ 12,500


Accumulated Depreciation-Leased Equipment
($150,000 X 1/8 X 8/12) .........................

8,296

12,500

BRIEF EXERCISE 20-7


Interest Payable .................................................. 8,296
Interest Expense ................................................ 4,148
Obligations under Lease.................................... 13,117
Cash.............................................................
($150,000 $25,561) X 10% X 4/12 = $4,148

25,561

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 20-8


Equipment under Lease ..................................... 147,047
Obligations under Lease ............................
Using tables:
PV of rentals
[PV of guar. RV

$28,000 X 4.88965
$17,000 X .59627

147,047

$136,910
10,137
$147,047

Excel formula =PV(rate,nper,pmt,fv,type)


Using a financial calculator:
PV
$ ?
I
9%
N
6
PMT
$ 28,000
FV
$ 17,000
Type
1

Yields $147,047

Obligations under Lease.................................... 28,000


Cash.............................................................

28,000

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 20-9


Equipment under Lease ..................................... 136,910
Obligations under Lease ............................
Using tables:
PV of rentals

$28,000 X 4.88965

136,910

$136,910

Excel formula =PV(rate,nper,pmt,fv,type)


Using a financial calculator:
PV
$ ?
I
9%
N
6
PMT
$( 28,000)
FV
0
Type
1

Yields $136,910

Obligations under Lease.................................... 28,000


Cash ...........................................................

28,000

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 20-10


Lease Receivable ............................................... 185,000
Sales Revenue ............................................
Unearned Interest Income ..........................
[($28,000 X 4.88965) + ($17,000 X .59627) = $147,047]
($28,000 X 6) + $17,000 = $185,000

147,047
37,953

Payments are assumed to be at the beginning of each year


Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
9%
N
6
PMT
$ 28,000
FV
$ 17,000
Type
1

Yields $(147,047)

Cost of Goods Sold ............................................ 121,000


Inventory .....................................................

121,000

Cash .................................................................... 28,000


Lease Receivable ........................................

28,000

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 20-11


August 15, 2014
Rent Expense ($31,500 12 X 3.5) .................... 9,188
Prepaid Rent ($31,500 12 X 8.5) ...................... 22,312
Cash.............................................................

31,500

An alternate to the above:


August 15, 2014
Prepaid Rent ...................................................... 31,500
Cash.............................................................

31,500

November 30, 2014


Rent Expense ($31,500 12 X 3.5) ....................
Prepaid Rent ..............................................

9,188
9,188

BRIEF EXERCISE 20-12


August 15, 2014
Cash .................................................................... 31,500
Unearned Rent Revenue ............................

31,500

June 30, 2015


Unearned Rent Revenue ................................... 27,563
Rent Revenue ($31,500 12 X 10.5) ..........

27,563

BRIEF EXERCISE 20-13


Lease Receivable ............................................... 202,920
Equipment Acquired for Lessee ................
Unearned Interest Income ..........................
Lease payments receivable
[ (5 X $40,584)
PV of rentals (4.31213 X $40,584)
Unearned interest

175,000
27,920

$202,920
175,000
$ 27,920

Cash .................................................................... 40,584


Lease Receivable ........................................

40,584

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 20-14


Lease Receivable ............................................... 202,920
Sales Revenue ............................................
Unearned Interest Income .........................

175,000
27,920

Cost of Goods Sold ............................................ 137,500


Inventory .....................................................

137,500

Cash .................................................................... 40,584


Lease Receivable ........................................

40,584

Unearned Interest Income ................................. 10,753


Interest Income ...........................................
[($175,000 $40,584) X 8%]

10,753

BRIEF EXERCISE 20-15


Unearned Interest Income ................................. 10,753
Interest Income ...........................................
[($175,000 $40,584) X 8%]

10,753

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 20-16


Lease Receivable ............................................... 519,650
Sales Revenue ............................................
Unearned Interest Income ..........................

410,000
109,650

[(95,930 X 4.03735) + (40,000 X .56743)] = 410,000


(95,930 X 5) + 40,000 = 519,650
Payments are assumed to be at the beginning of each year
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
Yields $(410,000)
I
12%
N
5
PMT
$ 95,930
FV
$ 40,000
Type
1
Cost of Goods Sold ............................................ 265,000
Inventory .....................................................

265,000

Cash .................................................................... 95,930


Lease Receivable ........................................

95,930

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Intermediate Accounting, Tenth Canadian Edition

BRIEF EXERCISE 20-17


Lease Receivable ............................................... 519,650
Cost of Goods Sold ($265,000 $22,697*)........ 242,303
Sales Revenue ($410,000 $22,697) .........
Unearned Interest Income ..........................
Inventory .....................................................

387,303
109,650
265,000

* ($40,000 X .56743) = $22,697


($95,930 X 4.03735) = $387,303
($95,930 X 5) + $40,000 = $519,650
Cash .................................................................... 95,930
Lease Receivable ........................................

95,930

*BRIEF EXERCISE 20-18


Deferred profit on sale-leaseback = $200,000 ($300,000
$120,000) = $20,000
(a) IFRS
Under IFRS, the deferred gain on sale is recognized over the
lease term. In this case, amortization of the deferred gain on sale
to be recorded at the end of 2014 is $4,000 ($20,000 5 years).
(b) ASPE
Under ASPE, the deferred gain on sale is amortized on the same
basis as the depreciation of the leased asset. In this case,
amortization of the deferred gain on sale to be recorded at the
end of 2014 is $8,000 ($20,000 X 2 5 years).

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*BRIEF EXERCISE 20-19


Cash .................................................................... 65,000
Accumulated Depreciation - Trucks ................. 26,000
Trucks..........................................................
Deferred Profit on Sale-Leaseback............
Vehicles under Lease......................................... 65,000
Obligations under Lease ............................
($17,147 X 3.79079)

79,000
12,000
65,000

Excel formula =PV(rate,nper,pmt,fv,type)


Using a financial calculator:
PV
$ ?
I
10%
N
5
PMT
$ (17,147)
FV
$ 0
Type
0

Yields $65,000

Depreciation Expense ........................................ 13,000


Accumulated Depreciation-Vehicles under Lease
($65,000 X 1/5) ............................................
Deferred Profit on Sale-Leaseback ...................
Depreciation Expense ($12,000 X 1/5) .......

13,000

2,400

Interest Expense ($65,000 X 10%) ..................... 6,500


Obligations under Lease.................................... 10,647
Cash.............................................................

2,400

17,147

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*BRIEF EXERCISE 20-20


January 1, 2014:
Land under Lease............................................ 100,000.00
Buildings under Lease .................................... 150,000.00
Obligations under Lease .........................
250,000.00
Obligations under Lease................................. 23,576.90
Cash..........................................................
23,576.90
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
Yields $ 250,000
I
8%
N
20
PMT
$ 23,576.90
FV
$ 0
Type
1
December 31, 2014:
Interest Expense ................................................ 18,113.85
Interest Payable
[($250,000.00 $23,576.90) X 8%] .......
18,113.85
Depreciation Expense ........................................ 7,500.00
Accumulated Depreciation Leased Buildings
($150,000 / 20) ......................................
7,500.00

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Intermediate Accounting, Tenth Canadian Edition

*BRIEF EXERCISE 20-21


January 1, 2014
Buildings under Lease .................................... 150,000.00
Obligations under Lease .........................
150,000.00
Obligations under Lease................................. 14,146.14
Rent Expense (Land) ...................................... 9,430.76
Cash..........................................................
23,576.90
[($23,576.90 X $150,000 / $250,000) = $14,146.14]
December 31, 2014:
Interest Expense ................................................ 10,868.31
Interest Payable ..........................................
10,868.31
[($150,000.00 $14,146.14) X 8%]
Depreciation Expense ........................................ 7,500.00
Accumulated Depreciation Leased Buildings7,500.00
($150,000 / 20)

*BRIEF EXERCISE 20-22


For the contract-based approach, the probability-weighted
expected value of the residual guarantee must be used in the
present value calculation of the lease payments liability.
Probability-weighted expected value
$16,000 X 50% =
$12,000 X 30% =
$10,000 X 20% =

$8,000
3,600
2,000

$13,600

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*BRIEF EXERCISE 20-23


(a) ASPE
The lease does not meet the transfer of ownership test, (the
bargain purchase test), or the economic life test [(4 years 8
years) < 75%], or the recovery of investment test [($116,025
$150,000) < 90%] used for ASPE. Therefore, Quong should
classify the lease as an operating lease.
(b) IFRS classification approach
The lease does not meet the transfer of ownership test (the
bargain purchase test), or the economic life test [(4 years 8
years) = 50%]. It may also be considered that the present value
of minimum lease payments does not represent substantially all
of the fair value of the leased asset [($116,025 $150,000) =
77%]. Therefore, Quong should classify the lease as an
operating lease.
(c) IFRS contract-based approach
Because the contractual right to use the asset is transferred
from Zareiga to Quong over the non-cancellable lease term, at
lease inception, Quong should measure and recognize the rightof-use asset and the liability (obligation) to make lease
payments.

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SOLUTIONS TO EXERCISES
EXERCISE 20-1 (15-20 minutes)
(a) This is a capital lease to Wong since the lease term (5
years) is greater than 75% of the economic life (6 years) of
the leased asset. The lease term is 83% (5 6) of the
assets economic life.
(b) Calculation of present value of minimum lease payments:
$13,668 X 4.16986* = $56,994
*Present value of an annuity due of 1 for 5 periods at 10%.
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
10%
N
5
PMT
$ (13,668)
FV
$ 0
Type
1

Yields $56,994

(c)
9/1/14

Equipment under Lease .................... 56,994


Obligations under Lease ............ 56,994
Obligations under Lease .................. 13,668
Cash ...........................................

13,668

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EXERCISE 20-1 (Continued)


12/31/14 Depreciation Expense .......................
Accumulated Depreciation
Leased Equipment..................
[($56,994/ 5) X 4/ 12 = $3,800]

3,800

Interest Expense ............................... 1,444


Interest Payable ..........................
[($56,994 $13,668) X .10 X 4/ 12 = $1,444]
9/1/15

Obligations under Lease .................. 9,335


Interest Payable................................. 1,444
Interest Expense ............................... 2,889
Cash ...........................................
[($56,994 $13,668) X .10 X 8/ 12 = $2,889]

3,800

1,444

13,668

(d)
Under IFRS, any one or a combination of the following situations
normally indicates that the risks and rewards of ownership are
transferred to the lessee, and supports classification as a
finance lease:
There is reasonable assurance that the lessee will obtain
ownership of the leased property by the end of the lease
term. If there is a bargain purchase option in the lease, it is
assumed that the lessee will exercise it and obtain
ownership of the asset.
The lease term is long enough that the lessee will receive
substantially all of the economic benefits that are expected
to be derived from using the leased property over its life.
The lease allows the lessor to recover substantially all of
its investment in the leased property and to earn a return
on the investment. Evidence of this is provided if the
present value of the minimum lease payments is close to
the fair value of the leased asset.
The leased assets are so specialized that, without major
modification, and/or significant cost to the lessor, they are
of use only to the lessee.

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EXERCISE 20-1 (Continued)


Other indicators include situations where the lessee absorbs the
lessors losses if the lessee cancels the lease, or the lessee
assumes the risk associated with the amount of the residual
value of the asset at the end of the lease, or where there is a
bargain renewal optionwhen the lessee can renew the lease
for an additional term at significantly less than the market rent.
The standard also states that these indicators are not always
conclusive. The decision has to be made on the substance of
each specific transaction. If the lessee determines that the risks
and benefits of ownership have not been transferred to it, the
lease is classified as an operating lease.
It is likely the lease would be classified as a capital lease under
IFRS.

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EXERCISE 20-2(20-25 minutes)


(a) This is an operating lease to Wong since the lease term (5
years) is less than 75% of the economic life (7 years) of the
leased asset. The lease term is 71.4% (5 7) of the assets
economic life. There is no bargain purchase option and the
present value of minimum lease payments of $56,994
represent 72% of the fair value at September 1 of $79,000
falling short of the criteria of 90% to treat the lease as a
capital lease.
(b)
September 1, 2014
Prepaid Rent ............................................... 13,668
Cash ...................................................
December 31, 2014
Rent Expense .............................................
Prepaid Rent .....................................
($13,668 X 4 / 12 = $4,556)

13,668

4,556
4,556

September 1, 2015
Prepaid Rent ............................................... 13,668
Cash ...................................................

13,668

December 31, 2015


Rent Expense ............................................. 13,668
Prepaid Rent ......................................

13,668

Alternately, the September 1, 2015 payment can be recorded


to rent expense, in which case no adjusting journal entry is
needed at December 31, 2015.

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EXERCISE 20-2 (Continued)


(c) and (d)
E20-2
Operating
Lease
Statement of Financial Position:
Current assets:
Prepaid rent
Property Plant & Equipment:
Equipment under lease
Less: Accumulated depreciation

$9,112
$ 56,994
(3,800)
53,194

Current Liabilities
Interest payable
Current portion of obligations under
lease

1,444
9,335

Long term liabilities


Obligations under lease
Less: Current portion
Income Statement:
Depreciation expense
Interest expense
Rent expense

E20-1
Capital
Lease

43,326
(9,335)
33,991
$ 3,800
1,444
$ 4,556

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EXERCISE 20-2 (Continued)


(e)

The amounts appearing on the financial statements in part


(c) and (d) above lead to the conclusion that net income
would be lower and therefore earnings per share would be
lower if the lease were treated as a capital lease, although
this difference would decrease over time as the total cash
paid out over the life of the asset is the same under either
alternative. As well, using statement of financial position
information, we can see that liquidity ratios would be
adversely affected since the equivalent of one lease
payment appears as a current liability when the lease is
treated as a capital lease. Debt to total asset ratios will be
affected by the presence of the long-term obligation and the
additional property, plant and equipment. An investor
should review the notes to the financial statements
discussing how the company has accounted for this lease,
and note the effect on the companys financial statements
and ratios.

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EXERCISE 20-3 (20-25 minutes)


(a) To New Bay, the lessee, this lease is a capital lease because
the terms satisfy the following criteria:
1. The lease term is greater than 75% of the economic life of
the leased asset; that is, the lease term is 76.4% (55/72)
of the economic life.
2. The present value of the minimum lease payments is
greater than or equal to 90% of the fair value of the
leased asset; that is, the present value of $19,356 is 90%
of the fair value of the leased asset: ($19,356 / $21,500 =
90%)
(b) The minimum lease payments, in the case of a residual
value guaranteed by the lessee include the guaranteed
residual value. The present value therefore is:
PV of monthly payment of $425 for 55 months ..... $17,910
PV of residual value of $2,500................................. 1,446
Present value of minimum lease payments ........... $19,356
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? Yields $19,358.88
I
1%
N
55
PMT
$ (425)
FV
$ (2,500)
Type
0
(c) Vehicles under Lease ................................. 19,356
Obligations under Lease ....................

19,356

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EXERCISE 20-3 (Continued)


(d) Depreciation Expense ................................ 306.47
Accumulated DepreciationVehicles under Lease306.47
[($19,356 $2,500) 55 months = 306.47]
(e) Obligations under Lease ............................ 231.44
Interest Expense (1% X $19,356) ............... 193.56
Cash .....................................................
(f)

425.00

Rather than using quantitative factors such as the 75


percent and the 90 percent hurdles often referred to as the
bright lines used in ASPE, the IFRS criteria use qualitative
factors to establish whether or not the risks and rewards of
ownership are transferred to the lessee, and supports
classification as a finance lease:
1. There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of
the lease term. If there is a bargain purchase option in
the lease, it is assumed that the lessee will exercise it
and obtain ownership of the asset.
2. The lease term is long enough that the lessee will
receive substantially all of the economic benefits that
are expected to be derived from using the leased
property over its life.
3. The lease allows the lessor to recover substantially all
of its investment in the leased property and to earn a
return on the investment. Evidence of this is provided if
the present value of the minimum lease payments is
close to the fair value of the leased asset.
4. The leased assets are so specialized that, without major
modification, they are of use only to the lessee.
None of the numerical thresholds need be applied, as was
the case in ASPE, and so the treatment of the lease by the
lessee would be the same, although it would be referred to
as a finance lease, rather than a capital lease.

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EXERCISE 20-4 (20-30 minutes)


(a)
Capitalized amount of the lease:
Yearly payment
Executory costs
Minimum annual lease payment

$73,580.00
2,470.29
$71,109.71

Present value of minimum lease payments


$71,109.71 X 6.32825 = $450,000.00
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
12%
N
10
PMT
$ (71,109.71)
FV
$ 0
Type
1

Yields $450,000

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EXERCISE 20-4 (Continued)


FINE CORP.
Lease Amortization Schedule
(Lessee)
Annual Pmt.
Excl.
Exec. Costs

Date
Jan. 1,
Jan. 1,
Jan. 1,
Jan. 1,
Jan. 1,
Jan. 1,
Jan. 1,
Jan. 1,
Jan. 1,
Jan. 1,

(b)
1/1/14

1/1/14

2014
2015
2016
2017
2018
2019
2020
2021
2022
2023

$71,109.71
71,109.71
71,109.71
71,109.71
71,109.71
71,109.71
71,109.71
71,109.71
71,109.71
71,109.71
711,097.10

Interest
(12%)
on Unpaid
Obligation

$45,466.83
42,389.69
38,943.29
35,083.32
30,760.15
25,918.20
20,495.22
14,421.48
7,618.92
261,097.10

Reduction
of Lease
Obligation
$71,109.71
25,642.88
28,720.02
32,166.42
36,026.39
40,349.56
45,191.51
50,614.49
56,688.23
63,490.79
450,000.00

Balance
of Lease
Obligation
$450,000.00
378,890.29
353,247.41
324,527.39
292,360.97
256,334.58
215,985.02
170,793.51
120,179.02
63,490.79
0

Equipment under Lease ................. 450,000.00


Obligations under Lease ....
450,000.00
Insurance Expense ......................... 2,470.29
Obligations under Lease ................ 71,109.71
Cash .....................................
73,580.00

12/31/14 Depreciation Expense.................... 45,000.00


Accumulated Depreciation
Leased Equipment ..........
45,000.00
($450,000 10)

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EXERCISE 20-4 (Continued)


12/31/14 Interest Expense
(See Schedule 1) .......................
Interest Payable ..................
1/1/15

Insurance Expense .......................


Interest Payable.............................
Obligations under Lease ..............
Cash .....................................

45,466.83
45,466.83
2,470.29
45,466.83
25,642.88
73,580.00

12/31/15 Depreciation Expense ................... 45,000.00


Accumulated Depreciation
Leased Equipment .........
45,000.00
12/31/15 Interest Expense ...........................
Interest Payable ..................
(c)

42,389.69
42,389.69

Note X:
The following is a schedule of future minimum lease
payments under the finance lease expiring December 31,
2023 together with the balance of the obligation under
finance lease.
Year ending December 31
2016
2017
2018
2019
2020
2021 and beyond
Total minimum lease payments
Less amount representing executory costs
Less amount representing interest at 12%
Balance of the obligation

$73,580
73,580
73,580
73,580
73,580
220,740
588,640
19,763
568,877
215,630
$353,247

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EXERCISE 20-4 (Continued)


Additional disclosures would also be required about
material lease arrangements including contingent rents,
sub-lease payments and lease-imposed restrictions. These
do not apply in this case.

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EXERCISE 20-5 (25-35 minutes)


1/1/14

Equipment under Lease ................. 450,000.00


Obligations under Lease ....
450,000.00

1/1/14

Insurance Expense * .......................


Prepaid Insurance ** .......................
Obligations under Lease ................
Cash .....................................
* ($2,470.29 X 5/12)
** ($2,470.29 X 7/12)

1,029.29
1,441.00
71,109.71
73,580.00

05/31/14 Depreciation Expense ................... 18,750.00


Accumulated Depreciation
Leased Equipment ..........
18,750.00
($450,000 10 X 5/12)
05/31/14

12/31/14

Interest Expense * ......................


Interest Payable ..................
* ($45,466.83 x 5/12)

18,944.51

Insurance Expense .....................


Prepaid Insurance ...............

1,441.00

18,944.51

1,441.00

Note: This entry could also be done at May 31, 2015


as a year-end adjusting entry.
1/1/15

Insurance Expense .......................


Prepaid Insurance .........................
Interest Expense * .........................
Interest Payable.............................
Obligations under Lease ..............
Cash .................................
* ($45,466.83 $18,944.51)

1,029.29
1,441.00
26,522.32
18,944.51
25,642.88
73,580.00

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EXERCISE 20-5 (Continued)


05/31/15

Depreciation Expense ................ 45,000.00


Accumulated Depreciation
Leased Equipment ..........

45,000.00

05/31/15

Interest Expense ......................... 17,662.37


Interest Payable ..................
17,662.37
($42,389.69 X 5/12)

12/31/15

Insurance Expense .....................


Prepaid Insurance ...............

1,441.00
1,441.00

Note: This entry could also be done at May 31, 2016


as a year-end adjusting entry.

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EXERCISE 20-6 (20-30 minutes)


(a) The lease agreement has a bargain purchase option and
thus meets the criteria to be classified as a capital lease
from the viewpoint of the lessee. The present value of the
minimum lease payments exceeds 90% of the fair value of
the assets.
(b) The lease agreement has a bargain purchase option. The
collectability of the lease payments is reasonably
predictable, and there are no important uncertainties
surrounding the costs yet to be incurred by the lessor. The
initial amount of net investment (which in this case equals
the present value of the minimum lease payments, $88,000)
exceeds the lessors cost ($60,000), the lease is a sales-type
lease to the lessor.
(c) Net investment calculation:
$20,066.26
Annual rental payment
X 4.23972
PV of annuity due of 1 for n = 5, i = 9%
$85,075.32
PV of periodic rental payments
$ 4,500.00
X .64993
$ 2,924.69

Bargain purchase option


PV of 1 for n= 5, i = 9%
PV of bargain purchase option

$85,075.32
+ 2,924.69
$88,000.01

PV of periodic rental payments


PV of bargain purchase option
Net investment at inception of lease

Excel formula =PV(rate,nper,pmt,fv,type)


Using a financial calculator:
PV
$ ? Yields $ 88,000
I
9%
N
5
PMT
$ (20,066.26)
FV
$ (4,500)
Type
1
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EXERCISE 20-6 (Continued)


Russell Corporation (Lessee)
Lease Amortization Schedule

Date
7/1/14
7/1/14
7/1/15
7/1/16
7/1/17
7/1/18
6/30/19

Annual
Lease
Payment
Plus BPO
$ 20,066.26
20,066.26
20,066.26
20,066.26
20,066.26
4,500.00
$104,831.30

Interest (9%)
on Unpaid
Obligation

Reduction
of Lease
Obligation

*$ 6,114.04*
* 4,858.34*
* 3,489.62*
* 1,997.73*
*
371.58*
*$16,831.30*

$20,066.26
13,952.22
15,207.92
16,576.64
18,068.53
4,128.42
$88,000.00

Balance
Lease
Obligation
$88,000.00
67,933.74
53,981.52
38,773.59
22,196.96
4,128.42
0.00

*Rounding error is $.02 cents.


(d)
7/1/14

Equipment under Lease ................ 88,000.00


Obligations under Lease .......
88,000.00
Obligations under Lease ................ 20,066.26
Cash ......................................
20,066.26

12/31/14 Interest Expense ...........................


Interest Payable ....................
($6,114.04 X 6/12 = ($3,057.02)

3,057.02
3,057.02

Depreciation Expense .................... 4,400.00


Accumulated Depreciation
Leased Equipment ........
4,400.00
($88,000.00 10 =
($8,800.00; $8,800.00 X 6/12 = $4,400)

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EXERCISE 20-6 (Continued)


7/1/15

Interest Payable ............................. 3,057.02


Interest Expense* .......................... 3,057.02
Obligations under Lease............... 13,952.22
Cash .....................................
20,066.26
* ($6,114.04 $3,057.02)

12/31/15 Interest Expense............................ 2,429.17


Interest Payable ..................
($4,858.34 X 6/12 = ($2,429.17)
12/31/15 Depreciation Expense ................... 8,800.00
Accumulated Depreciation
Leased Equipment ..
($88,000.00 10 years = ($8,800.00)

2,429.17

8,800.00

(Note to instructor: Because a bargain purchase option was


involved, the leased asset is depreciated over its economic
life rather than over the lease term.)
(e) For Russell Corporation(the lessee):
Rather than using quantitative factors such as the 75
percent and the 90 percent hurdles often referred to as the
bright lines used in ASPE, the IFRS criteria use qualitative
factors to establish whether or not the risks and rewards of
ownership are transferred to the lessee, and supports
classification as a finance lease:
1. There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of
the lease term. If there is a bargain purchase option in
the lease, it is assumed that the lessee will exercise it
and obtain ownership of the asset.
2. The lease term is long enough that the lessee will
receive substantially all of the economic benefits that
are expected to be derived from using the leased
property over its life.

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EXERCISE 20-6 (Continued)


3. The lease allows the lessor to recover substantially all
of its investment in the leased property and to earn a
return on the investment. Evidence of this is provided if
the present value of the minimum lease payments is
close to the fair value of the leased asset.
4. The leased assets are so specialized that, without major
modification, they are of use only to the lessee.
None of the numerical thresholds need be applied, as was
the case in ASPE, and so the treatment of the lease by the
lessee would be the same, although it would be referred to
as a finance lease, rather than a direct financing lease.
For Hebert Corporation(the lessor):
Under IFRS, the lease would receive the same treatment as
under ASPE except the criteria need not include the two
revenue recognition-based tests concerning collectability
and estimating unreimbursable costs. Instead of being
referred to as a sales-type lease, the lease would be referred
to as a finance leasemanufacturer or dealer.

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EXERCISE 20-7 (20-30 minutes)


Note as determined in Exercise 20-6, part (b):
The lease agreement has a bargain purchase option. The
collectability of the lease payments is reasonably predictable,
and there are no important uncertainties surrounding the costs
yet to be incurred by the lessor. The lease also qualifies as a
capital lease from the viewpoint of the lessee.
Due to the fact that the initial amount of net investment (which in
this case equals the present value of the minimum lease
payments, $88,000) exceeds the lessors cost ($60,000), the
lease is a sales-type lease.
(a) Gross investment = Minimum lease payments + any
unguaranteed residual value.
The minimum lease payments associated with this lease are
the periodic annual rents plus the bargain purchase option.
There is no residual value relevant to the lessors
accounting in this lease.
Calculation:

5 X $20,066.26 =$100,331.30
+ 4,500.00
Gross investment at inception
$104,831.30
(b) The net investment equals the present value of the
components of the gross investment calculation.
Net investment calculation:
$20,066.26
Annual rental payment
X 4.23972
PV of annuity due of 1 for n = 5, i = 9%
$85,075.32
PV of periodic rental payments
$ 4,500.00
X .64993
$ 2,924.69

Bargain purchase option


PV of 1 for n = 5, i = 9%
PV of bargain purchase option

$85,075.32
+ 2,924.69
$88,000.01

PV of periodic rental payments


PV of bargain purchase option
Net investment at inception

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EXERCISE 20-7 (Continued)


Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? Yields $88,000
I
9%
N
5
PMT
$ 20,066.26
FV
$ 4,500
Type
1
(c)
Herbert Leasing Corporation (Lessor)
Lease Amortization Schedule
Annual
Lease
Payment
Plus BPO

Interest (9%)
on Net
Investment

Net
Investment
Recovery

$ 20,066.26
20,066.26 *$ 6,114.04*
20,066.26 * 4,858.34*
20,066.26 * 3,489.62*
20,066.26 * 1,997.73*
4,500.00
*
371.58*
$104,831.30 *$16,831.30*
*Rounding error is $.02 cents.
(d)

$20,066.26
13,952.22
15,207.92
16,576.64
18,068.53
4,128.42
$88,000.00

Date
7/1/14
7/1/14
7/1/15
7/1/16
7/1/17
7/1/18
6/30/19

7/1/14

Balance
Net
Investment
$88,000.00
67,933.74
53,981.52
38,773.59
22,196.96
4,128.42
0.00

Lease Receivable .......................... 104,831.30


Cost of Goods Sold ....................... 60,000.00
Sales Revenue ......................
88,000.00
Unearned Interest Income ...
16,831.30
Inventory ...............................
60,000.00

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EXERCISE 20-7 (Continued)


7/1/14

Cash ............................................... 20,066.26


Lease Receivable .................
20,066.26

12/31/14 Unearned Interest Income ............ 3,057.02


Interest Income .....................
($6,114.04 X 6/12 = $3,057.02)

3,057.02

7/1/15

Cash ............................................... 20,066.26


Lease Receivable .................
20,066.26

7/1/15

Unearned Interest Income ............


Interest Income .....................
($6,114.04 $3,057.02)

3,057.02

12/31/15 Unearned Interest Income ............


Interest Income .....................
($4,858.34 X 6/12 = ($2,429.17)

2,429.17

7/1/16

3,057.02

2,429.17

Cash ............................................... 20,066.26


Lease Receivable .................
20,066.26
Unearned Interest Income ............
Interest Income .....................
($4,858.34 $2,429.17)

2,429.17

12/31/16 Unearned Interest Income ............


Interest Income .....................
($3,489.62 X 6/12 = $1,744.81)

1,744.81

2,429.17

1,744.81

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EXERCISE 20-8 (20-25 minutes)


(a)
Capitalized amount of the lease:
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
10.5%
N
8
PMT
$ (28,500.00)
FV
$ 0
Type
1
(b)

Yields $164,995

This is a capital lease to Xu since the lease term (8 years)


is greater than 75% of the economic life (8 years) of the
leased asset. The lease term is 100% (8 8) of the assets
economic life. This also meets the requirements of IFRS,
under which it is referred to as a financing lease.
The present value of the minimum lease payments is
greater than 90% of the fair value of the leased asset; that
is, the present value of $164,995 is 99% of the fair value of
the leased asset: ($164,995 / $166,000 = 99.4%). This
criteria for treating the lease as a capital lease has also
been met. Note that meeting just one of the criteria is
sufficient for classification as a capital lease.
There is no bargain purchase option in this case.

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EXERCISE 20-8 (Continued)


(c)

Xu Ltd.
Lease Amortization Schedule
(Lessee)
Annual
Lease
Payments

Date
Jan. 1, 2015
Jan. 1, 2016
Jan. 1, 2017
Jan. 1, 2018
Jan. 1, 2019
Jan. 1, 2020
Jan. 1, 2021
Jan. 1, 2022

(d)
1/1/15
1/1/15

12/31/15

$28,500.00
28,500.00
28,500.00
28,500.00
28,500.00
28,500.00
28,500.00
28,500.00
$228,000.00

Interest
(10.5%)
on Unpaid
Obligation

$14,331.98
12,844.33
11,200.49
9,384.04
7,376.86
5,158.93
2,708.37
$63,005.00

Reduction
of Lease
Obligation
$28,500.00
14,168.03
15,655.67
17,299.51
19,115.96
21,123.14
23,341.07
25,791.63
$164,995.00

Equipment under Lease .............


Obligations under Lease ....

164,995

Obligations under Lease ............


Cash .....................................

28,500

Depreciation Expense ................


Accumulated Depreciation
Leased Equipment ..........
($164,995 8)

20,624

Balance
of Lease
Obligation
$164,995.00
136,495.00
122,326.97
106,671.30
89,371.79
70,255.83
49,132.70
25,791.63
(0.00)

164,995
28,500

20,624

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EXERCISE 20-8 (Continued)


(d) (Continued)
12/31/15 Interest Expense .........................
Interest Payable ..................
1/1/16

12/31/16

12/31/16

14,332
14,332

Interest Payable ..........................


Obligations under Lease ............
Cash .....................................

14,332
14,168

Depreciation Expense ................


Accumulated Depreciation
Leased Equipment .........

20,624

Interest Expense .........................


Interest Payable ..................

12,844

28,500

20,624

12,844

(e)
Xu Ltd.
Statement of Financial Position (partial)
December 31,
2016
2015
Non-current assets
Property plant and equipment
Equipment under lease
$164,995 $164,995
Less accumulated depreciation
41,248
_20,624
123,747
144,371
Current liabilities
Interest payable
12,844
14,332
Obligations under lease
15,656
14,168
Non-current liabilities
Obligations under lease (Note X)
122,327
136,495
Current portion
(15,656)
(14,168)

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EXERCISE 20-8 (Continued)


(f)

Note X:
The following is a schedule of future minimum lease
payments under the capital lease expiring December 31,
2022 together with the balance of the obligation under
capital lease.
Year ending December 31
2017
$28,500
2018
28,500
2019
28,500
2020
28,500
2021
28,500
2022
28,500
Total minimum lease payments
171,000
Less amount representing interest at 10.5%
48,673
Balance of the obligation
$122,327

(g)

When negotiating a lease arrangement, the lessor sets the


lease payments receivable to obtain the appropriate return
for the asset leased. The amounts arrived at are negotiable.
In this case, the lessor likely tried to obtain an amount near
to or exceeding the resale price of the equipment and
arrived at annual payments in round amounts ($28,500).
The present value of the minimum lease payment
approximated the resale price without being exactly equal
(99.4% in this case). This is a natural outcome from the
negotiations process between the parties involved.

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EXERCISE 20-9 (20-30 minutes)


Note: This lease is a capital lease to the lessee because the
lease term (five 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.
$18,142.95
Annual rental payment
X 4.16986
PV of an annuity due of 1 for n = 5, i = 10%
$75,653.56
PV of minimum lease payments
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
10%
N
5
PMT
$ (18,142.95)
FV
$0
Type
1

Yields $75,654

(a)
LeBlanc Limited (Lessee)
Lease Amortization Schedule

Date
1/1/14
1/1/14
1/1/15
1/1/16
1/1/17
1/1/18

Annual
Lease
Payment

Interest
(10%) 1
on Unpaid
Obligation

$18,142.95
18,142.95
*$ 5,751.06*
18,142.95
* 4,511.87*
18,142.95
* 3,148.76*
18,142.95
* 1,649.50*
$90,714.75
*$15,061.19*
*Rounding error is 15 cents.

Reduction
of Lease
Obligation
$18,142.95
12,391.89
13,631.08
14,994.19
16,493.45
$75,653.56

Balance
of Lease
Obligation
$75,653.56
57,510.61
45,118.72
31,487.64
16,493.45
0.00

The implicit rate is known and is lower than the lessees


incremental borrowing rate of 11%

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EXERCISE 20-9 (Continued)


(b)
1/1/14

1/1/14

Equipment under Lease ................. 75,653.56


Obligations under Lease ....
75,653.56
Obligations under Lease ................ 18,142.95
Cash .....................................
18,142.95
During 2014
Insurance Expense .........................
Cash .....................................

900.00
900.00

Property Tax Expense ....................


Cash .....................................

1,600.00

12/31/14 Interest Expense .............................


Interest Payable...................

5,751.06

1,600.00
5,751.06

Depreciation Expense .................... 15,130.71


Accumulated Depreciation
Leased Equipment .......
15,130.71
($75,653.56 5 = $15,130.71)
1/1/15

Interest Payable* ............................


Interest Expense .................

5,751.06
5,751.06

Interest Expense ............................. 5,751.06


Obligations under Lease ................ 12,391.89
Cash .....................................
18,142.95
* Note to instructor:
The use of reversing entries is optional

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EXERCISE 20-9 (Continued)


During 2015
Insurance Expense .........................
Cash .....................................

900.00
900.00

Property Tax Expense ....................


Cash .....................................

1,600.00

12/31/15 Interest Expense .............................


Interest Payable .................

4,511.87

1,600.00
4,511.87

Depreciation Expense ................... 15,130.71


Accumulated Depreciation
Leased Equipment .
15,130.71
Note to instructor:
The lessor sets the annual rental payment as follows:
Fair value of leased asset to lessor
$80,000.00
Less: Present value of unguaranteed
residual value $7,000 X .62092
(present value of 1 at 10% for 5 periods)
4,346.44
Amount to be recovered through lease payments $75,653.56
Five periodic lease payments
$75,653.56 4.16986*
$18,142.95
*Present value of annuity due of 1 for 5 periods at 10%.
Excel formula =PMT(rate,nper,pv,fv,type)
Using a financial calculator:
PV
$ (80,000)
I
10%
N
5
PMT
$ ? Yields $18,142.92
FV
$ 7,000
Type
1

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EXERCISE 20-9 (Continued)


(c)

Note X:
The following is a schedule of future minimum lease
payments under the capital lease expiring December 31,
2018 together with the balance of the obligation under
capital lease.
Year ending December 31
2016
$18,143
2017
18,143
2018
18,143
Total minimum lease payments
54,429
Less amount representing interest at 10%
9,310
Balance of the obligation
$45,119

(d) Rather than using quantitative factors such as the 75


percent and the 90 percent hurdles often referred to as the
bright lines used in ASPE, the IFRS criteria use qualitative
factors to establish whether or not the risks and rewards of
ownership are transferred to the lessee, and supports
classification as a finance lease:
1. There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of
the lease term. If there is a bargain purchase option in
the lease, it is assumed that the lessee will exercise it
and obtain ownership of the asset.
2. The lease term is long enough that the lessee will
receive substantially all of the economic benefits that
are expected to be derived from using the leased
property over its life.
3. The lease allows the lessor to recover substantially all
of its investment in the leased property and to earn a
return on the investment. Evidence of this is provided if
the present value of the minimum lease payments is
close to the fair value of the leased asset.
4. The leased assets are so specialized that, without major
modification, they are of use only to the lessee.

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EXERCISE 20-9 (Continued)


None of the numerical thresholds need be applied, as was
the case in ASPE, and so the treatment of the lease by the
lessee would be the same, although it would be referred to
as a finance lease, rather than a capital lease.
As for the note disclosure provided in part (c) above,
additional disclosures would also be required about
material lease arrangements including contingent rents,
sub-lease payments and lease-imposed restrictions. These
do not apply in this case.

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EXERCISE 20-10 (20-25 minutes)


(a) This is a capital lease to Flynn since the lease term is 75%
(6 7) of the assets economic life. In addition, the present
value of the minimum lease payments is more than 90% of
the fair value of the asset.
This is a sales-type lease to Lavery since the lease is a
capital lease to Flynn, the lessee, and because the
collectability of the lease payments is reasonably
predictable, there are no important uncertainties
surrounding the unreimbursable costs yet to be incurred by
the lessor and the fair value of the equipment ($144,000)
exceeds the lessors cost ($111,000).
(b) Calculation of annual rental payment:
$144,000 $6,000 X 0.59627*
4.8897**

$28,718

**Present value of $1 at 9% for 6 periods.


**Present value of an annuity due at 9% for 6 periods.
Excel formula =PMT(rate,nper,pv,fv,type)
Using a financial calculator:
PV
$ (144,000)
I
9%
N
6
PMT
$ ?
FV
$ 6,000
Type
1

Yields $28,718

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EXERCISE 20-10 (Continued)


(c)
1/1/11

Equipment under Lease ...................... 137,582


Obligations under Lease ............
($28,718 X 4.79079)***
Obligations under Lease ..................... 28,718
Cash ............................................

137,582

28,718

***Present value of an annuity due at 10% for 6 periods.


Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
10%
N
6
PMT
$ (28,718)
FV
$ 0
Type
1

Yields $137,582

12/31/14 Depreciation Expense ........................ 22,930


Accumulated Depreciation
Leased Equipment........
($137,582 6 years)
Interest Expense................................. 10,886
Interest Payable .......................
[($137,582 $28,718) X .10]

22,930

10,886

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EXERCISE 20-10 (Continued)


(d)
1/1/11

Lease Receivable ...........................


Cost of Goods Sold ........................
Sales Revenue ......................
Inventory ...............................
Unearned Interest Income ...

178,308*
107,422
140,422
111,000
34,308**

*($28,718 X 6) + $6,000
**$178,308 $144,000
Since the residual value is not guaranteed, the present value of
the residual value of $6,000 is excluded from both sales and cost
of goods sold.
Sales Revenue
Less present value of residual value

$144,000
3,578*
$140,422

Cost of Goods Sold


Less present value of residual value

$111,000
3,578*
$107,422

*($6,000 X .59627**)
**Present value of $1 at 9% for 6 periods.
Cash ...............................................
Lease Receivable .................
12/31/14 Unearned Interest Income .............
Interest Income ....................
[($144,000 $28,718) X .09]

28,718
28,718
10,375
10,375

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EXERCISE 20-10 (Continued)


(c) For Lavery Corporation(the lessee):
Rather than using quantitative factors such as the 75
percent and the 90 percent hurdles often referred to as the
bright lines used in ASPE, the IFRS criteria use qualitative
factors to establish whether or not the risks and rewards of
ownership are transferred to the lessee, and supports
classification as a finance lease:
1. There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of
the lease term. If there is a bargain purchase option in
the lease, it is assumed that the lessee will exercise it
and obtain ownership of the asset.
2. The lease term is long enough that the lessee will
receive substantially all of the economic benefits that
are expected to be derived from using the leased
property over its life.
3. The lease allows the lessor to recover substantially all
of its investment in the leased property and to earn a
return on the investment. Evidence of this is provided if
the present value of the minimum lease payments is
close to the fair value of the leased asset.
4. The leased assets are so specialized that, without major
modification, they are of use only to the lessee.
None of the numerical thresholds need be applied, as was
the case in ASPE, and so the treatment of the lease by the
lessee would be the same, although it would be referred to
as a finance lease, rather than a direct financing lease.
For Flynn Corporation(the lessor):
Under IFRS, the lease would receive the same treatment as
under ASPE except the criteria need not include the two
revenue recognition-based tests concerning collectability
and estimating unreimbursable costs. Instead of being
referred to as a sales-type lease, the lease would be referred
to as a finance leasemanufacturer or dealer.

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EXERCISE 20-11 (15-20 minutes)


(a) When using ASPE, because the lease term is longer than
75% of the economic life of the asset and the present value
of the minimum lease payments is more than 90% of the fair
value of the asset, it is a capital lease to the lessee.
Assuming collectibility of the rents is reasonably assured,
no important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor, and
equal cost and fair value to Victoria Leasing, the lease is a
direct financing lease to the lessor.
Black Corporation, the lessee should adopt the capital lease
method and record the leased asset and obligations under
capital leases at the present value of the minimum lease
payments using the lessees incremental borrowing rate or
the interest rate implicit in the lease, if it is lower than the
incremental rate and is known to the lessee. The lessees
depreciation depends on whether ownership transfers to
the lessee or if there is a bargain purchase option. If one of
these conditions is fulfilled, depreciation would be over the
economic life of the asset. Otherwise, the asset would be
depreciated over the lease term. Because both the
economic life of the asset and the lease term are three
years, the leased asset should be depreciated over this
period.
The Victoria Leasing Corporation If a lease, in substance,
transfers the risks and benefits of ownership of the leased
asset to the lessee (decided in the same way as for Black
Corporation, the lessee) and revenue recognition criteria
related to collectability and ability to estimate any remaining
un-reimbursable costs are met, the lessor accounts for the
lease as either a direct financing or a sales-type lease.
Victoria is not a manufacturer or dealer trying to make a
sale and so the lease will be a direct financing lease to
Victoria.

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EXERCISE 20-11(Continued)
In this case, the credit risks associated with the lease are
normal and there are no unreimbursable costs that cannot
be estimated by the lessor. Victoria will replace the asset
cost of $95,000 with Lease Receivable of $112,590 and
Unearned Interest Income of $17,590. (See schedule in part
(c) below.) Interest would be recognized annually at a
constant rate applied to the unrecovered net investment.
(b)

The present value of minimum lease payments would be


equal to the amount to be recovered by the lessor through lease
payments, which equals $95,000. The annual lease payment
calculated below equals $37,530, and the factor for present value
of an annuity (Table A-4) at 9% for 3 periods is 2.53130. So the
present value of minimum lease payments is $95,000 ($37,530 X
2.53130). In summary:
Cost (fair value of leased asset) ...............................

$95,000

Amount to be recovered by lessor through lease


payments ................................................................

$95,000

Three annual lease payments: $95,000 2.53130* .

$37,530

Lease Receivable = $37,530 X 3 ....................................... $112,590


*Present value of an ordinary annuity of 1 for 3 periods at 9%.
Excel formula =PMT(rate,nper,pv,fv,type)
Using a financial calculator:
PV
$ (95,000)
I
9%
N
3
PMT
$ ? Yields $37,530
FV
$ 0
Type
0
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EXERCISE 20-11 (Continued)


(c)
Schedule of Interest and Amortization

1/1/14
12/31/14
12/31/15
12/31/16

Rent
Receipt/
Payment

Interest
Income/
Expense

Reduction
of Principal

Investment/
Obligation

$37,530
37,530
37,530

**$8,550**
** 5,942**
** 3,098**

$28,980
31,588
34,432

$95,000
66,020
34,432
0

**$95,000 X .09 = $8,550


**rounding difference

(d) For Black Corporation(the lessee):


Rather than using quantitative factors such as the 75
percent and the 90 percent hurdles often referred to as the
bright lines used in ASPE, the IFRS criteria use qualitative
factors to establish whether or not the risks and rewards of
ownership are transferred to the lessee, and supports
classification as a finance lease:

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EXERCISE 20-11 (Continued)


1. There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of
the lease term. If there is a bargain purchase option in
the lease, it is assumed that the lessee will exercise it
and obtain ownership of the asset.
2. The lease term is long enough that the lessee will
receive substantially all of the economic benefits that
are expected to be derived from using the leased
property over its life.
3. The lease allows the lessor to recover substantially all
of its investment in the leased property and to earn a
return on the investment. Evidence of this is provided if
the present value of the minimum lease payments is
close to the fair value of the leased asset.
4. The leased assets are so specialized that, without major
modification and/or significant cost to the lessor, they
are of use only to the lessee.
None of the numerical thresholds need be applied, as was
the case in ASPE, and so the treatment of the lease by the
lessee would be the same, although it would be referred to
as a finance lease, rather than a capital lease.
For Victoria Leasing Corporation(the lessor):
Under IFRS, the lease would receive the same treatment as
under ASPE except the criteria need not specifically include
the two revenue recognition-based tests concerning
collectability and estimating unreimbursable costs. These
are general recognition tests that would have to be met
regardless. The lease would be a financing lease since
Victoria is not a manufacturer or dealer.

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EXERCISE 20-12 (25-35 minutes)


Memorandum Prepared by:
Date:

(Your Initials)

DENG, INC.
December 31, 2014
Reclassification of Leased Auto
As a Capital Lease
While performing a routine inspection of the clients garage, I
found a 2013 Shirk automobile, which was not listed among the
companys assets in the equipment subsidiary ledger. I asked
the plant manager about the vehicle, and she indicated that
because the Shirk was only being leased, it was not listed along
with other company assets. Having accounted for this
agreement as an operating lease, Deng, Inc. had charged $2,640
to 2014 rent expense.
Examining the lease agreement entered into with Quick Deal
New and Used Cars on January 1, 2014, I determined that the
Shirk should be capitalized because its lease term (50 months)
is greater than 75% of its estimated useful life (60 months).
I advised the client to capitalize this lease at the present value of
its minimum lease payments: $8,623 (the present value of the
monthly payments), plus $1,277 (the present value of the
guaranteed residual). The following journal entry was
suggested:
Vehicles under Lease....................................
Obligations under Lease .......................

9,900
9,900

To account for the first years payments as well as to reverse the


original entries, I advised the client to make the following entry:

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EXERCISE 20-12 (Continued)


Obligations under Lease...............................
Interest Expense ...........................................
Rent Expense .........................................

1,535
1,105*
2,640

Lease Amortization Schedule

Month
1
2
3
4
5
6
7
8
9
10
11
12

Monthly
Lease
Payment

Interest
(1%)
Expense

$220.00
220.00
220.00
220.00
220.00
220.00
220.00
220.00
220.00
220.00
220.00
220.00
$2,640.00

$99.00
97.79
96.57
95.33
94.09
92.83
91.56
90.27
88.97
87.66
86.34
85.00
$1,105.42 *

Reduction
of Lease
Obligation
$121.00
122.21
123.43
124.67
125.91
127.17
128.44
129.73
131.03
132.34
133.66
135.00
$1,534.58

Balance
of Lease
Investment
$9,900.00
9,779.00
9,656.79
9,533.36
9,408.69
9,282.78
9,155.61
9,027.16
8,897.43
8,766.41
8,634.07
8,500.41
8,365.42

Finally, this Shirk must be depreciated over its lease term. Using
straight-line, I calculated monthly depreciation of $156 (the
capitalized amount, $9,900, minus the estimated residual, $2,100,
divided by the 50-month lease term). The client was advised to
make the following entry to record 2014 depreciation:
Depreciation Expense ...........................
Accumulated Depreciation-Vehicles
under Lease

1,872
1,872

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EXERCISE 20-13 (30-35 minutes)

Part 1 Using IFRS


(a)
In spite of Cuomos intention to exercise the one year renewal
option on the lease of the excavation equipment, the risks and
rewards of ownership have not been transferred at the time of
signing the lease and so the lease is treated as an operating
lease. The maximum term of the lease is four years and the
asset is expected to have an economic life of ten years.
Under IFRS, meeting any one or a combination of the following
criteria normally indicates that the risks and rewards of
ownership are transferred to the lessee, and supports
classification as a finance lease:
There is reasonable assurance that the lessee will obtain
ownership of the leased property by the end of the lease
term. If there is a bargain purchase option in the lease, it is
assumed that the lessee will exercise it and obtain
ownership of the asset.
The lease term is long enough that the lessee will receive
substantially all of the economic benefits that are expected
to be derived from using the leased property over its life.
The lease allows the lessor to recover substantially all of
its investment in the leased property and to earn a return
on the investment. Evidence of this is provided if the
present value of the minimum lease payments is close to
the fair value of the leased asset.
The leased assets are so specialized that, without major
modification, they are of use only to the lessee.
(b)
April 1, 2014
Rent Expense ($135,000 12 X 9) .................
Prepaid Rent ($135,000 12 X 3) ...................
Cash.........................................................

101,250
33,750
135,000

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EXERCISE 20-13 (Continued)


An alternate to the above:
April 1, 2014
Prepaid Rent ..................................................
Cash.........................................................

135,000

December 31, 2014


Rent Expense ($135,000 12 X 9) ..................... 101,250
Prepaid Rent ..............................................

135,000

101,250

Part 2 Contract-based Approach


When using this approach, the longest possible lease term that
is more likely than not to occur, is used in the calculations of
the discounted contractual lease payments liability.
Because the payments under the renewal are 125% of the
original lease payment ($135,000 X 125% = $168,750), two
calculations need to be made.
The first will be for the first term of the lease involving an
annuity due of $135,000 for three years at 8%, the implicit rate in
the lease, known to Cuomo.
$135,000
X 2.78326
$375,740.10

Annual rental payment


PV of annuity due of 1 for n = 3, i = 8%
PV of periodic rental payments

$ 168,750
X
.79383
$133,958.81

PV of renewal option rental in 3 years


PV of 1 for n = 3, i = 8%
PV of renewal option rental

$375,740.10
+133,958.81
$509,698.91

PV of periodic rental payments


PV of renewal option rental
PV of contractual lease payments liability

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EXERCISE 20-13 (Continued)

Excel formula =PV(rate,nper,pmt,fv,type)


Using a financial calculator:
PV
$ ?
I
8%
N
3
PMT
$( 135,000)
FV
$( 168,750)
Type
1
(b)

Date
Apr. 1
Apr. 1
Apr. 1
Apr. 1

Yields $509,699.93

Cuomo Mining Corporation


Lease Amortization Schedule
Interest
Annual
(8%)
Reduction
Lease
on Unpaid
of Lease
Payments
Liability
Liability
2014
2015
2016
2017

$135,000
135,000
135,000
168,750
$573,750

$29,976
21,574
12,500
$64,050

$135,000
105,024
113,426
156,250

Balance
of Lease
Liability
$509,700
374,700
269,676
156,250
0

(c)
April 1, 2014
Right-of-use Asset...............................
Obligations under Lease............

509,700

Obligations under Lease .....................


Cash ............................................

135,000

509,700
135,000

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EXERCISE 20-13 (Continued)


December 31, 2014
Interest Expense ..................................
Interest Payable ..........................
($29,976 X 9 12 = $22,482)

22,482
22,482

Amortization Expense .........................


95,569
Right-of-use Asset .....................
($509,700 4 years X 9 12 = $95,569)
April 1, 2015
Interest Expense ..................................
Interest Payable ...................................
Obligations under Lease .....................
Cash ............................................
*($29,976 X 3 12 = $7,494)
December 31, 2015
Interest Expense ..................................
Interest Payable ..........................
($21,574 X 9 12 = $16,181)
Amortization Expense .........................
Right-of-use Asset .....................
($509,700 4 years = $127,425)

95,569

7,494*
22,482
105,024
135,000

16,181
16,181

127,425
127,425

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EXERCISE 20-13 (Continued)


Part 3
Cuomo Mining Corporation
Statement of Financial Position Partial
December 31, 2015
Contract
Based
Current assets
Prepaid rent
Intangible assets
Right-of-use asset
Amortization to date
Net

$33,750
$509,700
(222,994) (1)
286,706

Liabilities:
Current liabilities:
Interest payable
Obligations under lease

16,181
113,426

Non-current liabilities:
Obligations under lease
Total liabilities

156,250
$285,857

Income statement
Amortization expense
Interest expense
Rent expense

Total expense - 4 years


Amortization expense
Interest expense
Rent expense

Operating
Lease

$127,425
23,675
________
$151,100
Contract
Based
$509,700
64,050 (2)
_______ (3)
$ 573,750

135,000
$ 135,000
Operating
Lease

$573,750
$573,750

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EXERCISE 20-13 (Continued)


(1) Sum of amortization 2014 ...................
And 2015 ..............................................
Total .....................................................

$ 95,569
127,425
$222,994

(2) Refer to total interest expense on amortization table.


(3) Rent expense
($135,000 X 3) + $168,750 = $573,750

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EXERCISE 20-14 (15-25 minutes)


(a)
Fair value of leased asset to lessor
Less: Present value of unguaranteed
residual value $45,626 X .56447
(present value of 1 at 10% for 6 periods)
Amount to be recovered through lease payments

$305,000.00
25,754.51
$279,245.49

Six periodic lease payments $279,245.49 4.79079*

$58,288**

*Present value of annuity due of 1 for 6 periods at 10%.


**Rounded to the nearest dollar.
Excel formula =PMT(rate,nper,pv,fv,type)
Using a financial calculator:
PV
$ (305,000)
I
10%
N
6
PMT
$ ?
FV
$ 45,626
Type
1

Yields $58,288

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EXERCISE 20-14 (Continued)


(b)

Date
1/1/14
1/1/14
1/1/15
1/1/16
1/1/17
1/1/18
1/1/19
12/31/19

Zoppas Leasing Corporation (Lessor)


Lease Amortization Schedule
Annual
Lease
Payment
Plus URV

$ 58,288
58,288
58,288
58,288
58,288
58,288
45,626
$395,354
* rounding of $1
(c)
1/1/14

1/1/14

Interest
(10%) on Net
Investment

Net
Investment
Recovery

$24,671
21,310
17,612
13,544
9,070
4,147*
$90,354

$ 58,288
33,617
36,978
40,676
44,744
49,218
41,479
$305,000

Balance
of Net
Investment
$305,000
246,712
213,095
176,117
135,441
90,697
41,479
0

Lease Receivable .......................... 395,354


Equipment Acquired for Lessee
Unearned Interest Income ....
Cash ...............................................
Lease Receivable ..................

58,288

31/10/14 Unearned Interest Income ............


Interest Income ......................
($24,671 12 X 10)

20,559

1/1/15

58,288

Cash ...............................................
Lease Receivable ..................

305,000
90,354

58,288

20,559

58,288

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EXERCISE 20-14 (Continued)


31/10/15 Unearned Interest Income ............
21,870
Interest Income ......................
($24,671 12 X 2) + ($21,310 12 X 10)

21,870

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EXERCISE 20-15 (20-25 minutes)


(a)
The lessor sets the annual rental payment as follows:
Fair value of leased asset to lessor
$28,500.00*
Less: Present value of bargain purchase
option $5,000 X .62026
(present value of 1 at 1% for 48 periods)
3,101.30
Amount to be recovered through lease payments $25,398.70
Forty-eight periodic lease payments
$25,398.70 38.3538**
$662.22
* Fair value of $29,500.00 less down payment of $1,000.00
**Present value of annuity due of 1 for 48 periods at 1%.
Excel formula =PMT(rate,nper,pv,fv,type)
Using a financial calculator:
PV
$ (28,500)
I
1%
N
48
PMT
$ ? Yields $662.22
FV
$ 5,000
Type
1
(b)
The lease agreement has a bargain purchase option. The lease,
therefore, qualifies as a capital lease from the viewpoint of the
lessee. The collectability of the lease payments is reasonably
predictable, and there are no important uncertainties
surrounding the costs yet to be incurred by the lessor. Due to
the fact that the initial amount of net investment (which in this
case equals the present value of the minimum lease payments,
($28,500 + the down payment of $1,000) exceeds the lessors
cost ($21,200), the lease is a sales-type lease to the lessor.

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EXERCISE 20-15 (Continued)


(c)
Turpin Corp. (Lessor)
Lease Amortization Schedule

Month
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23

Annual
Lease
Payment
Plus RV
$662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22

Interest
(1%) on Net
Investment

$278.38
274.54
270.66
266.75
262.79
258.80
254.76
250.69
246.57
242.42
238.22
233.98
229.70
225.37
221.00
216.59
212.13
207.63
203.09
198.50
193.86
189.18

Net
Investment
Recovery
$662.22
383.84
387.68
391.56
395.47
399.43
403.42
407.46
411.53
415.65
419.80
424.00
428.24
432.52
436.85
441.22
445.63
450.09
454.59
459.13
463.72
468.36
473.04

Balance
of Net
Investment
$28,500.00
27,837.78
27,453.94
27,066.26
26,674.70
26,279.23
25,879.80
25,476.38
25,068.92
24,657.39
24,241.74
23,821.94
23,397.94
22,969.70
22,537.18
22,100.33
21,659.11
21,213.48
20,763.40
20,308.81
19,849.68
19,385.96
18,917.60
18,444.55

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EXERCISE 20-15 (Continued)

Month
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48

Annual
Lease
Payment
Plus RV
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
662.22
5,000.00

Interest
(1%) on Net
Investment
184.45
179.67
174.84
169.97
165.05
160.07
155.05
149.98
144.86
139.69
134.46
129.18
123.85
118.47
113.03
107.54
101.99
96.39
90.73
85.02
79.24
73.41
67.53
61.58
55.57
49.33 *
$8,286.56

Net
Investment
Recovery
477.77
482.55
487.38
492.25
497.17
502.15
507.17
512.24
517.36
522.53
527.76
533.04
538.37
543.75
549.19
554.68
560.23
565.83
571.49
577.20
582.98
588.81
594.69
600.64
606.65
4,950.67
$28,500.00

Balance
of Net
Investment
17,966.78
17,484.23
16,996.85
16,504.60
16,007.42
15,505.28
14,998.11
14,485.87
13,968.51
13,445.97
12,918.21
12,385.18
11,846.81
11,303.06
10,753.87
10,199.19
9,638.96
9,073.13
8,501.64
7,924.43
7,341.46
6,752.65
6,157.96
5,557.32
4,950.67
-

* rounding by $.18
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EXERCISE 20-15 (Continued)


(d)

A journal entry would be required on December 31, 2014 by


Turpin Corp. to accrue the interest in the amount of
$254.76 related to payment no. 8, which is due January 1,
2015.
Unearned Interest Income ....................... 254.76
Interest Income ...................................

(e)

254.76

The income to be reported on the income statement of


Turpin Corp. for the fiscal year ending December 31, 2014
concerning this lease will be as follows:
Sales revenue
$29,500
Cost of goods sold
21,200
Gross profit
8,300
Interest income - lease
1,867
(Interest income represents the sum of the interest for
the first 7 payments from the table above and an accrual
of interest for the 8th payment)

(f)

At December 31, 2014, the statement of financial position


would have reported as a current asset, the amount of the
principal reduction that will be obtained in the next twelve
months. Based on the table above the sum of the principal
reduction for monthly payment 8 through 19 total $5,168.
The remaining amount of the balance of the investment at
December 31, 2014 ($25,476 less the current portion of
$5,168) of $20,308 will be reported as a long-term lease
receivable.

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EXERCISE 20-16 (25-35 minutes)


(a) Calculation of annual payments
Cost (fair value) of leased asset
to lessor
Less: Present value of residual value
$13,000 X .82645
(Present value of 1 at 10% for 2 periods)
Amount to be recovered through lease payments
Two periodic lease payments
$124,256.15 1.73554*

$135,000.00
(10,743.85)
$124,256.15
$71,595.09

*Present value of an ordinary annuity of 1 for 2 periods at 10%


Excel formula =PMT(rate,nper,pv,fv,type)
Using a financial calculator:
PV
$ (135,000)
I
10%
N
2
PMT
$ ? Yields $71,595.24
FV
$ 13,000
Type
0
Calculation of lease receivable
Annual payments ($71,595.09 X 2)
Residual value
Lease receivable

$143,190.18
13,000.00
$156,190.18

Calculation of unearned interest income


Gross investment by lessee
Asset cost (fair value)
Unearned interest income

$156,190.18
135,000.00
$ 21,190.18

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EXERCISE 20-16 (Continued)


(b) Castle Leasing Corporation should classify the lease as a
finance lease because it is not a manufacturer or dealer.
Wai Corporation, the lessee, will treat the lease as a finance
lease.
The IFRS criteria use qualitative factors to establish
whether or not the risks and rewards of ownership are
transferred to the lessee, and supports classification as a
finance lease:
1. There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of
the lease term. If there is a bargain purchase option in
the lease, it is assumed that the lessee will exercise it
and obtain ownership of the asset.
2. The lease term is long enough that the lessee will
receive substantially all of the economic benefits that
are expected to be derived from using the leased
property over its life.
3. The lease allows the lessor to recover substantially all
of its investment in the leased property and to earn a
return on the investment. Evidence of this is provided if
the present value of the minimum lease payments is
close to the fair value of the leased asset.
4. The leased assets are so specialized that, without major
modification, they are of use only to the lessee.
(c) For ASPE, rather than using qualitative factors described
under part (b) above for IFRS, quantitative criteria such as
any one of the following are used:
1. the term of the lease exceeding 75% of the remaining
economic life of the asset,
2. the present value of the minimum lease payments
exceeding 90% of the fair value of the asset, or
3. the transfer of title to the asset, perhaps represented
by the presence of a bargain purchase option will be
applied as the basis for the classification of the lease
as a capital lease for Wai Corporation.
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EXERCISE 20-16 (Continued)


For Castle Leasing, the lessor, the lease would receive the
same treatment as under IFRS, as long as the two revenue
recognition-based tests concerning collectability and
estimating unreimbursable costs are passed.
(d)
CASTLE LEASING CORPORATION (Lessor)
Lease Amortization Schedule

Date
1/1/14
12/31/14
12/31/15

Annual Pmt.
Interest
Excl. Exec.
on Net
Costs
Investment

Net
Investment
Recovery

$71,595.09
71,595.09

$58,095.09
63,904.91

*$13,500.00*
* 7,690.18*
*$21,190.18*
*Difference of $.31 due to rounding.

Net
Investment
$135,000.00
76,904.91
13,000.00

(e)
1/1/14

Lease Receivable ........................ 156,190.18


Equipment Acquired for Lessee
135,000.00
Unearned Interest
Income ..............................
21,190.18

12/31/14

Cash ($71,595.09 + $5,000) ......... 76,595.09


Accounts Payable (Executory Costs)
5,000.00
Lease Receivable .................
71,595.09
Unearned Interest Income .......... 13,500.00
Interest Income .....................
13,500.00

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EXERCISE 20-16 (Continued)


12/31/15

Cash ............................................. 76,595.09


Accounts Payable (Executory Costs)
5,000.00
Lease Receivable .................
71,595.09
Unearned Interest Income ..........
Interest Income .....................

(f)

12/31/15

7,690.18
7,690.18

Cash ..................................... 13,000.00


Lease Receivable ........
13,000.00

(g) Upon signing the lease, Wai Corporation should capitalize


the present value of the minimum lease payments in the
amount of $71,595.09 excluding the present value of the
option to purchase the equipment for $13,000. This will
yield an amount of $124,256.15 as calculated in part (a). The
lessee excludes this last payment, as it is not a guaranteed
payment by the lessee, Wai to the lessor, Castle Leasing.
Correspondingly, the obligation under finance lease should
be recorded at $124,256.15.
Using a financial calculator:
PV
$ ? Yields $ 124,255.94
I
10%
N
2
PMT
$ 71,595.09
FV
$ 0
Type
0

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EXERCISE 20-17 (25-35 minutes)


(a) Part 1. Annuity Due:
Fair value of leased asset to lessor
Less: Present value of unguaranteed
residual value $25,000 X .68058
(present value of 1 at 8% for 5 periods)
Amount to be recovered through lease payments

$415,000.00
17,014.50
$397,985.50

Five periodic lease payments $397,985.50 4.31213* $92,294.41


*Present value of annuity due of 1 for 5 periods at 8%.
Excel formula =PMT(rate,nper,pv,fv,type)
Using a financial calculator:
PV
$ (415,000)
I
8%
N
5
PMT
$ ? Yields $92,294
FV
$ 25,000
Type
1

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EXERCISE 20-17 (Continued)


(a) Part 2. Ordinary Annuity:
Fair value of leased asset to lessor
Less: Present value of unguaranteed
residual value $25,000 X .68058
(present value of 1 at 8% for 5 periods)
Amount to be recovered through lease payments

$415,000.00
17,014.50
$397,985.50

Five periodic lease payments $397,985.50 3.99271* $99,678.04


*Present value of annuity due of 1 for 5 periods at 8%.
Excel formula =PMT(rate,nper,pv,fv,type)
Excel formula =PMT(rate,nper,pv,fv,type)
Using a financial calculator:
PV
$ (415,000)
I
8%
N
5
PMT
$ ? Yields $99,678
FV
$ 25,000
Type
0

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EXERCISE 20-17 (Continued)


(b) 1
Vick Leasing Inc., (Lessor)
Lease Amortization Schedule

Date
Jan. 1,
Jan. 1,
Jan. 1,
Jan. 1,
Jan. 1,
Jan. 1,
Jan. 1,

Annual
Lease
Payment
Plus URV
2014
2014 $92,294.00
2015 92,294.00
2016 92,294.00
2017 92,294.00
2018 92,294.00
2019 25,000.00
$486,470.00

Interest
(8%) on Net
Investment

$25,816.48
20,498.28
14,754.62
8,551.47
1,849.15
$71,470.00

Net
Investment
Recovery
$92,294.00
66,477.52
71,795.72
77,539.38
83,742.53
23,150.85
$415,000.00

Balance
of Net
Investment
$415,000.00
322,706.00
256,228.48
184,432.76
106,893.38
23,150.85
0

(b) 2
Vick Leasing Inc., (Lessor)
Lease Amortization Schedule
Annual
Lease
Payment
Plus URV

Interest
(8%) on Net
Investment

Date
Jan. 1, 2014
Dec. 31, 2014 $99,678.00 $33,200.00
Dec. 31, 2015 99,678.00
27,881.76
Dec. 31, 2016 99,678.00
22,138.06
Dec. 31, 2017 99,678.00
15,934.87
Dec. 31, 2018 99,678.00
9,235.31
Dec. 31, 2018 25,000.00
$523,390.00 $108,390.00

Net
Balance
Investment
of Net
Recovery Investment
$415,000.00
$66,478.00 348,522.00
71,796.24 276,725.76
77,539.94 199,185.82
83,743.13 115,442.69
90,442.69
25,000.00
25,000.00
0.00
$415,000.00

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EXERCISE 20-17 (Continued)


(c)
1/1/14

Equipment Acquired for Lessee... 415,000.00


Cash ......................................
415,000.00
Lease Receivable .......................... 486,470.00
Unearned Interest Income ...
71,470.00
Equipment Acquired for Lessee
415,000.00

1/1/14

Cash ............................................... 96,294.00


Maintenance and Repairs Expense
Lease Receivable .................

4,000.00
92,294.00

during Maintenance and Repairs Expense 6,000.00


2014
Cash ......................................

6,000.00

12/31/14 Unearned Interest Income .........


Interest Income ..................
1/1/15

25,816.48
25,816.48

Cash ............................................... 96,294.00


Maintenance and Repairs Expense
Lease Receivable .................

4,000.00
92,294.00

during Maintenance and Repairs Expense 6,000.00


2015
Cash ......................................

6,000.00

12/31/15 Unearned Interest Income .........


Interest Income ..................

20,498.28
20,498.28

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EXERCISE 20-17 (Continued)


(d) Note X: (on Vick Leasing Inc.s financial statements:)
The company's net investment in a financing lease includes
the following:
Total minimum lease receivable
$301,882
Unearned income
45,654
$256,228
Future minimum lease payments receivable under the
financing lease are as follows:
Year ending December 31
2016
$92,294
2017
92,294
2018
92,294
Total minimum lease payments receivable
276,882
Unguaranteed residual value
25,000
$301,882
Vick Leasing would also need to disclose any contingent
rental income in the year, the allowance for doubtful
receivables and general information about their leasing
arrangement with Rock Corporation.

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EXERCISE 20-18 (15-20 minutes)


(a) Annual rental income ($480,000 X 8/12)
Less maintenance and other operating costs
Depreciation ($1,750,000 8 X 8/12)
Income before income tax

$320,000
(61,000)
(145,833)
$113,167

Note that any interest expense incurred by Pomeroy would also


be fully deductible for income tax purposes.
(b) Rent expense

$320,000

Note: Both the rent security deposit and the last months rent
prepayment should be reported as a non-current asset on
St. Isidors books and as a non-current liability on
Pomeroys books.
(c)

Under ASPE:
The disclosure requirements for operating leases from the
point of view of the lessee are few and include:
1. The future minimum lease payments, in total and for
each of the next five years.
2. A description of the nature of other commitments such
as this lease.
For the lessor, the disclosure recommended includes:
1. A description of the cost of property held for leasing
purposes and the amount of the accumulated
depreciation.
2. The amount of rental income from operating leases.
3. Any impairment information.

(d)

Under IFRS
For the lessee, additional disclosures are required about
material lease arrangements including contingent rents,
sub-lease payments and lease-imposed restrictions.

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EXERCISE 20-18 (Continued)


(d) (Continued)
For IFRS for operating leases, the lessor reports
information about the future minimum lease payments due
within one year, years two to five and after five years, as
well as about the entitys leasing arrangements.
As well, the property interest under an operating lease may
be recognized as an investment property and accounted
for under the fair value model.

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EXERCISE 20-19 (10-20 minutes)


(a) Entries for Morrison Corp. are as follows:
1/7/14

Buildings ...................................... 5,500,000


Cash ......................................
5,500,000
Property Tax Expense ...................
Insurance Expense ........................
Cash ......................................

12/31/14 Rent Receivable.............................


Rent Revenue .......................
($325,000 X 6 / 12 = $162,500)

57,000
11,000
68,000
162,500
162,500

Depreciation Expense ...................


68,750
Accumulated Depreciation
Buildings ......................
[($5,500,000 40) X 6 / 12 = $68,750]

68,750

(b) Entries for Wisen Inc. are as follows:


12/31/14 Rent Expense ................................
Rent Payable.........................

162,500
162,500

(c) The real estate brokers fee should be amortized equally


over the 10-year period. As a result, real estate fee expense
of $1,500 ($30,000 10 X 6 12) should be reported as an
expense in 2014 and $3,000 per year for each of the next
nine years until the last year of the lease when the expense
will be $1,500.
(d) None of the accounting treatment above would change if
Morrison were to use ASPE.

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EXERCISE 20-20 (15-20 minutes)


(a) (1) Calculation of gross investment:
$24,736 X 6 = $148,416
(2) Calculation of unearned interest income:
Gross investment
Less: Fair value of machine
Unearned interest income

$148,416
123,500*
$ 24,916

*$24,736 X 4.99271 (PV factor of annuity due at 8% for 6 periods)


Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
8%
N
6
PMT
$ 24,736
FV
$ 0
Type
1
(3)

Yields $123,499.68

Net investment in lease:


Lease receivable
Less: Unearned interest income

$148,416
24,916
$123,500

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EXERCISE 20-20 (Continued)


(b)
1/1/14

1/1/14

Lease Receivable ................................ 148,416


Cost of Goods Sold ............................. 99,000
Sales Revenue ............................
Inventory .....................................
Unearned Interest Income .........

123,500
99,000
24,916

Cash .................................................... 24,736


Lease Receivable ......................

24,736

12/31/14 Unearned Interest Income ..................


Interest Income .........................
[($123,500 $24,736) X .08]

7,901
7,901

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EXERCISE 20-21 (15-20 minutes)


(a)
Densmore Corporation
Rent Expense
For the Year Ended December 31, 2014
Monthly rental
Lease period in 2014 (MarchDecember)

$26,500
X 10 months
$265,000

(b)
Sigouin Inc.
Income or Loss from Lease before Tax
For the Year Ended December 31, 2014
Rent revenue ($26,500 X 10 months)
Less expenses
Depreciation
Commission
Income from lease before taxes

$265,000
$133,333**
7,500**

140,833
$124,167

**$1,600,000 cost 10 years = $160,000/year


$160,000 X 10/12 = $133,333
**(Note to instructor: Under principles of accrual
accounting, the commission should be amortized over the
life of the lease: $36,000 4 years = $9,000 X 10/12 =
$7,500.)
(c)

The amounts reported in (a) and (b) above would not


change if IFRS had been used by either company.

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*EXERCISE 20-22 (20-30 minutes)

1/1/14

Hein Corporation (Lessee)*


Cash ..........................................
720,000.00
Equipment (net) ..................
640,000.00
Deferred Profit on SaleLeaseback .......................
80,000.00

Equipment under Lease ...........


720,000.00
Obligations under Lease ....
720,000.00
($117,176.68 X 6.14457**)
**Present value of annuity of 1 for 10 periods at 10%
Excel formula =PV(rate,nper,pmt,fv,type)
PV
I
N
PMT
FV
Type

$ ?
10%
10
$ (117,176.68)
$ 0
0

Throughout 2014
Operating Expenses .................
Accounts Payable (or Cash)
12/31/14 Deferred Profit on Sale-Leaseback
Depreciation Expense*** ....
($80,000 10)

Yields $720,000

11,000.00
11,000.00
8,000.00
8,000.00

**Lease should be treated as a capital lease because present


value of minimum lease payments equals the fair value of the
computer. The lease term is greater than 75% of the economic
life of the asset, and title transfers at the end of the lease.
***The credit could also be to a gain account.

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*EXERCISE 20-22 (Continued)


12/31/14 Depreciation Expense ..............
Accumulated Depreciation
- Leased Equipment ......
($720,000 10)

72,000.00

Interest Expense.......................
Obligations under Lease* ........
Cash.....................................

72,000.00
45,176.68

72,000.00

117,176.68

Note to instructor:
1. The present value of an ordinary annuity at 10% for 10
periods should be used to capitalize the asset. In this case,
Hein would use the implicit rate of the lessor because it is
lower than its own incremental borrowing rate and known to
Hein.
2. The deferred profit on the sale-leaseback should be
amortized on the same basis that the asset is being
depreciated.
Partial Lease Amortization Schedule

Date
1/1/14
12/31/14
1/1/14

Annual
Lease
Payment

Interest
(10%)

Amortization

$117,176.68

$72,000.00

$45,176.68*

Balance
$720,000.00
674,823.32

Liquidity Finance Corp. (Lessor)*


Equipment Acquired for Lessee 720.000.00
Cash ...................................
720,000.00
Lease Receivable .......................1,171,766.80
($117,176.68 X 10)
Unearned Interest Income..
451,766.80
Equipment Acquired for Lessee
720,000.00

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*EXERCISE 20-22 (Continued)


12/31/14 Cash ............................................ 117,176.68
Lease Receivable ..............
117,176.68
Unearned Interest Income .........
Interest Income ..................

72,000.00
72,000.00

* Lease should be treated as a direct financing lease because


the present value of the minimum lease payments equals the
fair value of the equipment, and (1) collectability of the
payments is reasonably assured, (2) no important
uncertainties surround the costs yet to be incurred by the
lessor, and (3) the cost to the lessor equals the fair value of
the asset at the inception of the lease.
(b)

The primary reason for Hein to enter into a sale and


leaseback arrangement for its equipment is to borrow
cash. This transaction is similar to the purchase of new
equipment using capital leases, except that in this case,
Hein is using an asset it is already using and is familiar
with. Hein wishes to obtain some leverage by borrowing
funds for an amount that exceeds the carrying value of the
asset at the time of the sale.
Since the carrying value of the equipment on the books of
Hein at the time of the sale represents the depreciated cost
of the asset in use, this value is not intended to correspond
to its fair value. Hein can continue with its intention to use
the asset to the completion of its planned useful life. The
sale and leaseback arrangement will not disturb this plan.
Hein is taking advantage of the increase in value to obtain
additional financing at preferential rates. Creditors will not
view this action as a desperate measure since the gain on
the sale is being deferred and amortized.

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*EXERCISE 20-23 (20-30 minutes)


(a) Sale-leaseback arrangements are treated as though two
transactions were a single financing transaction if the lease
qualifies as a capital lease. Any gain or loss on the sale is
considered unearned and is deferred and amortized over the
lease term (if possession reverts to the lessor) or the
economic life (if ownership transfers to the lessee). In this
case, the lease qualifies as a capital lease because the lease
term (10 years) is 83% of the remaining economic life of the
leased property (12 years). Therefore, at 12/31/14, all of the
gain of $120,000 ($520,000 $400,000) would be deferred
and amortized over 10 years. Since the sale took place on
12/31/14, there is no depreciation for 2014.
(b) A sale-leaseback is usually treated as a single financing
transaction in which any profit on the sale is considered
unearned and is deferred and amortized by the seller.
However, the lease does not meet any of the criteria of a
capital lease for the property sold. In this case, the sale and
the leaseback are accounted for as separate transactions.
Therefore, the full gain ($480,000 $420,000, or $60,000) is
recognized.
(c) The profit on the sale of $121,000 should be deferred and
amortized over the lease term. The lease qualifies as a
capital lease. Since the leased asset is being depreciated
using the straight-line depreciation method, the deferred
gain should also be reported in the same manner. Therefore,
in the first year, $12,100 ($121,000 10) of the gain would be
recognized.
(d) In this case, Barnes Corp. would report a loss of $87,300
($300,000 $212,700) for the difference between the book
value and lower fair value. The CICA Handbook requires that
when the fair value of the asset is less than the book value
(carrying amount), a loss must be recognized immediately.
In addition, rent expense of $72,000 ($6,000 per month X 12
months) should be reported.
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*EXERCISE 20-24 (15-20 minutes)


(a)
September 15, 2014
Prepaid Rent .......................................................
Cash.............................................................
December 31, 2014
Rent Expense .....................................................
Prepaid Rent ...............................................
($30,000 X 3.5 / 12) = $8,750

30,000
30,000
8,750
8,750

(b) The rental of land can only be accounted for as a capital


lease by the lessee if the rental of the property contains a
bargain purchase option or if the lease transfers ownership
of the property to the lessee. Since this is not the case here,
the lease of the land had to be treated as an operating
lease. In the case of equipment, the possibility of
accounting for the lease as a capital lease is more likely to
depend on the terms of the lease in relation to the
capitalization criteria.
(c)
September 15, 2014
Cash .................................................................... 30,000
Unearned Rent Revenue ............................
December 31, 2014
Unearned Rent Revenue ....................................
Rent Revenue ..............................................
($30,000 X 3.5 / 12) = $8,750

30,000

8,750
8,750

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*EXERCISE 20-25 (20-25 minutes)


(a)
March 30, 2014
Land under Lease * ..............................................
Buildings under Lease .........................................
Obligations under Lease** ...........................
* (1/3 X $130,075** = $43,358)
Obligations under Lease......................................
Cash...............................................................

43,358
86,717
130,075
10,000
10,000

Excel formula =PV(rate,nper,pmt,fv,type)


**Using a financial calculator:
PV
$ ?
Yields $ 130,075
I
7%
N
15
PMT
$ (10,000)
FV
$ (90,000)
Type
1
Note: the $90,000 payment at the end of the lease is assumed to
be a bargain purchase option. At the end of the lease term, the
fair value of the land (2 X $50,000) and the building ($100,000 X
40%) combined is expected to be $140,000.
(b)
December 31, 2014:
Interest Expense ................................................
Interest Payable ..........................................
[($130,075 $10,000) X 7% X 9/12 = $6,304]
Depreciation Expense ........................................
Accumulated Depreciation
Leased Buildings .............
(($86,717-$10,000) / 20 year X 9/12 = $2,877)

6,304
6,304
2,877
2,877

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*EXERCISE 20-25 (Continued)


March 31, 2015
Interest Expense * ..............................................
Interest Payable ..................................................
Obligations under Lease.....................................
Cash.............................................................
* [($130,075 $10,000) X 7% X 3/12]

2,101
6,304
1,595
10,000

December 31, 2015:


Interest Expense ................................................
6,220
Interest Payable ..........................................
[($130,075 $10,000 - $1,595) X 7% X 9/12 = $6,220]
Depreciation Expense ........................................
Accumulated Depreciation
Leased Buildings ...................................
(($86,717-$10,000) / 20 year = $$3,836)

6,220

3,836
3,836

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TIME AND PURPOSE OF PROBLEMS


Problem 20-1

(Time 45-50 minutes)

Purposeto provide an opportunity for the student to contrast two alternative


means by which a business can acquire software for its business by using
leasing. Along with preparing all the necessary calculations, and journal entries,
the student must also contrast the financial statement effect of the two different
leasing alternatives. Finally the qualitative considerations and the short and longterm implications of each option must be outlined by the student.

Problem 20-2

(Time 45-50 minutes)

Purposeto provide an opportunity for the student to contrast two alternative


means by which a business can acquire equipment and software for its business
by using leasing. Along with preparing all the necessary calculations, the student
must also contrast the financial statement effect of the two different leasing
alternatives for the first year and for the overall term of lease plus a renewal
period under one option. Finally the qualitative considerations and the short and
long-term implications of each option must be outlined by the student,
emphasizing the effects on cash flow.

Problem 20-3

(Time 45-50 minutes)

Purposeto provide the student with a lease situation involving monthly


payments made for a truck. The lease has a residual value guaranteed by the
lessee. Along with preparing all the necessary calculations, and journal entries,
the student must also prepare the statement of financial position, the income and
cash flow statements on a comparative basis as well as any required note
disclosures. The must also prepare the journal entry at the completion of the
term of the lease involving the disposal of the truck and the lessees involvement
concerning the guaranteed residual value.

Problem 20-4

(Time 40-45 minutes)

Purposeto provide the student with a lease situation described in Problem 20-2
but from the perspective of the lessor. The requirement for comparative financial
statement disclosure is included in the problem.

Problem 20-5

(Time 40-45 minutes)

Purposeto provide an opportunity for the student to contrast the entries and
corresponding financial statements of the lessor and lessee when the conditions
call for the accounting of the lease as a capital lease to the lessee but as an
operating lease to the lessor. The odd result is that the asset is reported on both
statements of financial position.
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TIME AND PURPOSE OF PROBLEMS (CONTINUED)


Problem 20-6

(Time 20-30 minutes)

Purposeto develop an understanding of the accounting treatment for operating


leases. The student is required to identify the type of lease involved, explain the
respective reasons for their classification, and discuss the accounting treatment
that should be applied for both the lessee and lessor. The student is also asked
to record executory costs paid by the lessor and prepare the journal entries to
reflect the first year of this lease contract for both the lessee and lessor and to
discuss the disclosures required of the lessee and lessor. Included in this
problem is a requirement to compare the factors and criteria for classification
differences between IFRS and ASPE.

Problem 20-7

(Time 30-35 minutes)

Purposeto 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 must first discuss the conditions of
the case that support the argument to capitalize the lease and list specific
evidence to demonstrate that the transfer of risks and rewards of ownership has
taken place. The student must then calculate the appropriate amount at which to
capitalize the lease and, in a last requirement, given different interest rates,
prepare the statement of financial position and income statement presentation of
this lease by the lessee.

Problem 20-8

(Time 30-40 minutes)

Purposeto provide an understanding of how lease information is reported on


the statement of financial position and income statement for two different years in
regard to the lessee. In addition, the year-end month is changed in order to help
provide an understanding of the complications involved with partial periods.
Included in this problem is a requirement to compare the factors and criteria for
classification differences between IFRS and ASPE.

Problem 20-9

(Time 30-40 minutes)

Purposeto provide an understanding of how lease information is reported on


the statement of financial position and income statement for two different years in
regard to the lessor. In addition, the year-end month is changed in order to help
provide an understanding of the complications involved with partial periods.
Included in this problem is a requirement to compare the factors and criteria for
classification differences between IFRS and ASPE.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED)


Problem 20-10

(Time 40-50 minutes)

Purposeto develop an understanding of the accounting for capital leases


where the lease payments for the first half of the lease term differ from those for
the latter half. The student is required to calculate for the lessee the discounted
present value of the leased property and the related obligation at the leases
inception date. The student is also asked to prepare journal entries for the
lessee.

Problem 20-11

(Time 35-45 minutes)

Purposeto develop an understanding of the accounting procedures involved in


a sales-type leasing arrangement. The student is required to discuss the nature
of this lease transaction from the viewpoint of both the lessee and lessor. The
student is also requested to prepare the journal entries to record the lease for
both the lessee and lessor plus illustrate the items and amounts that would be
reported on the statement of financial position and statement of cash flows at the
end of the first year for the lessee and the lessor.

Problem 20-12

(Time 25-35 minutes)

Purposeto develop an understanding of the accounting for a capital lease by


the lessee in an annuity due arrangement. The student is required to prepare the
lease amortization schedule for the entire term of the lease and all the necessary
journal entries for the lease through the first two lease payments. The student is
also asked to indicate the amounts that would be reported on the lessees
statement of financial position and statement of cash flows. Finally the student
must contrast the financial statement reporting with that obtained for a new set of
conditions leading to the treatment of the lease as an operating lease.

Problem 20-13

(Time 35-45 minutes)

Purposeto develop an understanding of the accounting treatment accorded a


sales-type lease involving an unguaranteed and guaranteed residual value. The
student is required to discuss the nature of the lease with regard to the lessor
and to calculate the amount of the gross investment, the unearned interest
income, the sale price, and the cost of goods sols. The student is also required to
construct a 10-year lease amortization schedule for the leasing arrangement, and
to prepare the lessors journal entries for the first year of the lease contract.
Finally disclosure of the net investment must be prepared.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED)


Problem 20-14

(Time 40-50 minutes)

Purposeto develop an understanding of a capital lease with an unguaranteed


and guaranteed residual value, with and without a bargain purchase option. The
student explains why it is a capital lease and calculates the amount of the initial
obligation. The student prepares a 10-year amortization schedule and all of the
lessees journal entries for the first year under each of the different assumptions.
Included in this problem is a requirement to compare the factors and criteria for
classification differences between IFRS and ASPE.

Problem 20-15

(Time 40-45 minutes)

Purposeto develop an understanding of a sales-type lease with a guaranteed


and unguaranteed residual value. The student discusses the classification of the
lease and calculates the gross investment, unearned interest income, sales
price, and cost of sales. The student prepares a 10-year amortization schedule
and all of the lessors journal entries for the first year. The problem then goes on
to require the student to calculate the amount of depreciation to be recorded by
the lessee under conditions where the residual value is and is not guaranteed by
the lessee. The financial statement disclosure requirements to the lessor must
also be outlined based on these two conditions. Included in this problem is a
requirement to compare the factors and criteria for classification differences
between IFRS and ASPE.

Problem 20-16

(Time 30-40 minutes)

Purposeto develop an understanding of how residual values and direct costs in


processing the lease affect the accounting for the lessee and the lessor. The
student must understand both the accounting for a guaranteed and
unguaranteed residual value and determine how large the residual value must be
to have operating lease treatment. Included in this problem is a requirement to
compare the factors and criteria for classification differences between IFRS and
ASPE.

Problem 20-17

(Time 30-35 minutes)

Purposeto provide the student with the opportunity to contrast the financial
implications of two alternative leases offered to a business with liquidity
problems. The student must perform the necessary analysis to conclude as to
how the leases would be accounted for and provide a basis for the
recommendation in a formal report. The student will need to eliminate some
unnecessary minor factors (such as small differences in lease term dates) in
order to quickly zero in on the essential issues surrounding the choices offered.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED)


Problem 20-18

(Time 40-45 minutes)

Purposeto provide the student with the opportunity to contrast the financial
implications and reporting when a lease is treated as an operating lease by the
lessee and a capital lease by the lessor, on account of the involvement of a third
party when a guaranteed residual value exists. The student must prepare the
entries and the financial statement disclosure of both parties in the lease
agreement. This problem highlights the unsolved issue of the equipment not
being reported on either statement of financial position.

Problem 20-19

(Time 30-35 minutes)

Purposeto provide the student with the opportunity to prepare the accounting
for lease using the contract-based approach. Included in the instructions is a
revision of estimate concerning the guaranteed residual value of the leased
asset. Journal entries, adjusting journal entries and a revised amortization
schedule must also be prepared by the student.

Problem 20-20

(Time 50-80 minutes)

Purposeto provide the student with the opportunity to contrast three different
options to obtain a luxury vehicle, including: finance a purchase, lease and renew
a lease and lease and exercise the option to purchase. A fourth option must be
prepared suing the contract-based approach. Several calculations, amortization
tables and journal entries are also required in this problem. Finally, a summary
for the first years statement of financial position and income statement for all
options as well as a summary of all expenses for the 5 years use of the vehicle
must be summarized. Additional considerations in making choices must also be
provided by the student.

Problem 20-21

(Time 20-25 minutes)

Purposeto provide the student with the lessors accounting of one of the
options discussed in P20-20.

Problem 20-22*(Time 40-45 minutes)


Purposeto develop an understanding of how to handle a sale and leaseback
transaction, including the preparation of the lessees journal entries. A second set
of assumptions is used to arrive at a different conclusion, which is to account for
the lease as an operating lease.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED)


Problem 20-23*(Time 40-45 minutes)
Purposeto provide an opportunity for the student to account for a sale and
leaseback transaction where land and buildings are involved. The student must
apply the capitalization criteria to the building but leave the land as an operating
lease. The lease payments must therefore be disaggregated. This problem also
involves the financial statement disclosure required at the end of the first year of
the lease.

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SOLUTIONS TO PROBLEMS
PROBLEM 20-1
(a) Option No. 1 - Precision Inc.
Calculation of present value of minimum lease payments: The
$5,000 option to buy the software at the end of the lease of five
years is not considered a bargain purchase option in view of the
$200 price offered by Graphic Design Inc. in Option No. 2.
The lease payments are in the amount of $3,500 as the $1,000
annual licensing fee is an executory cost.
$3,500 X 3.79079* = $13,268
*Present value of an ordinary annuity of 1 for 5 periods at 10%.
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
10%
N
5
PMT
$ (3,500)
FV
$ 0
Type
0

Yields $13,268

Total lease payments:


At inception of lease January 1, 2014
Present value of minimum lease payments
Total

$12,000
13,268
$25,268

This is an operating lease to Interior Design Inc. since the lease


term (5 years) is less than 75% of the economic life (8 years) of
the leased asset. The lease term is 62.5% (5 8) of the assets
economic life. There is no bargain purchase option and the
present value of minimum lease payments of $25,268 represent
84% of the fair value at January 1, 2014 of $30,000 falling short
of the criteria of 90% to treat the lease as a capital lease under
ASPE.
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PROBLEM 20-1 (Continued)


(a) Option No. 2 Graphic Design Inc.
Calculation of present value of minimum lease payments:
The minimum lease payments in the case include the bargain
purchase option of $200. The present value therefore is:
PV of monthly payment * .......................................... $27,104
PV of bargain purchase option of $200 ** ................
124
Present value of minimum lease payments ............ $27,228
* Present value of an annuity due of 1 for 5 periods at 10%.
$6,500 X 4.16986 = $27,104
** Present value of a single payment of 1 for 5 periods at 10%
$200 X .62092 = $124
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
10%
N
5
PMT
$ (6,500)
FV
$ (200)
Type
1

Yields $27,228

To Interior Design Inc., this lease is a capital lease because the


terms satisfy the following criteria:
1.

Although as in Option No. 1, the lease term is not greater


than 75% of the economic life of the leased asset; that is, the
lease term is 62.5% (5/8) of the economic life, there is a
bargain purchase option.

2.

The present value of the minimum lease payments is greater


than 90% of the fair value of the leased asset; that is, the
present value of $27,228 is 91% of the fair value of the
leased asset of $30,000: ($27,228 / $30,000 = 90.76%)

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PROBLEM 20-1 (Continued)


(b)
January 1, 2015
Prepaid Rent ............................................... 12,000
Cash ...................................................

12,000

The first payment will be amortized straight-line over the


term of the lease.
December 31, 2015
Rent Expense (Software) ........................... 3,500
Operating Expenses ................................... 1,000
Cash ...................................................
4,500
December 31, 2015
Rent Expense (Software) ...........................
Prepaid Rent ........................................
($12,000 / 5 = $2,400)

2,400
2,400

(c)
Interior Design Inc.
Lease Amortization Schedule with Graphic Design Inc.

Date
1/1/15
1/1/15
1/1/16
1/1/17
1/1/18
1/1/19
1/1/19

Annual
Lease
Payment
$6,500
6,500
6,500
6,500
6,500
200
$32,700

Interest
(10%)
on Unpaid
Obligation

*$2,073
* 1,630
* 1,143
605607
18
*$5,471

Reduction
of Lease
Obligation
$6,500
4,427
4,870
5,357
5,893
182
$27,229

Balance
of Lease
Obligation
$27,228
20,728
16,301
11,431
6,074
181
0

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PROBLEM 20-1 (Continued)


(d)
January 1, 2015
Software under Lease ................................. 27,228
Obligations under Lease ....................

27,228

January 1, 2015
Obligations under Lease .............................
Cash .....................................................
December 31, 2015
Interest Expense ....................................
Interest Payable ....................

6,500
6,500

2,073
2,073

December 31, 2015


Depreciation Expense ................................. 3,404
Accumulated Depreciation
Software under Lease ...................
3,404
($27,228 8 years = $3,404)
Use 8 years, as option to purchase will be exercised as
it is a bargain price.
January 1, 2016
Interest Payable .....................................
Obligations under Lease .......................
Cash .....................................

2,073
4,427
6,500

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PROBLEM 20-1 (Continued)


(e)

Income statement effects:


Rent expense
Operating expense

Option No. 1
Operating
Lease
$3,500
1,000

Interest expense
Depreciation expense
Total expenses

_____
$4,500

Option No. 2
Capital
Lease

$2,073
3,404
$5,477

Asset and liability balances Dec. 31, 2015


Current assets:
Prepaid rent
$9,600
Non-current assets:
Software under lease
Less: accumulated depreciation

$27,228
(3,404)
$23,824

Current liabilities:
Interest payable
Current portion of obligations under
lease

2,073
4,427

Non-current liabilities:
Obligations under lease
Less current portion

20,728
(4,427)
16,301
$22,801

Total liabilities:
Total cash outflows during 2015

($16,500)

($6,500)

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PROBLEM 20-1 (Continued)


(f) Among Interiors paramount concerns will be ensuring that
it continues to meet its debt to equity covenant. Since all
financing is done with the bank, Interior Design Inc. may be
perceived to be of high risk by the bank. Entering into the
Precision Inc. lease (Option No. 1) would provide off balance
sheet financing, keeping the obligations under capital leases
off the balance sheet. Equity would be reduced by the lease
payments expensed each period.
In contrast the Graphic Design Inc. (Option No. 2) lease
would increase Interiors liabilities by the present value of
the minimum lease payments. Interest expense each period
and depreciation of the leased asset will decrease net
income and therefore equity each period.
To maintain their debt to equity covenant, Interior would
probably choose to enter into the Precision lease (operating
lease Option No. 1) to minimize debt on their statement of
financial position.
(g) In the long term, Option No. 2 presents the better option.
The software will be owned and used by Interior over the
eight-year useful life of the asset, instead of the five-year
term of lease under the operating lease, Option No. 1. The
other immediate disadvantage to the operating lease option
No. 1 is the large immediate (January 1, 2014) cash outflow
required by the prepayment clause under the operating
lease of $12,000. This payment could create an important
liquidity problem over the term of the lease, especially in the
first year.

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PROBLEM 20-1 (Continued)


(g) (Continued)
The conclusion to be drawn from this study is that choices
are often made by businesses for reasons outside what
makes economic sense overall. The FASB and IASB
movement towards removing the distinction between
operating and capital leases will eliminate this problem as
choices between leases will not be made based on the
objective to reduce or eliminate the presence of liabilities on
the statement of financial position.
Note to instructor:
The two alternatives are not, strictly speaking, comparable in a
capital budgeting sense as the difference in the purchase option
leaves option 1 with a 5 year life and option 2 with an 8 year life.
The present value of the purchase option in Option 1 (although a
non-GAAP treatment) is needed to make the two options
comparable (PV is $3,100). Option 2 is therefore superior in a
present value sense. It is important to mention that comparing
the accounting treatment without considering the impact on
cash flows is inadequate when evaluating managements
decisions.

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PROBLEM 20-2
Memorandum Prepared by:
TO: President of SWT
Date:

(Your Initials)

I have summarized the information regarding the two leases for


the customer service telecommunications and computer
equipment that you left with me.
Both leases are considered capital leases under generally
acceptable accounting principles, and I have indicated why this
is in the following chart, followed by my detailed calculations.
Capital lease arrangements are considered to be purchases from
an accounting standpoint, and accordingly, the costs that will
affect the income statement each year include: interest expense,
depreciation expense and any annual operating costs.
The following table shows that Lease Two has less of an impact
on income than Lease One in the 2014 year, and on average over
the number of years we will be using the leased equipment. As
both leases provide the SWT with similar equipment that meets
our requirement, it is my recommendation that we sign Lease
Two. From a cash flow standpoint, the lease payments of Lease
One are made in advance every year, while Lease Two payments
are made at the end of the year which gives us more liquidity.
Please keep in mind that with Lease One, the equipment will not
belong to us at the end of the lease term of five years, it will
revert to the lessor, and we are required to guarantee the value
at that time of $85,000. If we are interested in keeping the
equipment, we can decide at the end of the lease term if we wish
to purchase the equipment for $85,000; if we do not acquire it,
we may be required to make up any deficiency in its fair value
and this introduces considerable uncertainty. With Lease Two,
we will acquire the equipment over the seven year term of the
lease and cash flows are clearly defined. Accordingly, I am
recommending Lease Two.

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PROBLEM 20-2 (Continued)

Interest rate used in


calculations

Number of years of
use by SWT

Lease One
10% implicit
rate
unknown
5 years

Lease Two
8% - lower of
implicit rate and
incremental
borrowing rate
7 years

Present value of
minimum lease
payments
Type of Lease

$487,697 (1)

$444,404 (2)

Capital (3)

Capital (4)

Total cash outflow


from minimum lease
payments
Average per year

$606,500 (5)

$557,000 (6)

$121,300

Income statement effect first year


Interest expense
$38,339 (7)
Depreciation expense
$80,539 (9)
Operating expenses
$23,500
Total expenses
$142,378

$79,571

$35,552 (8)
$63,486 (10)
$26,500
$125,538

Total income statement effect over life of lease and renewal


Interest expense
$118,805 (11)
$112,596 (12)
Depreciation expense
$402,694 (13)
$444,404 (14)
Operating expenses
$117,500 (15)
$185,500 (16)
Total expenses
$638,999
$742,500
Average per year
$127,800
$106,071
Refer to Appendix A for details of calculations referenced to the
above.

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PROBLEM 20-2 (Continued)


Appendix A:
(1)

$104,300
X 4.16986
5)
$434,916.40
$85,000
X .62092
$52,778.20
$487,694.60
payments

Annual rental payment


PV of an annuity due 5 years at 10% (Table APV of minimum lease payments
Guaranteed residual value (or purchase price)
PV of 1 in 5 years at 10% (Table A-2)
Present value of guaranteed residual value
Total present value of minimum lease

Excel formula =PV(rate,nper,pmt,fv,type)


Using a financial calculator:
PV
$ ? Yields $487,695.28
I
10%
N
5
PMT
$ (104,300)
FV
$ (85,000)
Type
1
(2)

$111,000
X 3.99271
$443,190.81
$1,000
X 1.78326
1,783.26
X .68058
$1,213.65
$444,404.46

Annual rental payments ($137,500 $26,500)


PV, ordinary annuity 5 years at 8% (Table A-4)
PV of minimum lease payments
Annual rental renewal period ($27,500
$26,500)
PV, ordinary annuity 2 years at 8% (Table A-4)
PV of 1 in 5 years at 8% (Table A-2)
PV of lease renewal payments
Total present value of minimum lease
payments

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PROBLEM 20-2 (Continued)


Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? Yields $443,190.81
I
8%
N
5
PMT
$ 111,000*
FV
$0
Type
0
*($137,500 $26,500)
Using a financial calculator:
PV
$ ?
I
8%
N
2
PMT
$ 1,000*
FV
$0
Type
0
* ($27,500 $26,500)
Using a financial calculator:
PV
$ ?
I
8%
N
5
PMT
$0
FV
$ 1,783.26
Type
0

Yields $1,783.26

Yields $1,213.66

(3) The lease term is greater than 75% of the economic life of
the leased asset; that is, the lease term is 83% (5/6) of the
economic life.
The present value of the minimum lease payments equal the
fair value of the equipmentsee calculation

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PROBLEM 20-2 (Continued)


(4) The present value of the minimum lease payments is equal
to the fair value of the equipment.
(5) $104,300 x 5 + $85,000 = $606,500
(6) [($137,500 $26,500)*5] + [($27,500 $26,500) x 2)] =
$557,000
(7) ($487,694 104,300) x 10% = $38,339
(8) $444,404 x 8% = $35,552
(9) ($487,694 $85,000) 5 years = $80,539
(10) $444,404 7 = $63,486
(11) Cash outflows from lease (item 5) less PV min. lease
payments (item 1)
($606,500 $487,695 = $118,805)
(12) Cash outflows from lease (item 6) less PV min. lease
payments (item 2)
($557,000 $444,404 = $112,596)
(13) $487,694 $85,000 = $402,694 or item 9 X 5
(14) Capitalized amount of the lease or Item 10 X 7 = $444,404
(15) $23,500 X 5 = $117,500
(16) $26,500 X 7 = 185,500

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PROBLEM 20-3
(a) This is a finance lease to Hunter Ltd. The IFRS criteria use
qualitative factors to establish whether or not the risks and
rewards of ownership are transferred to the lessee, and
supports classification as a finance lease:
1. There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of
the lease term. If there is a bargain purchase option in
the lease, it is assumed that the lessee will exercise it
and obtain ownership of the asset.
2. The lease term is long enough that the lessee will
receive substantially all of the economic benefits that
are expected to be derived from using the leased
property over its life.
3. The lease allows the lessor to recover substantially all
of its investment in the leased property and to earn a
return on the investment. Evidence of this is provided if
the present value of the minimum lease payments is
close to the fair value of the leased asset.
4. The leased assets are so specialized that, without major
modification and/or significant cost to the lessor, they
are of use only to the lessee.
Other indicators include situations where the lessee
absorbs the lessors losses if the lessee cancels the lease,
or the lessee assumes the risk associated with the amount
of the residual value of the asset at the end of the lease, or
where there is a bargain renewal optionwhen the lessee
can renew the lease for an additional term at significantly
less than the market rent.
The standard also states that these indicators are not
always conclusive. The decision has to be made on the
substance of each specific transaction. If the lessee
determines that the risks and benefits of ownership have
not been transferred to it, the lease is classified as an
operating lease.
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PROBLEM 20-3 (Continued)


For Situ Ltd. the lessor, under IFRS, the lease would receive
the same treatment as under ASPE except the criteria need
not include the two revenue recognition-based tests
concerning collectability and estimating unreimbursable
costs. Situ is not a manufacturer or dealer and so this is
finance lease.
(b) Calculation of annual rental payment:
(Hint when using a financial calculator: ensure that the
compounding is done monthly, P/Y = 1)
Excel formula =PMT(rate,nper,pv,fv,type)
Using a financial calculator:
PV
$ 20,691
I
1%
N
36
PMT
$ ?
FV
$ (3,500)
Type
1

Yields ($600)

This confirms that the interest rate used to calculate the lease
payment was 12% or 1% per month. Alternatively, the RATE
function could have been used directly. (The lease payments
include the executory costs of $20 per month and are therefore
in the amount of $620.)

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PROBLEM 20-3 (Continued)


(c)
Lease Amortization Schedule

Date
Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sep.
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
Apr.
May
Jun.
July
Aug.
Sep.
Oct.
Nov.
Dec.

1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1

2014
2014
2014
2014
2014
2014
2014
2014
2014
2014
2014
2014
2015
2015
2015
2015
2015
2015
2015
2015
2015
2015
2015
2015

Monthly
Lease
Payment
Plus GRV
$ 600
600
600
600
600
600
600
600
600
600
600
600
600
600
600
600
600
600
600
600
600
600
600
600

Interest (1%)
on Unpaid
Obligation

$ 201
197
193
189
185
181
176
172
168
164
159
155
150
146
141
137
132
127
123
118
113
108
103

Reduction
of Lease
Obligation
$600
399
403
407
411
415
419
424
428
432
436
441
445
450
454
459
463
468
473
477
482
487
492
497

Balance
Lease
Obligation
$20,691
20,091
19,692
19,289
18,882
18,471
18,055
17,636
17,212
16,784
16,352
15,916
15,475
15,030
14,580
14,126
13,667
13,204
12,736
12,263
11,786
11,303
10,816
10,325
9,828

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PROBLEM 20-3 (Continued)


Lease Amortization Schedule

Date
Jan. 1
Feb. 1
Mar. 1
Apr. 1
May 1
Jun. 1
July 1
Aug. 1
Sep. 1
Oct. 1
Nov. 1
Dec. 1
Dec. 31

2016
2016
2016
2016
2016
2016
2016
2016
2016
2016
2016
2016
2016

Monthly
Lease
Payment
Plus GRV
$600
600
600
600
600
600
600
600
600
600
600
600
3,500
$25,100

Interest (1%)
on Unpaid
Obligation
$98
93
88
83
78
73
67
62
57
51
46
40
36*
$4,409

Reduction
of Lease
Obligation
$502
507
512
517
522
527
533
538
543
549
554
560
3,464
$ 20,691

Balance
Lease
Obligation
$9,326
8,819
8,308
7,791
7,269
6,741
6,209
5,671
5,127
4,579
4,025
3,465
0

* Rounding $1
(d)
January 1, 2014
Vehicles under Lease.....................................
Obligations under Lease ........................
(To record the lease of equipment
using finance lease method)
Obligations under Lease................................
Insurance Expense.........................................
Cash.........................................................
(To record the first rental payment)

20,691
20,691

600
20
620

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PROBLEM 20-3 (Continued)


(d) (Continued)
December 31, 2014
Interest Expense ............................................
155
Interest Payable ......................................
(To record accrual of Dec/2014 interest on
obligation under finance lease)

155

Depreciation Expense ....................................


5,730
Accumulated DepreciationVehicles ...
5,730
under Lease (To record depreciation expense for
first year [$20,691 - $3,500] 3)
January 1, 2015
Obligations under Lease................................
Interest Payable ..............................................
Insurance Expense.........................................
Cash.........................................................

445
155
20
620

(e)
Hunter Ltd.
Statement of Financial Position
December 31,
2015
Non-current assets
Property plant and equipment
Vehicles under lease
$20,691
Less accumulated depreciation
11,460
9,231
Current liabilities
Interest payable
98
Obligations under lease*
9,828
Non-current liabilities
Obligations under lease (Note X)
Current portion

2014
$20,691
5,730
14,961
155
5,704
15,475
(5,704)

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PROBLEM 20-3 (Continued)


(e) (Continued)
(Note X)
The following is a schedule of future minimum payments under
finance lease expiring December 31, 2016, together with the
present balance of the obligation under the lease.
2015
Amounts due in 2015
Amounts due in 2016
Amount representing executory costs
Amount representing interest
Balance of obligation
From lease amortization schedule:
Balance at December 31
Add accrued interest
Balance

$10,940
10,940
(240)
(774)
$9,926

2014
$7,440
10,940
18,380
(480)
(2,270)
$15,630

$9,828
98
$9,926

$15,475
155
$15,630

Hunter Ltd.
Income Statement
For the Year Ended December 31,
2015
Administrative expense
Depreciation expense
Insurance expense
Other expenses
Interest expense*

2014

$5,730
240

$5,730
240

1,497

2,139

* from lease amortization schedule part (c)

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PROBLEM 20-3 (Continued)


(f)
December 21, 2016
Interest Expense ............................................
36
Obligations under Lease................................
3,465*
Accumulated DepreciationVehicles
under Lease ......................................................... 17,190
Loss on Lease ................................................
300
Vehicles under Lease .............................
Cash.........................................................
* rounding $1

20,691
300

(g)
Hunter Ltd.
Statement of Cash Flows
For the Year Ended December 31,
2015
Indirect Format:
Cash flows from operating activities
Depreciation expense
Increase (decrease) in interest payable

$5,730
(57)*

Financing Activities:
Lease payment **
(5,646)
* ($155 $98)
** from lease amortization schedule part (c)

2014

$5,730
155
(5,216)

In the notes to the financial statements:


Non-cash Investing and Financing Activities:
Purchase of vehicle under lease

$20,691

Direct Format:
Cash flows from operating activities
Cash paid for interest
Cash paid for insurance

($1,984)
(240)

($1,554)
(240)

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PROBLEM 20-4
(a)
January 1, 2014
Lease Receivable ..........................................
Equipment Acquired for Lessee ...........
Unearned Interest Income .....................

25,100
20,691
4,409

Cash ..............................................................
Insurance Expense ................................
Lease Receivable ...................................
December 31, 2014
Unearned Interest Income ............................
Interest Income ......................................

620
20
600

1,984
1,984

Interest Receivable.........................................
Interest Income .......................................

155
155

(b)
Situ Ltd.
Income Statement
For the Year Ended December 31,
2015
Revenue
Interest Income (leases)*
Other expenses
(Recovery) of insurance expense

$1,497
(240)

2014
$2,139
(240)

* from lease amortization schedule part (c) of P20-3

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PROBLEM 20-4 (Continued)


(b) (Continued)
Situ Ltd.
Statement of Financial Position
December 31,
Current assets
Interest receivable
Net investment in vehicle leases
Non-current assets
Net investment in vehicle leases
Balance

2015

2014

$ 98
9,828

$ 155
5,647

$9,926

9,828
$15,630

Net investment in lease :


2015
Beginning balance ......................................... $15,475
Less recovery in year (see table P20-3) ........ (5,647)
Ending balance ............................................... $9,828
Recoverable within 12 months ......................
Non-current portion of net investment .........

2014
$20,691
(5,216)
15,475
(5,647)
$9,828

Reconciliation of balance:
From lease amortization schedule P20-3:
Balance at December 31
Add accrued interest
Balance

$15,475
155
$15,630

$9,828
98
$9,926

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PROBLEM 20-4 (Continued)


(c)
Situ Ltd.
Statement of Cash Flows
For the Year Ended December 31,

Indirect Format:
Cash flows from operating activities
(Increase) decrease in interest receivable
Investing Activities:
Collected on investment in lease*
Increase in investment in lease (net)
Direct Format:
Cash flows from operating activities
Cash collected for interest**
Cash collected for insurance expense

2015

2014

$57

($155)

5,646

5,216
(20,691)

$1,554
240

$1,984
240

* Amounts are the same as Cash paid on lease financing


activity of Hunter Ltd. P20-3 part (g)
** Amounts are the same as Cash paid for interest operating
activity of Hunter Ltd. P20-3 part (g)

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PROBLEM 20-5

(a) This is a capital lease to Labont 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 assets economic life.
For LePage, the collectibility of the lease payments is not
reasonably predictable, and there are important
uncertainties surrounding the costs yet to be incurred.
Accordingly, the earnings process is not considered
complete and, in spite of the fact that the fair value
($560,000) of the equipment exceeds the lessors cost
($420,000), the lease cannot be recorded as a sales-type
lease by LePage and must be recorded as an operating
lease.
(b) Calculation of annual rental payment:
To calculate the amount of the payments using Tables:
$560,000 ($80,000 X .37594*)
= $110,759
4.78448 * *

**Present value of $1 at 15% for 7 periods.


**Present value of an annuity due at 15% for 7 periods.
Excel formula =PMT(rate,nper,pv,fv,type)
Using a financial calculator:
PV
$ (560,000.00)
I
15%
N
7
PMT
$ ? Yields $110,759
FV
$
80,000
Type
1

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PROBLEM 20-5 (Continued)


(c)
7/15/14

Equipment under Lease ................


Obligations under Lease ........

560,000

Obligations under Lease...............


Cash ........................................

110,759

12/31/14 Depreciation Expense ...................


Accumulated Depreciation
-Leased Equipment ............
($560,000 - $80,000) 7 X 5.5/12

560,000
110,759
31,429
31,429

Interest Expense............................
30,885
Interest Payable ......................
($560,000 $110,759) X .15 X 5.5/12
7/15/15

Obligations under Lease...............


43,373
Interest Expense* ..........................
36,501
Interest Payable .............................
30,885
Cash ........................................
*($560,000 $110,759) X .15 X 6.5/12

12/31/15 Depreciation Expense ...................


Accumulated Depreciation
-Leased Equipment ............
($560,000 - $80,000) 7

30,885

110,759

68,571

Interest Expense............................
27,903
Interest Payable ......................
[($560,000 $110,759 $43,373) X .15 X 5.5/12]

68,571

27,903

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PROBLEM 20-5 (Continued)


(e)
7/15/14 Rental Equipment .........................
Inventory .................................

420,000
420,000

Cash ...............................................
Unearned Rent Revenue ........

110,759

Legal Expense* ..............................


Cash ........................................

4,000

12/31/14 Unearned Rent Revenue ...............


Rent Revenue .........................
($110,759 X 5.5/12)

50,765

110,759
4,000
50,765

Depreciation Expense ...................


Accumulated Depreciation
-Rental Equipment .............
($420,000 - $80,000) 7 X 5.5/12

22,262

Unearned Rent Revenue ...............


Rent Revenue .........................
($110,759 X 6.5/12)

59,994

Cash ...............................................
Unearned Rent Revenue ........

110,759

12/31/15 Depreciation Expense ...................


Accumulated Depreciation
-Rental Equipment .............
($420,000 - $80,000) 7

48,571

12/31/15 Unearned Rent Revenue ...............


Rent Revenue .........................
($110,759 X 5.5/12)

50,765

7/15/15

22,262

59,994

110,759

48,571

50,765

* If the amounts are significant, these costs might be capitalized


and amortized to expense to achieve better matching with
revenues.
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PROBLEM 20-5 (Continued)


(d)
Labont
Capital
Lease
Statement of financial position:
Property Plant & Equipment:
Equipment under lease
Rental equipment
Less: Accumulated depreciation
Current Liabilities:
Interest payable
Current portion of obligations under
lease
Unearned rent revenue
Long term liabilities:
Obligations under lease
Less: Current portion

Statement of income:
Rent revenue
Depreciation expense
Interest expense
Legal expense

(f)
LePage
Operating
Lease

$560,000
(31,429)
528,571

$ 420,000
(22,262)
397,738

30,885
43,373
59,994

449,241
(43,373)
405,868

$ 31,429
30,885

$ 50,765
22,262
4,000

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PROBLEM 20-5 (Continued)


(g) Although it might seem odd that the same asset is reported
on two different statements of financial position, the
collection risks under which the lessor, LePage, is
operating do not justify the recognition of income under a
sales type lease. There are too many uncertainties
surrounding the related costs and collections under the
terms of its lease with Labont. Should Labont default on
the lease, LePage might have to rent the used equipment to
another lessee. It is not unreasonable, also, to consider that
the guarantee of the residual value by the lease, Labont,
should not be considered in the calculations (e.g. for
depreciation) as that companys financial situation may
make them unable to make good on the guarantee.

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PROBLEM 20-6
(a)
Under IFRS, meeting any one or a combination of the following
criteria normally indicates that the risks and rewards of
ownership are transferred to the lessee, and supports
classification as a finance lease:
1. There is reasonable assurance that the lessee will obtain
ownership of the leased property by the end of the lease
term. If there is a bargain purchase option in the lease, it is
assumed that the lessee will exercise it and obtain
ownership of the asset.
2. The lease term is long enough that the lessee will receive
substantially all of the economic benefits that are
expected to be derived from using the leased property
over its life.
3. The lease allows the lessor to recover substantially all of
its investment in the leased property and to earn a return
on the investment. Evidence of this is provided if the
present value of the minimum lease payments is close to
the fair value of the leased asset.
4. The leased assets are so specialized that, without major
modification and/or significant cost to the lessor they are
of use only to the lessee.
None of these conditions have been met and so the lease is an
operating lease to both Synergetics and Gumowski.
(b)
Under ASPE, the lease is an operating lease to the lessee and
lessor because:
1.

it does not transfer ownership, or it does not contain a


bargain purchase option,

2.

it does not cover at least 75% of the estimated


economic life of the crane, and

3.

the present value of the lease payments is not at least


90% of the fair value of the leased crane.

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PROBLEM 20-6 (Continued)


(b) (Continued)
$21,500 Annual Lease Payments X PV of annuity due at 7%
for 6 years $21,500 X 5.10020 = $109,654, which is less than
$144,000.00 (90% X $160,000.00)
At least one of the three criteria would have had to be
satisfied for the lease to be classified as other than an
operating lease. The property is recorded as a rental
property to the lessor and will be treated as a payment of
rent by the lessee under the operating lease.
(c)

Lessees Entries
February 1, 2014
Prepaid Rent .............................................
Cash ...................................................

21,500

December 31, 2014


Rent Expense ............................................
Prepaid Rent ......................................
($21,500 X 11/12)

19,708

21,500

19,708

Lessors Entries
February 1, 2014
Cash...............................................................
Unearned Rent Revenue .......................

21,500

February 1, 2014
Prepaid Insurance.........................................
Prepaid Expenses (other) ($1,200 + 200)....
Cash or Accounts Payable ...................

450
1,400

21,500

1,850

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PROBLEM 20-6 (Continued)


December 31, 2014
Unearned Rent Revenue ..........................
Rent Revenue ....................................
($21,500 X 11/12)
Insurance Expense ($450 X 11/12)...........
Maintenance and Repairs Expense
($1,200 X 11/12) .............................
Other Expenses ($200 X 11/11) ................
Prepaid Insurance .........................
Prepaid Expenses (other) .............
Depreciation Expense ..............................
Accumulated Depreciation
Rental Equipment ....................
[($160,000 $20,000) 12 X 11/12]
(d)

19,708
19,708
413
1,100
200
413
1,300
10,694
10,694

Gumowski Construction as lessee must disclose in the


income statement the $19,708 of rent expense and in the
notes the total future minimum rental payments required of
$107,500, and for each of the following periods: in 2015 $21,500; 2016 to 2019 - $86,000. Additional disclosures are
required about material lease arrangements including
contingent rents, sub-lease payments and lease-imposed
restrictions. No information regarding this lease would
appear on the lessees statement of financial position.
Synergetics Inc. as lessor must disclose in the statement
of financial position or in the notes the cost of the leased
crane ($160,000) and the accumulated depreciation of
$10,694 separately from assets not leased. Additionally,
Synergetics discloses in the notes the future minimum
lease payments to be received as a total of $107,500, and
for each of the following periods: in 2015 - $21,500; 2016 to
2019 - $86,000.

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PROBLEM 20-7
(a) Benefits of ownership are the ability to use the asset to
generate profits over its useful life, to benefit from any
appreciation in the assets value, and to realize its residual
value at the end of its economic life. The risks, on the other
hand, are the exposure to uncertain costs and returns, and
to risk of loss from use or idle capacity and from
technological obsolescence.
The IFRS criteria use qualitative factors to establish
whether or not the risks and rewards of ownership are
transferred to the lessee, and supports classification as a
finance lease:
1. There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of
the lease term. If there is a bargain purchase option in
the lease, it is assumed that the lessee will exercise it
and obtain ownership of the asset.
2. The lease term is long enough that the lessee will
receive substantially all of the economic benefits that
are expected to be derived from using the leased
property over its life.
3. The lease allows the lessor to recover substantially all
of its investment in the leased property and to earn a
return on the investment. Evidence of this is provided if
the present value of the minimum lease payments is
close to the fair value of the leased asset.
4. The leased assets are so specialized that, without major
modification at significant cost to the lessor, they are of
use only to the lessee.
No numerical thresholds are applied, as is the case with
ASPE, and so the treatment of the lease by the lessee
would be the same, although it would be referred to as a
finance lease, rather than a capital lease.

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PROBLEM 20-7 (Continued)


(b) The conditions of the lease lead us to conclude that the
risks and benefits of ownership have passed from the
lessor to the lessee. Evidence of this includes the bargain
purchase option of $44,440 compared to the residual value,
which is estimated at $100,000 and will never fall below
$75,000. This fact taken with the fact that the lease term is
10 of the 15 years of the useful life of the airplane, it would
be foolish for Ramey not to exercise the option to purchase
the plane. Airplanes, when properly maintained, retain their
value. Since Ramey is already paying for the maintenance, it
will benefit from this investment in the increased resale
value of the airplane once the bargain purchase option is
exercised. Ramey will consequently benefit from any
appreciation in value of this asset, beyond the term of the
lease.
(c) The appropriate amount for the leased aircraft on Ramey
Corporations statement of financial position after the lease
is signed is $1,000,000, the fair value of the plane and the
present value of the net rental payments and bargain
purchase option discounted at 8%.
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? Yields $1,000,001.22
I
8%
N
10
PMT
$( 135,150)
FV
$( 44,440)
Type
1

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PROBLEM 20-7 (Continued)


(d) The leased aircraft will be reflected on Ramey Corporations
statement of financial position as follows:
Noncurrent assets
Equipment under lease
Less accumulated depreciation
Current liabilities
Obligations under lease (Note A):
Interest payable
Principal current portion

$1,000,000
59,097
$ 940,903

74,366
60,180

Non-current liabilities
Obligations under lease (Note A)
$ 802,040
The following items relating to the leased aircraft will be
reflected on Ramey Corporations income statement:
Depreciation expense (Note A)
$59,097
Interest expense
74,366*
Maintenance and repairs expense
6,900
Insurance and tax expense
4,000
*[($1,000,000 - $137,780) X 9% X 11.5/12]
Note A
The company leases a Viking turboprop aircraft under a finance
lease. The lease runs until January 15, 2024. The annual lease
payment is paid in advance on January 15 and amounts to
$141,780, of which $4,000 is executory costs. The aircraft is
being depreciated on the straight-line basis over the economic
life of the asset, estimated as 15 years. The depreciation on the
aircraft included in the current years depreciation expense and
the accumulated depreciation on the aircraft amount to $59,097
($61,667 X 11.5/12).

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PROBLEM 20-7 (Continued)


Calculations
Depreciation expense:
Capitalized amount
Residual value
Economic life
Annual depreciation

$1,000,000
75,000
$ 925,000
15 years
$61,667

Depreciation for the first year prorated to 11.5 months:


$61,667 X 11.5/12
$59,097
Liability amounts:
Obligations under lease 1/15/14
$1,000,000
Payment 1/15/14 ($141,780 - $4,000)
137,780
Obligations under lease 12/31/14
862,220
Reduction of principal* in next 12 months
60,180
Non-current obligations under lease 12/31/14 $ 802,040
*Lease payment, Jan. 15/15
Interest: 9% X $862,220 =
Principal payment =

$137,780
77,600
$ 60,180

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PROBLEM 20-8

(a) 1.

2.

3.

Interest expense (See amort. schedule)


Operating expenses
Depreciation expense ($150,690 6)
Property, plant, and equipment:
Property under lease
Accumulated depreciation

$10,216
$2,500
$25,115
$150,690
($25,115)

Current liabilities:
Obligations under lease
Interest payable

$20,284
$10,216

Long-term liabilities:
Obligations under lease

$99,906

Interest expense (See amort. schedule)


Operating expenses
Depreciation expense ($150,690 6)

$8,492
$2,500
$25,115

4. Property, plant, and equipment:


Property under lease
Accumulated depreciation

$150,690
($50,230)

Current liabilities:
Obligations under lease
Interest payable

$22,008
$8,492

Long-term liabilities:
Obligations under lease

$77,898

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PROBLEM 20-8 (Continued)

(b) 1.

2.

Interest expense ($10,216 X 3/12 )


Operating expenses ($2,500 X 3/12)
Depreciation expense
($150,690 6 = $25,115 X 3/12)
Current assets:
Prepaid expenses
($2,500 X 9/12 = $1,875)
Property, plant, and equipment:
Property under lease
Accumulated depreciation

3.

$2,554
$625
$6,279

$1,875

$150,690
($6,279)

Current liabilities:
Obligations under lease
Interest payable

$20,284
$2,554

Long-term liabilities:
Obligations under lease

$99,906

Interest expense
[($10,216 $2,554) + ($8,492 X 3/12) =
$7,662 + [$2,123 = $9,785]
Operating expenses
Depreciation expense ($150,690 6)

$9,785
$2,500
$25,115

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PROBLEM 20-8 (Continued)


4.

Current assets:
Prepaid expenses

$1,875

($2,500 X 9/12 = $1,875)


Property, plant, and equipment:
Property under lease
Accumulated depreciation

$150,690
($31,394)

($6,279 + $25,115 = $31,394)


Current liabilities:
Obligations under lease
Interest payable ($8,492 X 3/12)

$22,008
$2,123

Long-term liabilities:
Obligations under lease

$77,898

(c) For McKee Electronics Ltd.(the lessee):


Rather than using quantitative factors such as the 75
percent and the 90 percent hurdles often referred to as the
bright lines used in ASPE, IFRS criteria use qualitative
factors to establish whether or not the risks and rewards of
ownership are transferred to the lessee, and supports
classification as a finance lease:
1. There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of
the lease term. If there is a bargain purchase option in
the lease, it is assumed that the lessee will exercise it
and obtain ownership of the asset.
2. The lease term is long enough that the lessee will
receive substantially all of the economic benefits that
are expected to be derived from using the leased
property over its life.

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PROBLEM 20-8 (Continued)


3. The lease allows the lessor to recover substantially all
of its investment in the leased property and to earn a
return on the investment. Evidence of this is provided if
the present value of the minimum lease payments is
close to the fair value of the leased asset.
4. The leased assets are so specialized that, without major
modification and cost to the lessor, they are of use only
to the lessee.

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PROBLEM 20-9
(a) 1.
2.

Interest income

$10,216

Current assets:
Lease receivable
Unearned interest income
Net investment in lease

$30,500
(0)
$30,500

Noncurrent assets:
Lease receivable
($183,000 $30,500 $30,500)
Unearned interest income
($32,310 $10,216)
Net investment in lease
3.

Interest income

4.

Current assets:
Lease receivable
Unearned interest income
Net investment in lease
Noncurrent assets:
Lease receivable
($183,000 $30,500 $30,500 $30,500)
Unearned interest income
($32,310 $10,216 $8,492)
Net investment in lease

(b) 1.
2.

Interest income ($10,216 X 3/12 = $2,554)


Current assets:
Lease receivable
Unearned interest income
($10,216 $2,554)
Net investment in lease

$122,000
(22,094)
$99,906
$8,492
$30,500
(0)
$30,500
$91,500
(13,602)
$77,898
$2,554

$30,500
(7,662)
$22,838

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PROBLEM 20-9 (Continued)


Noncurrent assets:
Lease receivable
($183,000 $30,500 $30,500)
Unearned interest income
($32,310 $10,216)
Net investment in lease
3.

Interest income
[($10,216 $2,554) + ($8,492 X 3/12) =
$7,662 +$2,123]

4.

Current assets:
Lease receivable
Unearned interest income
($8,492 $2,123)
Net investment in lease
Noncurrent assets:
Lease receivable
($183,000 $30,500 $30,500 30,500)
Unearned interest income
($32,310 $10,216 $8,492)
Net investment in lease

(c)

$122,000
(22,094)
$99,906
$9,785

$30,500
(6,369)
$24,131
$91,500
(13,602)
$77,898

Using IFRS, Woodhouse considers the same factors as


McKee, the lessee, in determining whether the risks and
benefits of ownership of the leased property are transferred.
These factors include:
1. There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of
the lease term. If there is a bargain purchase option in
the lease, it is assumed that the lessee will exercise it
and obtain ownership of the asset.

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PROBLEM 20-9 (Continued)


2. The lease term is long enough that the lessee will
receive substantially all of the economic benefits that
are expected to be derived from using the leased
property over its life.
3. The lease allows the lessor to recover substantially all
of its investment in the leased property and to earn a
return on the investment. Evidence of this is provided if
the present value of the minimum lease payments is
close to the fair value of the leased asset.
4. The leased assets are so specialized that, without major
modification, and significant cost to the lessor, they are
of use only to the lessee.
In this case, the lessor would record the lease as a
financing-type lease, as Woodhouse is not a manufacturer
or dealer.

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PROBLEM 20-10

(a)

YIN TRUCKING CORPORATION


Schedule to Calculate the Discounted Present Value of
Terminal Facilities and the Related Obligations
January 1, 2012

Present value of first 10 payments:


Present value of an annuity due for
10 years at 6% ($900,000 X 7.80169)
Present value of last 10 payments:
Present value of an annuity due for
10 years at 6% ($320,000 X 7.80169)
Discounted to January 1, 2012
($2,496,541 X .558395)
Present value of bargain purchase option
of ($1,000,000 X .31180)
Present value of terminal
facilities and related obligations

$7,021,521

2,496,541
1,394,056
311,800
$8,727,377

(Note to instructor: For the last ten periods, the present value
of an annuity due for 20 periods less the present value of an
annuity due for 10 periods can be used as follows: ([12.15812
7.80169] X $320,000 = $1,394,056).
Excel formula =PV(rate,nper,pmt,fv,type)

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PROBLEM 20-10 (Continued)


Present value of the first ten years of annuity of $900,000 is
$7,021,523
Using a financial calculator:
PV
$?
I
6%
N
10
PMT
$ (900,000)
FV
$ 0
Type
1

Yields $7,021,523.05

Present value (at end of first ten years) of the next ten year
annuity of $320,000 is $2,496,541
Using a financial calculator:
PV
$?
I
6%
N
10
PMT
$ (320,000)
FV
$ 0
Type
1

Yields $2,496,541

Calculate the present value of single amount of $2,496,541 for


ten years at 6% and obtain $1,394,056
Using a financial calculator:
PV
$ ?
I
6%
N
10
PMT
$ 0
FV
$ (2,496,541)
Type
1

Yields $1,394,056

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PROBLEM 20-10 (Continued)


Calculate the present value of single amount of $1,000,000 for
twenty years at 6% and obtain $311,805
Using a financial calculator:
PV
$ ?
I
6%
N
20
PMT
$ 0
FV
$ (1,000,000)
Type
1
(b)
(1)

Yields $311,805

YIN TRUCKING CORPORATION


Journal Entries
2014
1/1/14

Interest Payable ............................................


Obligations under Lease..............................
Property Tax Expense ..................................
Insurance Expense.......................................
Cash.......................................................

442,080
457,920
125,000
23,000
1,048,000

Partial Amortization Schedule


(Annuity Due Basis)
Date
1/1/12
1/1/12
1/1/13
1/1/14
1/1/15

Lease
Payment

$1,048,000
1,048,000
1,048,000
1,048,000

Executory Interest
Principal
Principal
Costs
at 6%
Reduction Balance

$8,700,000
$148,000 $
0 $900,000
7,800,000
468,000
7,368,000
148,000
432,000
148,000
457,920
442,080
6,910,080
148,000
414,605
485,395
6,424,685

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PROBLEM 20-10 (Continued)


(2)
12/31/14
Depreciation Expense ..................................
217,500
Accumulated DepreciationLeased Terminals
(To record annual depreciation expense
on assets under lease) ($8,700,000 40)

217,500

(3)
12/31/14
Interest Expense ...........................................
Interest Payable .....................................
(To record interest accrual at 6% on
outstanding debt of $6,910,080)

414,605

414,605

(c) Yins statement of financial position at December 31, 2014


would show the following:
Property plant and equipment
Terminals under lease
Accumulated depreciation
Current liabilities:
Interest payable
Current portion of obligations under
lease
Long-term liabilities:
Obligations under lease

$8,700,000
652,500*
8,047,500
$442,080
457,920
6,910,080

* $217,500 X 3 years

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PROBLEM 20-11
(a) The lease should be treated as a capital lease by Lee
Industries, requiring the lessee to capitalize the leased
asset. The lease qualifies for capital lease accounting by the
lessee because: (1) title to the engines transfers to the
lessee, and (2) the lease term is equal to the estimated life
of the asset. While no mention is made of the amount of the
fair value of the leased asset at January 1, 2014, it is
reasonable to assume that it would be above the cost to
manufacture the engines. Lor Inc. is in business to
manufacture and sell its products, so Lor would want to
recover the sales price of the engines, not just their cost.
The present value of the minimum lease payments (see
below) is $4,500,000 and the assumption is that this is the
selling price and fair value of the engines. The transaction
represents a purchase financed by instalment payments
over a 10-year period.
For Lor Inc. the transaction is a sales-type lease because a
manufacturers profit accrues to Lor Inc. This lease
arrangement also represents the manufacturers financing
of the transaction over a period of 10 years.
Lease Payment Receivable
Payment per period
Periods
Lease receivable

$ 620,956
X
10
$6,209,560

Present Value of Lease Payments


$620,956 X 7.24689*

$4,500,000

*Present value of an annuity due at 8% for 10 years.

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PROBLEM 20-11 (Continued)


Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
8%
N
10
PMT
$ (620,956)
FV
$ 0
Type
1

Yields $4,499,999

Unearned Interest Income


Lease receivable
Less: Present value of lease payments
Unearned interest income

$6,209,560
4,500,000
$1,709,560

Dealer Profit
Sales revenue
(present value of lease payments)
Less cost
Profit on sale

$4,500,000
3,900,000
$ 600,000

(b) Equipment under Lease .......................... 4,500,000


Obligations under Lease .................
4,500,000
Obligations under Lease .......................
Cash ................................................

620,956
620,956

(c) Lease Receivable ................................... 6,209,560


Cost of Goods Sold ............................... 3,900,000
Sales Revenue ................................
4,500,000
Inventory .........................................
3,900,000
Unearned Interest Income .............
1,709,560
Cash........................................................
Lease Receivable ...........................

620,956
620,956

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PROBLEM 20-11 (Continued)


(d)

Lee Industries
Lor Inc.
Lease Amortization Schedule

Date
1/1/14
1/1/14
1/1/15
1/1/16

(e)

Annual
Lease
Payment/
Receipt
620,956
620,956
620,956

Interest
Income/
Expense
at 8%

Reduction
in Present
Value of
Lease

310,324
285,473

620,956
310,632
335,483

Present
Value of
Lease
4,500,000
3,879,044
3,568,412
3,232,929

Lessee (December 31, 2014)


Interest Expense ....................................
310,324
Interest Payable..............................

310,324

Lessor (December 31, 2014)


Unearned Interest Income .....................
310,324
Interest Income...............................

310,324

LEE INDUSTRIES
Statement of Financial Position
December 31, 2014

Property, plant, and equipment:


Equipment under
lease
$4,500,000
Less accumulated
depreciation
450,000*
$4,050,000

Current liabilities:
Interest payable
Obligations under
lease
Long-term liabilities:
Obligations under
lease

$ 310,324
310,632***

3,568,412**

***$4,500,000 10 = $450,000
*** taken from amortization schedule above

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PROBLEM 20-11 (Continued)


LOR INC.
Statement of Financial Position
December 31, 2014
Assets:
Current assets:
Net investment in leases
Noncurrent assets:
Net investment in leases

$ 310,632*
$3,568,412*

* from amortization schedule


(f) The transaction securing the equipment using the capital
lease would not be reported on the statement of cash flows
for the year ending December 31, 2014 of Lee, the lessee.
This is a non-cash financing and investing transaction to
Lee. These transactions would be described in the notes to
the respective financial statements. The only cash
transaction between the parties during 2014 is the January
1, 2014 lease payment in the amount of $620,956. This
transaction is an operating activity inflow to Lor and is a
financing outflow to Lee. For Lee, the annual depreciation
for 2014 would be an adjustment to determine cash flow
from operations under the indirect approach. For Lor, the
operating cash flows would be included in the adjustments
to net income under the indirect approach and would be
shown as part of cash collected from customers under the
direct approach.

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PROBLEM 20-11 (Continued)


(g) Note X: (on Lees financial statements:)
The following is a schedule of future minimum lease
payments under the capital lease expiring December 31,
2023 together with the balance of the obligations under
capital leases.
Year ending December 31
2015
$620,956
2016
620,956
2017
620,956
2018
620,956
2019
620,956
2020 and beyond
2,483,824
Total minimum lease payments
5,588,604
Less amount representing interest at 8%
1,709,560
Balance of the obligations
$3,879,044
(h) Note Y: (on Lors financial statements:)
The company's future minimum lease payments receivable
under the sales-type lease and the net investment in lease
are as follows:
Year ending December 31
2015
$620,956
2016
620,956
2017
620,956
2018
620,956
2019
620,956
2020 and beyond
2,483,824
Total minimum lease payments receivable
$5,588,604
Unearned income
1,709,560
Net investment in lease
$3,879,044

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PROBLEM 20-12
(a)

January 31, 2014


Equipment under Lease ............................. 173,448
Obligations under Lease ....................
173,448
(To record leased asset and related obligations)

PV of monthly payment of $41,000 X 4.16987* .............. $170,964


PV of residual value of $4,000 X .62092** ......................
2,484
Present value of minimum lease payments .................. $173,448
* (PV factor for annuity due for 5 years at 10%)
** (PV factor for $1 for 5 years at 10%)
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? Yields $ 173,448.17
I
10%
N
5
PMT
$ (41,000)
FV
$ (4,000)
Type
1
January 31, 2014
Obligations under Lease ............................ 41,000
Cash .....................................................
(To record the first rental payment)
(b)

December 31, 2014


Depreciation Expense ................................ 22,713
Accumulated DepreciationLeased
Equipment .....................................
(To record depreciation of the leased
asset based upon a cost to Dubois of
$173,448 and a life of 7 years X 11/ 12)

41,000

22,713

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PROBLEM 20-12 (Continued)


December 31, 2014
Interest Expense ................................................ 12,141
Interest Payable ..........................................
(To record accrual of interest on finance lease
obligation $13,245 X 11 / 12)
January 31, 2015
Interest Payable .................................................. 12,141
Interest Expense ................................................ 1,104
Obligations under Lease.................................... 27,755
Cash.............................................................
(To record annual payment on finance lease
obligation)

12,141

41,000

During year
Property Tax Expense ......................................
XXX
Insurance Expense...........................................
XXX
Maintenance and Repairs Expense.................
XXX
Cash........................................................... .
(To record payment for executory costs)

XXX

Dubois Steel Corporation (Lessee)


Lease Amortization Schedule
(Annuity Due Basis)

Date
1/31/14
1/31/14
1/31/15
1/31/16
1/31/17
1/31/18
1/31/19
* rounded

Annual Interest (10%) Reduction Balance


Lease
on Unpaid
of Lease
of Lease
Payment
Obligation
Obligation Obligation

$173,448
$41,000
$
0
$41,000
132,448
41,000
13,245
27,755
104,693
41,000
10,469
30,531
74,162
40,578
41,000
7,416
33,584
41,000
4,058
36,942
3,636
4,000
364*
3,636

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PROBLEM 20-12 (Continued)


(c)
December 31, 2015
Depreciation Expense ....................................
Accumulated DepreciationLeased
Equipment .......................................
(To record annual depreciation
on assets leased $173,448 7)

24,778

December 31, 2015


Interest Expense ............................................
9,597
Interest Payable ......................................
(To record accrual of interest on finance lease
obligation $10,469 X 11 12)
January 31, 2016
Interest Payable .................................................. 9,597
Interest Expense ................................................
872
Obligations under Lease.................................... 30,531
Cash.............................................................
(To record annual payment on finance lease
obligation)

(d)

24,778

9,597

41,000

Dubois Steel Corporation


Statement of Financial Position
December 31, 2015

Property, plant, and equipment:


Equipment under
lease
$173,448
Less: Accumulated
depreciation
47,491
$125,957

Current liabilities:
Interest payable
Obligations under
lease
Long-term:
Obligations under
lease

$9,597
30,531

74,162

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PROBLEM 20-12 (Continued)


(e)

The transaction securing the equipment using the finance


lease would not be reported on the statement of cash flows
for the year ending December 31, 2014. This is non-cash
investing transaction, which should be described in the
notes to the financial statements. The first lease payment
would appear as a cash outflow for the debt repayment in
the financing activities section of the statement.
When using the direct method, for the operating activities
of the cash flow statement, no amounts need to appear. On
the other hand using the indirect method, adjustments to
net income would include the adding back of depreciation
expense in the amount of $22,713 and the increase in the
interest payable in the amount of $9,597.

(f)

Based on these new facts, the lease would be reported as


an operating lease by Dubois as the risks and rewards of
ownership are not transferred to the lessee.
Consequently, no balances would appear on the statement
of financial position of Dubois at December 31, 2015. No
amount would appear on the statement of cash flows as
the amount of rent expense would correspond to the lease
payment made of $41,000.

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PROBLEM 20-13
(a) The lease is a sales-type lease because: (1) the lease term
exceeds 75% of the assets estimated economic life, (2)
collectability of payments is reasonably assured and there
are no further costs to be incurred, and (3) CHL Corporation
realized an element of profit aside from the financing
charge.
1.

Gross investment is $265,000 (10 annual lease


payments of $25,000 each, plus the unguaranteed
residual value of $15,000).

2.

Unearned interest income, $76,880, is the gross


investment of $265,000 less $188,120, the initial present
value of the investment, calculated as follows:

Annual lease payment


Present value of an annuity due of $1 for
10 periods discounted at 8%

$ 25,000

Present value of the 10 rental payments


Add present value of estimated residual
value of $15,000 in 10 years at 8%
($15,000 X .46319)
Initial present value

181,172

7.24689

6,948
$188,120

Excel formula =PV(rate,nper,pmt,fv,type)


Using a financial calculator:
PV
$ ?
I
8%
N
10
PMT
$ (25,000)
FV
$ (15,000)
Type
1

Yields $188,120

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PROBLEM 20-13 (Continued)

(b)

3.

Sale price is $181,172 (the present value of the 10


annual lease payments); i.e. the initial PV of $188,120
minus the PV of the unguaranteed residual value of
$6,948.

4.

Cost of goods sold is $98,052 (the $105,000 cost of the


asset less the present value of the unguaranteed
residual value of $6,948).
CHL CORPORATION (Lessor)
Lease Amortization Schedule
Annuity Due Basis, Unguaranteed Residual Value

Annual Lease
Beginning Payment Plus
of Year
Residual
Value
(a)
Initial PV

1
$ 25,000
2
25,000
3
25,000
4
25,000
5
25,000
6
25,000
7
25,000
8
25,000
9
25,000
10
25,000
End of 10
15,000
$265,000

Interest
(8%) on Net
Investment
(b)

*$ 13,050*
* 12,094*
* 11,061*
* 9,946*
* 8,742*
* 7,441*
*
6,036*
*
4,519*
*
2,881*
*
1,110*
*$76,880*

Net
Investment
Net
Recovery Investment
(c)

$ 25,000
11,952
12,906
13,939
15,054
16,258
17,559
18,964
20,481
22,119
13,890
$188,120

(d)
$188,120
163,120
151,170
138,264
124,325
109,271
93,013
75,454
56,490
36,009
13,890
0

*Rounding error is $1.


(a) Annual lease payment required by lease contract.
(b) Preceding balance of (d) X 8%, except beginning of first
year of lease term.
(c) (a) minus (b).
(d) Preceding balance minus (c).

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PROBLEM 20-13 (Continued)


(c)
Beginning of Lease Year 1
Lease Receivable ............................................. 265,000
Cost of Goods Sold .......................................... 98,052
Sales Revenue ..........................................
181,172
Inventory ...................................................
105,000
Unearned Interest Income ........................
76,880
(To record the sales revenue and the cost of goods sold
in the lease transaction)
Selling Expenses ..............................................
Cash...........................................................
(To record payment of the initial direct
costs relating to the lease)

7,000

Cash ..................................................................
Lease Receivable ......................................
(To record receipt of the first lease
payment)

25,000

7,000

End of fiscal Year 5 months after signing lease


Unearned Interest Income ...............................
5,438
Interest Income .........................................
(To record interest earned during the
first year of the lease $13,050 X 5/12)

25,000

5,438

12 months after signing lease


Unearned Interest Income ...............................
7,612
Interest Income .........................................
7,612
(To record interest earned during the
remainder of the first year of the lease $13,050 X 7/12)

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PROBLEM 20-13 (Continued)


(d)

The balance of the net investment should be the net


investment of $163,120 plus the interest earned to the end
of the year of $5,438, for a total of $168,558. This should be
reported as follows:
Current portion
$17,388*
Non-current portion
151,170**
Total ($188,120 $25,000 + $5,438)
$168,558
* Lease receivable
Less unearned payment ($13,050 $5,438)
Current Portion
** Non-current:
Total lease receivable
Less unearned ($76,880 $13,050)

$25,000
7,612
$17,388
$215,000
63,830
$151,170

(e) Assuming the $15,000 residual value was guaranteed by the


lessee, this would change the initial entry for the sale to be
as follows:
Lease Receivable ............................................. 265,000
Cost of Goods Sold .......................................... 105,000
Sales Revenue ..........................................
Inventory ...................................................
Unearned Interest Income ........................

188,120
105,000
76,880

The sales revenue and cost of goods sold would not need to be
reduced by the present value of the estimated residual value
calculated in part (a) of $6,948.

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PROBLEM 20-13 (Continued)


(f)

The present value of minimum lease payments would be


equal to the estimated selling price of $210,482. The annual
lease payment would equal $X, and the factor for the
present value of an annuity due (Table A-5) at 8% for 12
periods is 8.13896. To obtain a present value of minimum
lease payments of $210,482, the annual payment would = (X
* 8.13896), so the annual payment would be $25,861.

Excel formula =PMT(nper,pmt,pv,fv,type)


Using a financial calculator:
PV
$ 210,482
I
8%
N
12
PMT
$ ?
FV
$ Type
1

Yields $25,861.03

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PROBLEM 20-14
(a) For the lessee under ASPE, rather than using quantitative
factors described under part (b) below for IFRS, quantitative
criteria such as:
1. the term of the lease exceeding 75% of the remaining
economic life of the asset,
2. the present value of the minimum lease payments
exceeding 90% of the fair value of the asset, or
3. the presence of a bargain purchase option will be
applied as the basis for the classification of the lease.
(b) It will be classified as a capital lease for Provincial Airlines
Corp. because:
(1) the lease term is 75% or more of the assets economic
life and (2) the present value of the minimum lease
payments exceeds 90% of the fair value of the leased asset.
(c) The IFRS criteria use qualitative factors to establish
whether or not the risks and rewards of ownership are
transferred to the lessee, and supports classification as a
finance lease:
1. There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of
the lease term. If there is a bargain purchase option in
the lease, it is assumed that the lessee will exercise it
and obtain ownership of the asset.
2. The lease term is long enough that the lessee will
receive substantially all of the economic benefits that
are expected to be derived from using the leased
property over its life.
3. The lease allows the lessor to recover substantially all
of its investment in the leased property and to earn a
return on the investment. Evidence of this is provided if
the present value of the minimum lease payments is
close to the fair value of the leased asset.
4. The leased assets are so specialized that, without major
modification, they are of use only to the lessee.
The lease would be classified as a finance lease.
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PROBLEM 20-14 (Continued)


(d) Initial Obligations Under Leases:
Minimum lease payments ($25,000) X PV of an
annuity due for 10 periods at 8% (7.24689)
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
8%
N
10
PMT
$ (25,000)
FV
$ 0
Type
1

(e)

$181,172

Yields $181,172

Provincial Airlines Corp. (Lessee)


Lease Amortization Schedule
(Annuity due basis and URV)

Beginning
of Year
Initial PV
1
2
3
4
5
6
7
8
9
10

Annual
Lease
Payment
(a)

$25,000
25,000
25,000
25,000
25,000
25,000
25,000
25,000
25,000
25,000
$250,000

Interest (8%)
on Unpaid
Obligation
(b)

*$12,494*
* 11,493*
* 10,413*
* 9,246*
* 7,985*
* 6,624*
* 5,154*
* 3,566*
* 1,853*
*$68,828*

Reduction
of Lease
Lease
Obligation Obligation
(c)
(d)

$181,172
$ 25,000
156,172
12,506
143,666
13,507
130,159
14,589
115,572
15,754
99,818
17,015
82,803
18,376
64,427
19,846
44,581
21,434
23,147
0
23,147
$181,172

*Rounding error is $1.

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PROBLEM 20-14 (Continued)


(a) Annual lease payment required by lease contract.
(b) Preceding balance of (d) X 8%, except beginning of first
year of lease term.
(c) (a) minus (b).
(d) Preceding balance minus (c).
(f)

Lessees journal entries:

Beginning of the Year


Equipment under Lease .................................
Obligations under Lease ........................
(To record the lease of equipment
using capital lease method)
Obligations under Lease................................
Cash.........................................................
(To record the first rental payment)

181,172
181,172

25,000

End of the Year


Interest Expense ............................................
12,494
Interest Payable ......................................
(To record accrual of annual interest on
lease obligation)
Depreciation Expense ....................................
18,117
Accumulated DepreciationLeased Equipment
(To record depreciation expense for
first year [$181,172 10])

25,000

12,494

18,117

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PROBLEM 20-14 (Continued)


(g) Refer to the calculations and table of P20-13 for the
amounts using the guaranteed residual value in the
calculations of payments made by the lessee Provincial
Airlines Corp.
Beginning of the Year
Equipment under Lease .................................
Obligations under Lease ........................
(To record the lease of equipment
using capital lease method)
Obligations under Lease................................
Cash.........................................................
(To record the first rental payment)

188,120
188,120

25,000

End of the Year


Interest Expense ............................................
13,050
Interest Payable ......................................
(To record accrual of annual interest on
capital lease obligation)
Depreciation Expense ....................................
17,312
Accumulated DepreciationLeased Equipment
(To record depreciation expense for
first year [$188,120 - $15,000 10])

25,000

13,050

17,312

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PROBLEM 20-14 (Continued)


(h) The residual value of $45,000 will not be included in
calculation of the present value of the minimum lease
payments. Rather, the bargain purchase option of $15,000
will be the future outflow in the calculations below. The
bargain purchase option will permit depreciation of the
equipment over its economic life of 12 years.
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
Yields $188,120
I
8%
N
10
PMT
$ (25,000)
FV
$ (15,000)
Type
1
Beginning of the Year
Equipment under Lease ................................. 188,120
Obligations under Lease ........................
(To record the lease of
equipment using capital lease method)
Obligations under Lease................................
25,000
Cash.........................................................
(To record the first rental payment)
End of the Year
Interest Expense ............................................
13,050
Interest Payable ......................................
(To record accrual of annual interest on
lease obligation)
[($188,120 - $25,000) X 8%]
Depreciation Expense ....................................
15,677
Accumulated DepreciationLeased Equipment
(To record depreciation expense for
first year [$188,120 12])

188,120

25,000

13,050

15,677

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PROBLEM 20-15
(a)

Jennings, the lessor, considers the same factors as SNC


Medical, the lessee, in determining whether the risks and
benefits of ownership of the leased property are
transferred. These factors include:
1. There is reasonable assurance that the lessee will
obtain ownership of the leased property, including
through a bargain purchase option.
2. The lessee will benefit from most of the asset use due to
the length of the lease term which is substantially all of
the leased property's economic life.
3. The lessor recovers substantially all of its investment
and earns a return on that investment
Jennings is a manufacturer and consequently the signing
of the lease involves the sale of inventory and the
financing of their customers purchase. The lease is
therefore a manufacturer or dealer lease to Jennings.

Present value of minimum lease payments:


1.

2.

Present value of annual payments of


$50,000 made at the beginning of each
period for 10 years, $50,000 X 6.75902
(PV of an annuity due at 10%)

$337,951

Present value of guaranteed residual value,


$15,000 X .38554 (PV of $1, 10 years at 10%)
Present value of minimum lease payments

5,783
$343,734

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PROBLEM 20-15 (Continued)


Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? Yields $343,734
I
10%
N
10
PMT
$ (50,000)
FV
$ (15,000)
Type
1
1.

2.
3.

4.

Gross investment:
Lease payments of $50,000 made at the
beginning of each year for 10 years
Guaranteed residual value due at the end
of 10 years
Gross investment

15,000
$515,000

Sale price is the same as the present value of


minimum lease payments

$343,734

Unearned interest income:


Gross investment
Less: Fair value of the X-ray
machine
Unearned interest income
Cost of goods sold is the cost of manufacturing
the X-ray machine

$500,000

$515,000
343,734
$171,266

$210,000

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PROBLEM 20-15 (Continued)


(b)

JENNINGS INC. (Lessor)


Lease Amortization Schedule
(Annuity due basis, guaranteed residual value)

Annual Lease
Interest
Net
Beginning Payment Plus (10%) on Net Investment
Net
of Year
Residual Value Investment Recovery Investment
$343,734
Initial PV
$ 50,000

$ 50,000
293,734
1
50,000
*$ 29,373*
20,627
273,107
2
50,000
* 27,311*
22,689
250,418
3
50,000
* 25,042*
24,958
225,460
4
50,000
* 22,546*
27,454
198,006
5
50,000
* 19,801*
30,199
167,807
6
50,000
* 16,781*
33,219
134,588
7
50,000
* 13,459*
36,541
98,047
8
50,000
*
9,805*
40,195
57,852
9
50,000
*
5,785*
44,215
13,637
10
0
15,000
*
1,363*
13,637
End of 10
$515,000
*$171,266*
$343,734
*Rounding error is $1.

(c) Lessors journal entries:


Beginning of the Year
Lease Receivable ............................................. 515,000
Cost of Goods Sold .......................................... 210,000
Sales Revenue ..........................................
343,734
Inventory ...................................................
210,000
Unearned Interest Income ........................
171,266
(To record the sales revenue and the cost of goods sold
in the lease transaction)
Selling Expenses ................................................ 14,000
Cash/Accounts Payable .............................
(To record the incurrence of initial direct
costs relating to the lease)

14,000

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PROBLEM 20-15 (Continued)


Cash .................................................................... 50,000
Lease Receivable ........................................
(To record receipt of the first lease
payment)
End of the Year
Unearned Interest Income ................................. 29,373
Interest Income ...........................................
(To record interest earned during the first
year of the lease)
(d)

50,000

29,373

At December 31, the end of the first year of the lease,


Jennings Inc. will report on the income statement the sales
revenue amount of $343,734 and cost of goods sold of
$210,000, indicating gross profit from the sale of the X-ray
equipment in the amount of $133,734. They will also report
the interest income on the lease of $29,373 and selling
expenses of $14,000.
The statement of financial position would report the
current portion of the lease receivable of $50,000 and the
non-current portion of $415,000, reduced by the current
portion of the unearned interest income on the lease in the
amount of $27,311 and the non-current portion for
$114,582.
For the statement of cash flows, using the indirect format
for the cash flow from operations, there will be an
adjustment of an addition to income for the reduction of
inventory of $210,000 and an addition for the net increase
in unearned income of $141,893 ($171,266 $29,373). For
investing activities the statement will show a net increase
in lease payments receivable of $465,000 ($515,000
$50,000).

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PROBLEM 20-15 (Continued)


(d) (Continued)
For the note disclosure, the list of required and desirable
disclosures include: the total future minimum lease
payments receivable, unguaranteed residual values,
unearned finance income, executory costs included in
minimum lease payments, contingent rentals taken into
income, lease terms, and the amounts of minimum lease
payments receivable for each of the next five years.
(e)

Since the implicit rate in the lease of 10% is known to the


lessee, SNC Medical Centre, the interest rate used by SNC
will be the same as that of the lessor, Jennings Inc.
Consequently, the machinery will be capitalized at the
amount of $343,734, the present value of the minimum
lease payments as calculated in (a) above.
The
depreciation of the machinery will be based on the term of
the lease as SNC has guaranteed the residual value. The
depreciation expense will therefore be $32,873 (($343,734 $15,000) / 10 years).

(f)

Had the residual value of the X-ray machine not been


guaranteed, the amount of the sale and the cost of goods
sold recorded would have been reduced by the present
value of the residual value in the amount of $5,783 ($15,000
X .38554 for PV of $1, for 10 years at 10%).

Excel formula =PV(rate,nper,pmt,fv,type)


Using a financial calculator:
PV
$ ?
I
10%
N
10
PMT
$ 0
FV
$ 15,000
Type
1

Yields $5,783

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PROBLEM 20-15 (Continued)


(f) (Continued)
From the perspective of the lessor, the entries concerning
the recording of the lease receivable do not change, except
as noted above since the lessor assumes that they will
recover the residual value whether that amount is
guaranteed by the lessee or not. Consequently the amount
of interest accrued at the end of the year will be the same
amount as given in (c). The financial statements of the
lessor remain unaffected with the exception of the
reduction of $5,783 for the sales revenue and cost of goods
sold amounts on the income statement.
From the perspective of the lessee, the amount used to
capitalize the machinery will exclude the residual value,
since the lessee does not guarantee that amount. Using the
same variables as in (a) above but excluding the residual
value yields an amount of $337,951. The depreciation
expense will therefore be $33,795 ($337,951 / 10 years).
(g) Had Jennings been using ASPE, quantitative factors would
apply. The 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
collectability of the lease payments is reasonably
predictable and no uncertainties exist as to unreimbursable
costs yet to be incurred by the lessor, and (4) the lease
provides the lessor with manufacturers profit in addition to
interest income.

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PROBLEM 20-16
(a)

Green Finance Corporation, the lessor, considers the same


factors as Lanier Dairy Ltd., the lessee, in determining
whether the risks and benefits of ownership of the leased
property are transferred. These factors include:
There is reasonable assurance that the lessee will
obtain ownership of the leased property by the end of
the lease term. If there is a bargain purchase option in
the lease, it is assumed that the lessee will exercise it
and obtain ownership of the asset.
The lease term is long enough that the lessee will
receive substantially all of the economic benefits that
are expected to be derived from using the leased
property over its life.
The lease allows the lessor to recover substantially all
of its investment in the leased property and to earn a
return on the investment. Evidence of this is provided if
the present value of the minimum lease payments is
close to the fair value of the leased asset.
The leased assets are so specialized that, without major
modification and significant cost to the lessor they are
of use only to the lessee.
In this case, Lanier Dairy Ltd., the lessee, would record the
lease as a finance lease. Green Finance Corporation is not
a manufacturer or dealer and consequently the lease is a
finance lease to Green Finance Corporation.

(b)
May 30, 2014
Lessee:
Equipment under Lease ................................
211,902
Obligations under Lease .......................
$30,000 X 6.58238*
= $197,471.40)
($23,000 X .62741**
= 14,430.43)
= $211,901.83
* PV factor of annuity due at 6% for 8 years
** PV factor of $1 at 6% for 8 years

211,902

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PROBLEM 20-16 (Continued)


(b) (Continued)
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? Yields $211,901.93
I
6%
N
8
PMT
$ (30,000)
FV
$ (23,000)
Type
1
Obligations under Lease...............................
Cash........................................................

30,000
30,000

May 30, 2014


Lessor:
Lease Receivable ..........................................
Equipment Acquired for Lessee ...........
Unearned Interest Income .....................
($263,000 = 8 X $30,000; add $23,000
for residual value)
Cash ...............................................................
Lease Receivable ...................................

263,000
211,902
51,098

30,000
30,000

December 31, 2014


Lessee:
Interest Expense ...........................................
Interest Payable .....................................
[($211,902 $30,000) X .06 X 7/12]
Depreciation Expense ...................................
Accumulated Depreciation-Leased
Equipment .........................................
[($211,902 $23,000) 8 X 7/12]

6,367
6,367
13,774
13,774

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PROBLEM 20-16 (Continued)


December 31, 2014
Lessor:
Unearned Interest Income ............................
Interest Income ......................................
(c)
May 30, 2015
Lessee:
Obligations under Lease...............................
Interest Expense ...........................................
Interest Payable .............................................
Cash........................................................

6,367
6,367

19,086
4,547*
6,367
30,000

*[($211,902 $30,000) X .06 X 5/12]


Lessor:
Unearned Interest Income ............................
Interest Income ......................................
Cash ...............................................................
Lease Receivable ..................................

4,547
4,547
30,000
30,000

(d) (1) and (2) are both $197,471, as the lessee has no
obligation to pay the residual value.
Using a financial calculator:
PV
$ ? Yields $197,471.44
I
6%
N
8
PMT
$ (30,000)
FV
$ 0
Type
1

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PROBLEM 20-16 (Continued)


(e) In the case of (1) the amount of the net investment at the
inception of the lease would be $211,902 + $1,200 or
$213,102. For (2) and (3) both would be $211,902, as the
estimated residual value exists whether or not it is
guaranteed.
(f)

The present value of the residual would have to be at least


10% of the fair value of the leased asset or 10% X $211,902 =
$21,190.20. The future value of this lump sum (n=8, i=6) =
$21,190.20 X 1.59385 or $21,190,190.20/.62741, both of
which = $33,774.
Using a financial calculator:
PV
$ 21,190
I
6%
N
8
PMT
$ 0
FV
$?
Type
1

Yields $33,773,64

Excel formula: =FV(rate,nper,pmt,pv,type)


(g) Had Green been using ASPE:
The lease agreement satisfies both the 75% and 90%
quantitative requirements, collectability is reasonably
predictable, and there are no important uncertainties
surrounding the costs yet to be incurred by the lessor. For
Lanier Dairy Ltd., the lessee, it is a capital lease, and for
Green Finance Corporation, the lessor, it is a direct
financing lease (since cost equals fair value).

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PROBLEM 20-17

Memorandum Prepared by:


Date:

(Your Initials)

Fram Fibreglass Corp. (FFC)


Assessing Leasing Proposals
Industrial Development Bank (IDB) vs.
Municipal Finance Corp. (MFC)
The purpose of this memorandum is to outline the analysis and
recommendations concerning leasing alternatives obtained from
IDB and MFC.
The objective is to lease equipment with a current selling price
of $50,000 for a term of 5 years. Both proposals require that the
equipment be returned to the lessor at the end of the term. Both
lease terms start and end at approximately the same dates. The
terms of the leases differ in other respects, which will result in
alternate accounting treatments on the books of FFC.
MFC proposal:
To FFC, this lease is a capital lease because the terms satisfy
the following criteria:
1. The present value of the minimum lease payments is
slightly greater than 90% of the fair value of the leased
asset; that is, the present value of $45,030 (see below) is
90.1% of the fair value of the leased asset ($45,030 /
$50,000).
2. The lease fails in the second criteria concerning the
presence of a bargain purchase option.
3. The lease also fails the third capitalization criteria in that
the lease term is not greater than 75% of the economic life
of the leased asset; that is, the lease term is 71% (5/7) of
the economic life of the equipment.
Note that in this case, since there is no interest rate mentioned
in the lease proposal, FFC must impute the companys
incremental borrowing rate of 15%.
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PROBLEM 20-17 (Continued)


Using a financial calculator:
PV
$?
I
15%
N
5
PMT
$ (11,681)
FV
$ 0
Type
1

Yields $ 45,030

IDB - proposal:
IDB is providing an operating lease to FFC since the lease term
(5 years) is less than 75% of the economic life (7 years) of the
leased asset. The lease term is 71.4% (5 7) of the assets
economic life. There is no bargain purchase option and the
present value of minimum lease payments of $44,330 (see
below) represents 88.7% of the fair value at April 23, 2014 of
$50,000 falling short of the criteria of 90% to treat the lease as a
capital lease.
Using a financial calculator:
PV
$ ?
Yields $ 44,330
I
12%
N
5
PMT
$ (10,980)*
FV
$ 0
Type
1
* Rental payment of $12,000 less $1,020 in executory costs.

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PROBLEM 20-17 (Continued)


Let us contrast the charges to the income statement for a typical
lease year as well as look at the cash outflows and statement of
financial position balances at the end of the first lease year. The
table below assumes a 12 month period from the inception of
the lease to eliminate any differences caused by different start
dates.
MFC
IDB
Capital
Operating
Lease
Lease
Statement of financial position:
Property Plant & Equipment:
Equipment under lease
$ 45,030
Less: Accumulated depreciation
(9,006) (1)
36,024
Current Liabilities
Interest payable
5,002 (2)
Current portion of obligations
under lease
6,679 (3)
Long term liabilities
Obligations under lease
Less: Current portion
Statement of income:
Rent expense
Depreciation expense
Interest expense
Other operating costs

Statement of cash flows:


Cash paid for lease

33,349 (4)
(6,679) (3)
26,670
$ 10,980
$ 9,006
5,002
300
$ 14,308

1,020
$12,000

$ (11,981)

$ (12,000)

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PROBLEM 20-17 (Continued)


(1) $45,030 / 5 (2), (3), and (4) See Amortization schedule
MFC Lease
Lease Amortization Schedule
Annual Pmt.
Excl.
Yr. Exec. Costs
1
2
3
4
5

11,681.00
11,681.00
11,681.00
11,681.00
11,681.00

Interest
(15%)
on Unpaid
Obligation

Reduction
of Lease
Obligation

Balance
of Lease
Obligation
45,030.00
11,681.00
33,349.00 (4)
5,002.35 (2) 6,678.65 (3) 26,670.35
4,000.55
7,680.45
18,989.90
2,848.49
8,832.51
10,157.39
1,523.61
10,157.39
(0.00)

Based on the analysis above, my recommendation is for FFC to


choose the operating lease with IDB because:
1. Although the cash outflows are practically identical, the
charges to the income statement are 19% lower with the
operating lease.
2. Given the current financial situation of FFC concerning
liquidity, the capital lease would adversely affect the
current ratio.
3. Additional debt on the statement of financial position will
not be viewed well by FFCs creditors if the capital lease
alternative offered by MFC were selected. Choosing this
alternative would be violating the stipulation of Royal
Montreal Bank that FFC not increase the debt-to-equity
ratio above the current levels.
Note to Instructor: Some students will treat this as a capital
budgeting problem and compare the present value of the cash
flows of the two alternatives. It may be useful when assigning
the problem to remind the students to write the report based on
financial reporting considerations.
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PROBLEM 20-18
(a)

For the purpose of calculating the lease payment that will


yield a 12% return to Galt, the residual value guaranteed by
a third party will be included in the calculations below:

Using a financial calculator:


PV
$ (415,000)
I
12%
N
7
PMT
$ ?
Yields $72,341
FV
$ 100,000
Type
1
(b)
Galt Manufacturing Ltd. (Lessor)
Lease Amortization Schedule

Date
5/2/14
5/2/14
5/2/15
5/2/16
5/2/17
5/2/18
5/2/19
5/2/20
5/2/21

Annual
Lease
Payment
Plus RV

Interest
(12%) on Net
Investment

Net
Investment
Recovery

$ 72,341
72,341
72,341
72,341
72,341
72,341
72,341
100,000
$606,387

$41,119
37,372
33,176
28,476
23,213
17,317
10,714
$191,387

$ 72,341
31,222
34,969
39,165
43,865
49,128
55,024
89,286
$415,000

Balance
of Net
Investment
$415,000
342,659
311,437
276,468
237,303
193,438
144,310
89,286
0

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PROBLEM 20-18 (Continued)


(c)
5/2/14

5/2/14

Lease Receivable* ............................... 606,387


Cost of Goods Sold ............................. 327,500
Sales Revenue ............................
Inventory .....................................
Unearned Interest Income .........
* ($72,341 X 7) +$100,000
Cash .................................................... 72,341
Lease Receivable ......................

12/31/14 Unearned Interest Income .................. 27,413


Interest Income .........................
[($415,000 $72,341) X .12 X 8/12]
5/2/15

5/2/15

Unearned Interest Income .................. 13,706


Interest Income .........................
[($415,000 $72,341) X .12 X 4/12]
Cash .................................................... 72,341
Lease Receivable ......................

415,000
327,500
191,387

72,341

27,413

13,706

72,341

12/31/15 Unearned Interest Income .................. 24,915


Interest Income .........................
24,915
[($415,000 $72,341 - $31,222) X .12 X 8/12]
5/2/16

Unearned Interest Income .................. 12,457


Interest Income .........................
12,457
[($415,000 $72,341 - $31,222) X .12 X 4/12]

5/2/16

Cash .................................................... 72,341


Lease Receivable ......................

72,341

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PROBLEM 20-18 (Continued)


(d)
As at and for the period ending December 31, 2014
Statement of financial position:
Current assets
Net investment in leases
$ 72,341
Noncurrent assets (investments)

297,731 *

* ($342,659 + $27,413 - $72,341 current)


Statement of income:
Sales revenue
Cost of goods sold
Gross profit
Interest income

$ 415,000
327,500
87,500
27,413

Statement of cash flows:


Operating Activities:
Cash received for lease

$ 72,341

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PROBLEM 20-18 (Continued)


(e) Mulholland Corp. would account for the lease as an
operating lease since:
Using a financial calculator:
PV
$ ? Yields $369,764
I
12%
N
7
PMT
$ 72,341
FV
$0
Type
1
The lease term (7 years) is less than 75% of the economic life (10
years) of the leased asset. The lease term is 70% (7 10) of the
assets economic life. There is no bargain purchase option and
the present value of minimum lease payments of $72,341
represents 89% ($369,764 / $415,000) of the fair value at May 2,
2014 of $415,000 falling short of the criteria of 90% to treat the
lease as a capital lease.
Fiscal year ending December 31, 2014:
During 2014:
Operating Expenses .....................
Cash..........................................
5/2/14

Prepaid Rent .................................


Cash..........................................

12/31/14 Rent Expense ................................


Prepaid Rent ...............................
($72,341 X 8/12)
Fiscal year ending December 31, 2015:
During 2015:
Operating Expenses ......................
Cash..........................................

14,000
14,000
72,341
72,341
48,227
48,227

14,400
14,400

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PROBLEM 20-18 (Continued)


5/2/15

5/2/15

Rent Expense ................................


Prepaid Rent ...............................
($72,341 X 4/12)

24,114

Prepaid Rent .................................


Cash..........................................

72,341

12/31/15 Rent Expense ................................


Prepaid Rent ...............................
($72,341 X 8/12)
Fiscal year ending December 31, 2016:
During 2013:
Operating Expenses .....................
Cash..........................................
5/2/16

5/2/16

24,114

72,341
48,227
48,227

14,950
14,950

Rent Expense ................................


Prepaid Rent ...............................
($72,341 X 4/12)

24,114

Prepaid Rent .................................


Cash..........................................

72,341

24,114

72,341

(f)
As at and for the period ending December 31, 2014
Statement of financial position:
Current assets:
Prepaid rent
$ 24,114
Statement of Income:
Rent expense
Other operating expenses

$ 48,227
14,000

Statement of cash flows:


Operating Activities:
Cash paid for lease

$ (72,341)

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PROBLEM 20-18 (Continued)


(g)

In this set of circumstances, the equipment is on neither


the lessors (Galts) nor the lessees (Mulhollands)
statements of financial position. The equipment should
likely be on the statement of financial position of the lessee
as they have avoided recording the lease as an operating
lease by involving a third party in the guaranteed residual
value. In this case, the present value of minimum lease
payments represents 89% of the fair value of the asset.
This is very close to the 90% capitalization criteria
guideline. The 90% criteria is not an absolute rule and
therefore accountants should look beyond the numbers to
the substance of the transaction to determine the
accounting treatment of the lease; in this case
capitalization of the lease may be a more meaningful
presentation.

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PROBLEM 20-19

(a)

1. Contractual obligations and rights under lease, July 1, 2014.


Using tables:
PV of lease payments
$545,000 X 5.62288*
* Annuity due Table A-5 at 8%

$3,064,470

Excel formula =PV(rate,nper,pmt,fv,type)


Using a financial calculator:
PV
$ ? Yields $3,064,469.42
I
8%
N
7
PMT
$ 545,000
FV
$ 0
Type
1
2.

Wagner Inc.
Lease Amortization Schedule
Interest
Annual
(8%)
Reduction
Lease
on Unpaid
of Lease
Payments
Obligation
Obligation

Date
July 1
July 1
July 1
July 1
July 1
July 1
July 1

2014
2015
2016
2017
2018
2019
2020

$ 545,000
545,000
545,000
545,000
545,000
545,000
545,000

$201,558
174,082
144,409
112,361
77,750
40,369 *

$545,000
343,442
370,918
400,591
432,639
467,250
504,631

Balance
of Lease
Obligation
$3,064,470
2,519,470
2,176,028
1,805,110
1,404,519
971,880
504,630
(0)

* one dollar rounding

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PROBLEM 20-19 (Continued)


3.
July 1, 2014
Right-of-use Asset...............................
Obligations under Lease............

3,064,470

Obligations under Lease .....................


Cash ............................................

545,000

December 31, 2014


Interest Expense ..................................
Interest Payable ..........................
($201,558 X 6 / 12 = $100,779)

3,064,470
545,000
100,779
100,779

Amortization Expense .........................


218,891
Right-of-use Asset .....................
($3,064,470 7 years X 6/ 12 = $218,891)
July 1, 2015
Interest Expense ..................................
Interest Payable ...................................
Obligations under Lease .....................
Cash ............................................
(b)
1.

218,891

100,779
100,779
343,442
545,000

Probability-weighted expected value of residual


$400,000 X 60% =
$240,000
$300,000 X 40% =
120,000
Probability-weighted value
360,000
Guaranteed value
450,000
Liability July 1, 2021
$90,000

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PROBLEM 20-19 (Continued)


To calculate the present value of this additional cash outflow:
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ?
I
8%
N
6
PMT
$0
FV
$ 90,000
Type
1

Yields $56,715

2.
July 1, 2015
Right-of-use Asset .....................................
Obligations under Lease............

56,715
56,715

The carrying amount of the lease obligation after the above


entry is $2,232,743 (balance from the original amortization
schedule $2,176,028 after the July 1, 2015 payment +
$56,715)
3.

Wagner Inc.
Lease Amortization ScheduleRevised July 1, 2015
Interest
Annual
(8%)
Reduction Balance
Lease
on Unpaid
of Lease
of Lease
Date
Payments
Obligation Obligation Obligation
$ 2,232,743
July 1
2016 $ 545,000
$ 178,619
$366,381
1,866,362
July 1
2017
545,000
149,309
395,691
1,470,671
July 1
2018
545,000
117,654
427,346
1,043,325
July 1
2019
545,000
83,466
461,534
581,791
July 1
2020
545,000
46,543
498,457
83,334
July 1
2021
90,000
6,666 *
83,334
(0)
* one dollar rounding
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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-19 (Continued)


4.
December 31, 2015
Interest Expense ..................................
Interest Payable ..........................
($178,619 X 6 12 = $89,310)
Amortization Expense .........................
Right-of-use Asset .....................
($2,902,294* 6 years = $483,716)

89,310
89,310
483,716
483,716

* Original entry for the rights


$3,064,470
Amortization recorded in 2014
(218,891)
Change in estimate: residual value
56,715
Amortizable balance
$2,902,294

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PROBLEM 20-20
(a) Option 1:
1.
Excel formula =PMT(rate,nper,pv,fv,type)

PV
I
N
PMT
FV
Type
*7%4

$79,000
1.75%*
20
?
$0
1

Yields $4,715.61

2.
Sanderson Inc.
Instalment Note Payable Amortization Schedule
Note
Effective
Principal
Carrying
Payment
Interest
Reduction
Amount
1/1/2014
$79,000.00
1/4/2014
$4,715.61
$ 1,382.50
$3,333.11
75,666.89
1/7/2014
4,715.61
1,324.17
3,391.44
72,275.46
1/10/2014
4,715.61
1,264.82
3,450.79
68,824.67
1/1/2015
4,715.61
1,204.43
3,511.17
65,313.50
1/4/2015
4,715.61
1,142.99
3,572.62
61,740.88
1/7/2015
4,715.61
1,080.47
3,635.14
58,105.73
1/10/2015
4,715.61
1,016.85
3,698.76
54,406.98
1/1/2016
4,715.61
952.12
3,763.48
50,643.49
1/4/2016
4,715.61
886.26
3,829.35
46,814.15
1/7/2016
4,715.61
819.25
3,896.36
42,917.79
1/10/2016
4,715.61
751.06
3,964.55
38,953.24
1/1/2017
4,715.61
681.68
4,033.92
34,919.32
1/4/2017
4,715.61
611.09
4,104.52
30,814.80

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PROBLEM 20-20 (Continued)


Sanderson Inc.
Instalment Note Payable Amortization Schedule
Note
Effective
Principal
Carrying
Payment
Interest
Reduction
Amount
1/7/2017
4,715.61
539.26
4,176.35
26,638.45
1/10/2017
4,715.61
466.17
4,249.43
22,389.02
1/1/2018
4,715.61
391.81
4,323.80
18,065.22
1/4/2018
4,715.61
316.14
4,399.47
13,665.75
1/7/2018
4,715.61
239.15
4,476.46
9,189.30
1/10/2018
4,715.61
160.81
4,554.79
4,634.50
1/1/2019
4,715.61
81.10
4,634.50
0.00
$15,312.13
3.
January 1, 2014
Vehicles ..................................................... 79,000.00
Notes Payable ...................................
79,000.00
April 1, 2014
Interest Expense ....................................... 1,382.50
Notes Payable ........................................... 3,333.11
Cash ...................................................

4,715.61

December 31, 2014


Interest Expense ....................................... 1,204.43
Interest Payable.................................

1,204.43

December 31, 2014


Depreciation Expense ............................ 13,800.00
Accumulated Depreciation Vehicles
13,800.00
under Lease[($79,000 $10,000) 5]

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PROBLEM 20-20 (Continued)


(b) Option 2:
1.

BMW Canada calculates the lease payments using a twostep approach.


The first step involves the calculation of the lease payments
for the original lease period of 36 months beginning
January 1, 2014. For this lease, the recoverable amount of
50% of the fair value of the car on January 1, 2014 is used
for the future value, at the end of the three year period.

Excel formula =PMT(rate,nper,pv,fv,type)


Using a financial calculator:
PV
$(79,000)
I
0.5%*
N
36
PMT
?
Yields $ 1,392.21
FV
$39,500**
Type
1
* 6% 12
** ($79,000 X 50% = $39,500)
The second step is the calculation of the lease payments for
the lease renewal period of 24 months beginning January 1,
2017.
Although the fair value of the car at January 1, 2019 of
$10,000 is not guaranteed, it is used in the calculation of the
lease amortization schedule by the lessor, BMW Canada.
As well, although there is a small probability that Sanderson
will incur additional kilometre charges for exceeding the
limits set in the lease, these penalties are not included in
the calculation.

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PROBLEM 20-20 (Continued)


Excel formula =PMT(rate,nper,pv,fv,type)

PV
I
N
PMT
FV
Type
* 7% 12
2.

$(39,500)
0. 5833%*
24
?
$10,000
1

Yields $1,371.00

The lease is an operating lease to Sanderson because:


a) it does not transfer ownership, nor does it contain a
bargain purchase option,
b) it does not cover at least 75% of the estimated economic
life of the car, (3 8 = 37.5%) and
c) the present value of the lease payments of $45,992* is not
at least 90% of the fair value of the car.

Excel formula =PV(rate,nper,pmt,fv,type)


Using a financial calculator:
PV
$ ?
I
.5%
N
36
PMT
$ 1,392.21
FV
0
Type
1

* Yields $45,992

At least one of the three criteria would have had to be


satisfied for the lease to be classified as other than an
operating lease.

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PROBLEM 20-20 (Continued)


3.

ASPE assumes that the risks and benefits of ownership are


normally transferred to the lessee, and the lessee should
classify and account for the arrangement as a capital lease
if any one or more of the following criteria is met:
a) There is reasonable assurance that the lessee will
obtain ownership of the leased property, including
through a bargain purchase option.
b) The lessee will benefit from most of the asset benefits
due to the length of the lease term. In addition, a
numerical threshold is included: this is usually assumed
to occur if the lease term is 75% or more of the leased
property's economic life.
c) The lessor recovers substantially all of its investment
and earns a return on that investment. In addition, a
numerical threshold is included: this is usually assumed
if the present value of the minimum lease payments is
equal to 90% or more of the fair value of the leased
asset.
Including the renewal period, Sanderson is using the car for
5 of its 8 years of economic life. This translates to 62.5%
and so the 75% threshold is not reached.
There is no option to purchase that is a bargain during the
initial or renewal terms of the lease with BMW Canada.
The present value of the minimum lease payments paid by
Sanderson Inc. is $71,730.00 calculated as follows, in a
three step approach:
The first step is for the renewal period of 2 years:

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PROBLEM 20-20 (Continued)


Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? Yields $30,800.05
I
0.5833%*
N
24
PMT
1,371.00
FV
$ 0
Type
1
*7 % 12
The second step is to calculate the present value of the
amount arrived in the first step back to January 1, 2014 for a
period of 3 years.
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? Yields $25,737.91
I
0.5%*
N
36
PMT
0
FV
$ 30,800.05
Type
1
* 6% 12
The third step is for the calculation of the present value of
the initial lease payments by Sanderson Inc.

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-20 (Continued)


Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? Yields $45,992.17
I
0.5%*
N
36
PMT
$1,392.21
FV
$ 0
Type
1
* 6% 12
Add the present value of the lease renewal
to the present value of the initial lease
Present value of the minimum lease payments

$25,737.91
45,992.17
$71,730.08 rounded

Present value of the minimum lease payments divided by


the fair value of the asset $71,730 $79,000 = 90.8% and so
the lease is a capital lease to Sanderson Inc.
4.
Sanderson Inc. Lessee
Lease Amortization Schedule
Annual
Interest
Reduction
Lease
on Unpaid
of Lease
Payment
Obligation
Obligation

Date
Jan.
Feb.
Mar
Apr.
May
June
July

1
1
1
1
1
1
1

2014
2014
2014
2014
2014
2014
2014

1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21

351.69
346.49
341.26
336.00
330.72
325.41

1,392.21
1,040.52
1,045.72
1,050.95
1,056.21
1,061.49
1,066.80

Balance
of Lease
Obligation
71,730.00
70,337.79
69,297.27
68,251.55
67,200.59
66,144.39
65,082.90
64,016.10

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PROBLEM 20-20 (Continued)

Date
Aug. 1 2014
Sep. 1 2015
Oct 1 2015
Nov. 1 2015
Dec. 1 2015
Jan. 1 2015
Feb. 1 2015
Mar 1 2015
Apr. 1 2015
May 1 2015
June 1 2015
July 1 2015
Aug. 1 2015
Sep. 1 2016
Oct 1 2016
Nov. 1 2016
Dec. 1 2016
Jan. 1 2016
Feb. 1 2016
Mar 1 2016
Apr. 1 2016
May 1 2016
June 1 2016
July 1 2016
Aug. 1 2016
Sep. 1 2016
Oct 1 2016
Nov. 1 2016
Dec. 1 2016
Jan. 1 2017

Annual
Lease
Payment
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21
1,392.21

Interest
on Unpaid
Obligation
320.08
314.72
309.33
303.92
298.48
293.01
287.51
281.99
276.44
270.86
265.25
259.62
253.95
248.26
242.54
236.79
231.02
225.21
219.38
213.51
207.62
201.70
195.74
189.76
183.75
177.71
171.63
165.53
159.40
153.41

Reduction
Balance
of Lease
of Lease
Obligation Obligation
1,072.13
62,943.97
1,077.49
61,866.48
1,082.88
60,783.61
1,088.29
59,695.31
1,093.73
58,601.58
1,099.20
57,502.38
1,104.70
56,397.68
1,110.22
55,287.46
1,115.77
54,171.69
1,121.35
53,050.33
1,126.96
51,923.38
1,132.59
50,790.78
1,138.26
49,652.53
1,143.95
48,508.58
1,149.67
47,358.91
1,155.42
46,203.50
1,161.19
45,042.30
1,167.00
43,875.31
1,172.83
42,702.47
1,178.70
41,523.77
1,184.59
40,339.18
1,190.51
39,148.67
1,196.47
37,952.20
1,202.45
36,749.75
1,208.46
35,541.29
1,214.50
34,326.79
1,220.58
33,106.21
1,226.68
31,879.53
1,232.81
30,646.72
(153.41)
30,800.13

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PROBLEM 20-20 (Continued)

Date
Jan. 1 2017
Feb. 1 2017
Mar 1 2017
Apr. 1 2017
May 1 2017
June 1 2017
July 1 2017
Aug. 1 2017
Sep. 1 2017
Oct 1 2017
Nov. 1 2017
Dec. 1 2017
Jan. 1 2018
Feb. 1 2018
Mar 1 2018
Apr. 1 2018
May 1 2018
June 1 2018
July 1 2018
Aug. 1 2018
Sep. 1 2018
Oct 1 2018
Nov. 1 2018
Dec. 1 2018

Annual
Lease
Payment
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
1,371.00
83,023.56

Interest
on Unpaid
Obligation
171.67
164.67
157.64
150.56
143.44
136.28
129.08
121.83
114.55
107.22
99.84
92.43
84.97
77.47
69.92
62.33
54.70
47.02
39.30
31.53
23.72
15.86
7.85
11,293.56

Reduction
Balance
of Lease
of Lease
Obligation Obligation
1,371.00
29,429.13
1,199.33
28,229.80
1,206.33
27,023.48
1,213.36
25,810.12
1,220.44
24,589.67
1,227.56
23,362.11
1,234.72
22,127.39
1,241.92
20,885.47
1,249.17
19,636.30
1,256.45
18,379.85
1,263.78
17,116.06
1,271.16
15,844.91
1,278.57
14,566.33
1,286.03
13,280.31
1,293.53
11,986.77
1,301.08
10,685.70
1,308.67
9,377.03
1,316.30
8,060.73
1,323.98
6,736.75
1,331.70
5,405.05
1,339.47
4,065.58
1,347.28
2,718.29
1,355.14
1,363.15
1,363.15
0.00

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PROBLEM 20-20 (Continued)


5.
January 1, 2014
Vehicles under Lease ........................... 71,730.00
Obligations under Lease ..................
71,730.00
Obligations under Lease .......................... 1,392.21
Cash ...................................................
February 1, 2014
Obligations under Lease .......................... 1,040.52
Interest Expense ....................................... 351.69
Cash ...................................................
December 31, 2014
Interest Expense .......................................
Interest Payable.................................

1,392.21

1,392.21

293.01
293.01

Depreciation Expense .............................. 12,346.00


Accumulated Depreciation Vehicles
under Lease .......................................
12,346.00
[($71,730 $10,000) 5]
(c) Option 3:
1.

Under this option, Sanderson Inc. must treat the lease as an


operating lease as none of the criteria for treatment as a
capital lease is met.

2.
January 1, 2014
Rent Expense ............................................ 1,392.21
Cash ...................................................
December 31, 2014
Rent Expense ............................................ 1,392.21
Rent Payable .....................................

1,392.21

1,392.21

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PROBLEM 20-20 (Continued)


3.
Excel formula =PMT(rate,nper,pv,fv,type)
PV
I
N
PMT
FV
Type
* 8% 4

$39,500
2%*
24
?
$0
1

Yields $5,392.14

4.
Sanderson Inc.
Instalment Note Payable Amortization Schedule
Payment
1/1/2017
1/4/2017
1/7/2017
1/10/2017
1/1/2018
1/4/2018
1/7/2018
1/10/2018
1/1/2019

$5,392.14
5,392.14
5,392.14
5,392.14
5,392.14
5,392.14
5,392.14
5,392.14

Effective
Interest

Principal
Reduction

$790.00
697.96
604.07
508.31
410.64
311.01
209.38
105.73
$3,637.10

$4,602.14
4,694.18
4,788.06
4,883.82
4,981.50
5,081.13
5,182.75
5,286.41

Carrying
Amount
$39,500.00
34,897.86
30,203.68
25,415.62
20,531.80
15,550.29
10,469.16
5,286.41
0.00

5.
January 1, 2017
Cash........................................................... 39,500.00
Notes Payable ...................................
39,500.00
Vehicles ..................................................... 39,500.00
Cash ...................................................
39,500.00

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PROBLEM 20-20 (Continued)


April 1, 2017
Interest Expense ....................................... 790.00
Notes Payable ........................................... 4,602.14
Cash ...................................................
December 31, 2017
Interest Expense .......................................
Interest Payable.................................

5,392.14

508.31
508.31

Depreciation Expense ............................ 14,750.00


Accumulated Depreciation Vehicles
14,750.00
[($39,500 $10,000) 2]
(d) For the contract-based approach, the probability-weighted
expected value of the excess mileage penalty must be used
in the present value calculation of the lease rights and
obligations.
$0 X 75%
10,000 kilometres X 25 cents X 10%=
20,000 kilometres X 25 cents X 15%=
Probability-weighted amount

$250
750
$1,000

Excel formula =PV(rate,nper,pmt,fv,type)


Using a financial calculator:
PV
$ ?
I
0.5%*
N
36
PMT
$0
FV
$ 1,000
Type
0
* 6% 12

Yields $835.64

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PROBLEM 20-20 (Continued)


(d) (Continued)
Consequently the capitalized amount of the right-of-use
asset and the lease payments liability increases by $835.64.
The same lease amortization schedule for Option 2, item 4,
except that the carrying amount at the inception will be
$71,730.00 + $835.64 = $72,565.64 and a payment of $1,000
is made January 1, 2017.
Lease Amortization Schedule Contract Based Approach
Annual
Interest
Reduction
Balance
Lease
on Unpaid
of Lease
of Lease
Date
Payment
Obligation Obligation Obligation
$72,565.64
Jan. 1/14

$1,392.21

$1,392.21

71,173.43

Feb. 1/14

1,392.21

$355.87

1,036.34

70,137.09

Mar. 1/14

1,392.21

350.69

1,041.52

69,095.56

Apr. 1/14

1,392.21

345.48

1,046.73

68,048.83

May 1/14

1,392.21

340.24

1,051.97

66,996.86

Jun. 1/14

1,392.21

334.98

1,057.23

65,939.64

Jul. 1/14

1,392.21

329.70

1,062.51

64,877.13

Aug. 1/14

1,392.21

324.39

1,067.82

63,809.30

Sept.1/14

1,392.21

319.05

1,073.16

62,736.14

Oct. 1/14

1,392.21

313.68

1,078.53

61,657.61

Nov. 1/14

1,392.21

308.29

1,083.92

60,573.69

Dec. 1/14

1,392.21

302.87

1,089.34

59,484.35

Jan. 1/14

1,392.21

297.42
$3,922.66

1,094.79

58,389.56

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-20 (Continued)


(d) (Continued)
January 1, 2014
Right-of-use Asset .................................. 72,565.64
Obligations under Lease ..................
72,565.64
Obligations under Lease .......................... 1,392.21
Cash ...................................................

1,392.21

February 1, 2014
Obligations under Lease .......................... 1,036.34
Interest Expense ....................................... 355.87
Cash ...................................................

1,392.21

December 31, 2014


Interest Expense .......................................
Interest Payable.................................

297.42
297.42

Amortization Expense ............................. 12,513.13


Right-of-use Asset ............................
12,513.13
[($72,565.64 $10,000) 5]
(e) Assuming the entries in part (d), the $1,000 payment is the
last payment on the amortization schedule, and it will be a
combination of the final payment on the principal
outstanding and interest on the outstanding obligation
since the last payment date a year earlier. Assuming the
entries in part (b), the penalty would be recognized as a
loss when it can first be estimated reliably.

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-20 (Continued)


(f)
Option 1
Statement of financial position
Assets:
Property plant and equipment
Vehicles
Vehicles under lease
Accumulated depreciation
Net

Option 2

Option 3

$79,000
(13,800)
65,200

$71,730
(12,346)
59,384

Intangible assets
Right-of-use asset
Amortization of rights to date
Net
Liabilities:
Current liabilities:
Interest payable
Rent payable
Instalment note payable current
Obligations under lease current

Solutions Manual

Contract
Based

$72,566
(12,513)
60,053

1,204

293

297
1,392

14,418
13,559

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13,505

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-20 (Continued)


Option 1
Non-current liabilities:
Instalment note payable
Obligations under lease
Total liabilities
Income statement - 2014
Depreciation expense
Amortization expense
Rent expense
Interest expense

Option 2

Option 3

Contract
Based

54,407
45,042
70,029

58,894

$13,800

$12,346

45,980
1,392

59,782

$12,513
$16,707
5,176
$18.976

3,871
$16,666

$16,707

3,923
$16,436

(g)
Total expense - 5 years
Depreciation expense
Amortization expense
Auto expense (excess km.)
Rent expense
Interest expense

Solutions Manual

Option 1
$69,000 (1)

Option 2
$61,730

(3)

Option 3
$29,500

Contract
Based
(5)
$62,565 (8)

1,000
15,312 (2)
$84,312

11,294
$74,024

(4)

50,120

(6)

3,637
$83,257

(7)

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11,459 (9)
$74,024

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-20 (Continued)


(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)

Annual depreciation X 5 or Cost $79,000 less residual


value $10,000
Refer to Instalment note table Option 1 part 2
Annual depreciation X 5 or capitalized amount $71,730
less residual value $10,000
Refer to lease amortization schedule Option 2 part 4
Annual depreciation $14,750 X 2 or Cost $39,500 less
residual value $10,000
Monthly rental of $1,392.21 X 36 months
Refer to Instalment note table Option 3 part 4
Annual amortization X 5 (=$62,565) or capitalized
amount $72,565 less residual value $10,000
Same as item 4 of $11,294 plus the interest on the
penalty of $835.64 (difference between present value of
$835.64 and future value of $1,000.00) = $11,459

(h) Not coincidently, the total expenses under Option 2 are


equal to those for the accounting using the contract-based
approach in part (c). The main difference in the choices can
be found in the choice between purchase Option 1 or lease
Option 2. Option 3 is somewhat of a hybrid between the
Option 1 and 2 but what it has most in common with Option
1 is that the vehicle is purchased. Although the purchase
option results in the highest total expense for five year,
(Option 1 and 3) it also provides the highest potential for a
gain from the sale of the vehicle at the end of the useful life,
as the residual value employed in the calculations at lease
inception might be a conservative estimate.
The second major consideration is the difference in the way
in which income tax will be applied to the different
alternatives, particularly since the asset is a luxury vehicle
and there are limits on deductibility under the Income Tax
Act.
Finally, cash flow consideration should be taken into
account as well as financial ratios that are of particular
interest to the creditors and investors of Sanderson Inc.
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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-21
(a) The lease is an operating lease to BMW Canada. The lease
1. does not transfer ownership, nor contain a bargain
purchase option,
2. does not cover at least 75% of the estimated economic life
of the car, (3 8 = 37.5%) and
3. the present value of the lease payments of $45,992* is not
at least 90% of the fair value of the car.
Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? * Yields $45,992
I
.5%
N
36
PMT
$ 1,392.21
FV
0
Type
1
At least one of the three criteria would have had to be
satisfied for the lease to be classified as other than an
operating lease. The property is recorded as a rental
property to BMW and will be treated as a payment of rent
by the lessee under the operating lease.
(b)
January 1, 2014
Cash.....................................................
Rent Revenue ..............................

1,392.21
1,392.21

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-21 (Continued)


(c) 1.

Date
Jan.
Feb.
Mar
Apr.
May
June
July
Aug.
Sep.
Oct
Nov.
Dec.
Jan.
Feb.
Mar
Apr.
May
June
July
Aug.
Sep.
Oct
Nov.
Dec.

1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1

2014
2014
2014
2014
2014
2014
2014
2014
2015
2015
2015
2015
2015
2015
2015
2015
2015
2015
2015
2015
2016
2016
2016
2016

BMW Canada Lessor


Lease Amortization Schedule
Annual
Lease
Interest
Net
Balance
Payment
on Net
Investment
of Net
Plus URV Investment Recovery Investment
79,000.00
1,392.21
1,392.21
77,607.79
1,392.21
388.04
1,004.17
76,603.62
1,392.21
383.02
1,009.19
75,594.43
1,392.21
377.97
1,014.24
74,580.19
1,392.21
372.90
1,019.31
73,560.88
1,392.21
367.80
1,024.41
72,536.47
1,392.21
362.68
1,029.53
71,506.95
1,392.21
357.53
1,034.68
70,472.27
1,392.21
352.36
1,039.85
69,432.42
1,392.21
347.16
1,045.05
68,387.38
1,392.21
341.94
1,050.27
67,337.10
1,392.21
336.69
1,055.52
66,281.58
1,392.21
331.41
1,060.80
65,220.78
1,392.21
326.10
1,066.11
64,154.67
1,392.21
320.77
1,071.44
63,083.23
1,392.21
315.42
1,076.79
62,006.44
1,392.21
310.03
1,082.18
60,924.26
1,392.21
304.62
1,087.59
59,836.67
1,392.21
299.18
1,093.03
58,743.65
1,392.21
293.72
1,098.49
57,645.15
1,392.21
288.23
1,103.98
56,541.17
1,392.21
282.71
1,109.50
55,431.67
1,392.21
277.16
1,115.05
54,316.61
1,392.21
271.58
1,120.63
53,195.99

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-21 (Continued)

Jan.
Feb.
Mar
Apr.
May
June
July
Aug.
Sep.
Oct
Nov.
Dec.
Jan.
Jan.
Feb.
Mar
Apr.
May
June
July
Aug.
Sep.
Oct
Nov.
Dec.
Jan.
Feb.
Mar
Apr.

Date
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1

2016
2016
2016
2016
2016
2016
2016
2016
2016
2016
2016
2016
2017
2017
2017
2017
2017
2017
2017
2017
2017
2017
2017
2017
2017
2018
2018
2018
2018

Annual
Lease
Interest
Net
Balance
Payment
on Net
Investment
of Net
Plus URV Investment Recovery Investment
1,392.21
265.98
1,126.23
52,069.76
1,392.21
260.35
1,131.86
50,937.90
1,392.21
254.69
1,137.52
49,800.38
1,392.21
249.00
1,143.21
48,657.17
1,392.21
243.29
1,148.92
47,508.24
1,392.21
237.54
1,154.67
46,353.57
1,392.21
231.77
1,160.44
45,193.13
1,392.21
225.97
1,166.24
44,026.89
1,392.21
220.13
1,172.08
42,854.81
1,392.21
214.27
1,177.94
41,676.88
1,392.21
208.38
1,183.83
40,493.05
1,392.21
202.47
1,189.74
39,303.31
196.70
196.70
39,500.00
1,371.00
1,371.00
38,129.00
1,371.00
222.42
1,148.58
36,980.42
1,371.00
215.72
1,155.28
35,825.14
1,371.00
208.98
1,162.02
34,663.12
1,371.00
202.20
1,168.80
33,494.32
1,371.00
195.38
1,175.62
32,318.71
1,371.00
188.53
1,182.47
31,136.23
1,371.00
181.63
1,189.37
29,946.86
1,371.00
174.69
1,196.31
28,750.55
1,371.00
167.71
1,203.29
27,547.26
1,371.00
160.69
1,210.31
26,336.95
1,371.00
153.63
1,217.37
25,119.59
1,371.00
146.53
1,224.47
23,895.12
1,371.00
139.39
1,231.61
22,663.50
1,371.00
132.20
1,238.80
21,424.71
1,371.00
124.98
1,246.02
20,178.69

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-21 (Continued)

May
June
July
Aug.
Sep.
Oct
Nov.
Dec.
Jan.

Date
1
1
1
1
1
1
1
1
1

2018
2018
2018
2018
2018
2018
2018
2018
2018

Annual
Lease
Interest
Net
Balance
Payment
on Net Investment
of Net
Plus URV Investment Recovery Investment
1,371.00
117.71
1,253.29
18,925.39
1,371.00
110.40
1,260.60
17,664.79
1,371.00
103.04
1,267.96
16,396.84
1,371.00
95.65
1,275.35
15,121.49
1,371.00
88.21
1,282.79
13,838.69
1,371.00
80.73
1,290.27
12,548.42
1,371.00
73.20
1,297.80
11,250.62
1,371.00
65.71
1,305.29
9,945.33
10,000.00
54.67*
9,945.33
0.00
$13,968.89

*Rounded
2.

The lease is a sales-type lease to BMW Canada. The present


value of the unguaranteed residual value is calculated as
follows using two steps:
The first step is for the renewal period of 2 years:

Excel formula =PV(rate,nper,pmt,fv,type)


Using a financial calculator:
PV
$ ? Yields $8,734.39
I
7%
N
2
PMT
0
FV
$ 10,000
Type
1
The second step is to calculate the present value of the
amount arrived in the first step back to January 1, 2014 for a
period of 3 years.

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-21 (Continued)


Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV
$ ? Yields $7,333.56
I
6%
N
3
PMT
0
FV
$ 8,734.39
Type
1
Consequently the sale price is $79,000.00 less the present
value of the unguaranteed residual value of $7,333.56 or
$71,666.44
The cost of goods sold is $70,000.00 less the present value
of the unguaranteed residual value of $7,333.56 or
$62,666.44.
The amount of the lease payments receivable is the sum of
the lease payments under the initial lease and the renewal
lease calculated as follows:
36 payments @ 1,392.21 =
$50,119.56
24 payments @ 1,371.00 =
32,904.00
Unguaranteed residual value
10,000.00
Total receivable
$93,023.56
3.
January 1, 2014
Lease Receivable ..................................... 93,023.56
Cost of Goods Sold ................................. 62,666.44
Sales Revenue ..................................
71,666.44
Inventory ...........................................
70,000.00
Unearned Interest Income ...............
14,023.56
Cash.......................................................... 1,392.21
Lease Receivable .............................

1,392.21

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-21 (Continued)


February 1, 2014
Cash.......................................................... 1,392.21
Lease Receivable .............................

1,392.21

December 31, 2014


Unearned Interest Income ....................... 4,319.51
Interest Income.................................

4,319.51

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-22*
(a)
29/6/14

29/6/14

Cash ..........................................
8,000,000
Buildings ............................
9,500,000
Accumulated Depreciation
-Buildings .........................
3,321,429*
Deferred Profit on SaleLeaseback .......................
1,821,429
*($9,500,000 - $2,000,000) / 35 X 15.5 years)
Buildings under Lease .............
Obligations under Lease ....
($838,380 X 9.36492*) +
($1,000,000 X .14864**)

8,000,000
8,000,000

* Present value of annuity due for 20 periods at 10%


** Present value of single payment for 20 periods at 10%
Excel formula =PV(rate,nper,pmt,fv,type)
PV
I
N
PMT
FV
Type
29/6/14

$ ?
10%
20
$ (838,380)
$ (1,000,000)
1

Obligations under Lease..........


Cash.....................................

Yields $8,000,005

838,380
838,380

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-22* (Continued)


Partial Lease Amortization Schedule

Date
29/06/14
29/06/14
29/06/15

Annual
Lease
Payment
$838,380
838,380

Interest
(10%)

$716,162

Amortization
$838,380
122,218

12/31/14 Deferred Profit on Sale-Leaseback


Depreciation Expense** ........
($1,821,429 20 X 6/12)

Balance
$8,000,000
7,161,620
7,039,402

45,536
45,536

**The credit could also be to a gain account.


The deferred profit on the sale-leaseback should be amortized
on the same basis that the asset is being depreciated.
Maintenance, insurance and property taxes would also have
been paid during the year.
12/31/14 Depreciation Expense ..................
150,000
Accumulated Depreciation
-Leased Buildings.............
(($8,000,000 - $2,000,000) 20 X 6/12)
12/31/14 Interest Expense ..........................
Interest Payable .....................
($7,161,620 X 10% X 6/12)

358,081

29/6/15

122,218
358,081
358,081

Obligations under Lease..........


Interest Payable..............................
Interest Expense ............................
Cash .......................................

12/31/15 Deferred Profit on Sale-Leaseback


Depreciation Expense ...........
($1,821,429 20)

150,000

358,081

838,380
91,071
91,071

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-22* (Continued)


12/31/15 Depreciation Expense ..................
300,000
Accumulated Depreciation
-Leased Buildings..............
(($8,000,000 - $2,000,000) 20)
12/31/15 Interest Expense ..........................
Interest Payable .....................
($7,039,402 X 10% X 6/12)

300,000

351,970
351,970

(b) The lease must now be recorded as an operating lease as it


is no longer a capital lease because: (1) the lease term is for
60% (12 20) of the economic life of the leased asset and
(2) the present value of the minimum lease payments is 79%
($6,283,709 / $8,000,000) of the fair value of the leased asset
and (3) there is no longer a bargain purchase option.
Maintenance, insurance and property tax expenses would
also be incurred.
The present value of the minimum lease payments:
Using a financial calculator:
PV
$ ? Yields $ 6,283,709
I
10%
N
12
PMT
$ (838,380)
FV
$ 0
Type
1
29/6/14

Cash ............................................... 8,000,000


Buildings .................................
9,500,000
Accumulated Depreciation
-Buildings .............................. 3,321,429*
Deferred Profit on SaleLeaseback .............................
1,821,429
*($9,500,000 - $2,000,000) / 35 X 15.5 years)

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-22* (Continued)


29/6/14 Rent Expense .................................
Cash..........................................

838,380

31/12/14 Prepaid Rent .................................


Rent Expense ...........................

419,190

31/12/14 Deferred Profit on SaleLeaseback .................................


Rent Expense ...........................
*($1,821,429 / 12 X 6/12)

838,380
419,190
75,893
75,893

29/6/15 *Rent Expense ................................


Prepaid Rent ............................

419,190

29/6/15 Rent Expense .................................


Cash..........................................

838,380

31/12/15 *Prepaid Rent ..................................


Rent Expense ...........................

419,190

31/12/15 Deferred Profit on SaleLeaseback ..................................


Rent Expense ...........................
($1,821,429 / 12)

419,190
838,380
419,190
151,786
151,786

*Note to instructor: these two entries cancel each other out and
could be omitted.

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-22* (Continued)


(c)

The net assets amount (or equity) on the statement of


financial position of North Central will be very similar after
the completion of the sale and leaseback as it was before.
Any excess of the capitalized amount of the building over
the carrying value at the time of the sale (i.e. the gain) will
be deferred and amortized over the term of the lease, or the
life of the asset. Eventually this gain will be realized to
equity. Over the term of the lease, the additional costs
related to the borrowing will affect equity but this is no
different, for example, than if a loan had been obtained in
exchange for a mortgage obligation.

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-23*
(a)
To the lessee, this lease of the building is accounted for as a
capital lease and the lease of the land is treated an operating
lease, since there is no bargain purchase option for the property
and because the terms of the lease satisfy at least one of the
quantitative criteria for capitalization.
The present value of the minimum lease payments is greater
than 90% of the fair value of the leased property; that is, the
present value of $1,705,457 (see below) is 97.5% of the fair value
of the leased property ($1,705,457 / $1,750,000).
Using a financial calculator:
PV
$ ? Yields $1,705,457
I
7%
N
15
PMT
$ (175,000)
FV
$ 0
Type
1
The land and building must be considered separately for the
purpose of classifying the lease. The minimum lease payments
must be allocated between the land and the building in
proportion to their fair values.
The portion of the gain related to the lease of the land, which is
an operating lease, is amortized over the term of the lease. The
portion of the gain related to the building must be deferred and
amortized in proportion to the depreciation of the leased asset.

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Intermediate Accounting, Tenth Canadian Edition

PROBLEM 20-23* (Continued)


October 1, 2014
Cash .................................................................. 1,750,000
Land and Building (net) ............................
250,000
Deferred Profit on Sale-Leaseback(Land) (40%)
600,000
Deferred Profit on Sale-Leaseback(Building) (60%) 900,000
Buildings under Lease ..................................... 1,023,274
Obligations under Lease ..........................
1,023,274
($1,705,457 X 60% = $1,023,274)
Obligations under Lease..................................... 105,000
Rent Expense ...................................................... 70,000
Cash..............................................................
175,000
[($175,000 X 40 % = $70,000]
September 30, 2015:
Interest Expense ................................................
Interest Payable
[($1,023,274 $105,000) X 7%] ............

64,279
64,279

Depreciation Expense ........................................


Accumulated Depreciation Leased
Buildings
($1,023,274 X 10%) ..............................

102,327

Deferred Profit on Sale-Leaseback(Land) ........


Gain on Sale of Land ..................................
($600,000 / 15)

40,000

Deferred Profit on Sale-Leasehold(Building) ...


Gain on Sale of Buildings ..........................
($900,000 X 10%)

90,000

October 1, 2015:
Interest Payable ...................................................
Obligations under Lease.....................................
Rent Expense ......................................................
Cash..............................................................

102,327
40,000

90,000

64,279
40,721
70,000
175,000

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PROBLEM 20-23* (Continued)


(b) Financial Statement disclosure at September 30, 2015:
Statement of financial position:
Property Plant & Equipment:
Buildings under lease
$ 1,023,274
Less: Accumulated depreciation
(102,327)
920,947
Current Liabilities
Interest payable
Current portion of obligations under
lease
Deferred profit on sale of land and
building
Long term liabilities
Deferred profit on sale-leasehold of land
and
building
Obligations under lease
Less: Current portion

Land
Deferred profit on saleleasehold of land and
building

64,279
40,721
121,000

1,249,000
918,274
(40,721)
877,553
Building

$ 600,000 $ 900,000

Depreciation - Fiscal year 2015

(40,000)

(90,000)

Balance September 30, 2015

560,000

810,000

40,000

81,000

Current Portion
Non- Current Portion

Total

520,000

$ 121,000

729,000 $1,249,000

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PROBLEM 20-23* (Continued)


Statement of Income:
Gain on sale of property
Rent expense
Depreciation expense
Interest expense

Statement of cash flows: - indirect format


Operating Activities:
Depreciation expense
Gain on sale of property
Increase in interest payable
Investing Activities:
Proceeds on sale of property

$130,000
70,000
102,327
64,279

$102,327
130,000
64,279 *

1,750,000

Financing Activities:
Payment of long term obligations under
lease
(105,000)
* would likely be combined with other amounts of interest
The sale and leaseback transaction is a non-cash financing and
investing activity, which would be reported in the notes to the
financial statements and not on the face of the statement of cash
flows.
The disclosure requirements for the operating lease for the land
includes the future minimum lease payments, in total and for
each of the next five years.

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CASES
Note: See the Case Primer on the Student website, as well as
the Summary of the Case Primer in the front of the text. Note
that the first few chapters in volume 1 lay the foundation for
financial reporting decision making.
CA 20-1 CROWN INC.
Overview
-

CIs management has a financial reporting bias; that is, they do not want
to increase the debt that is presently on the balance sheet.
Note that the company wants to know the differences between IFRS and
ASPE.
Since the company appears to have other debt, the creditors will be key
users. They will want objective information and will be concerned with the
debt-to-equity ratio to assess how leveraged the company is, and thereby
assess the company's ability to repay debt.
As the auditor you will want conservative and transparent financial
statements.

Analysis and Recommendations


Issue: Whether the lease is a capital/finance lease or an operating lease
-

There is no evidence that legal title passes to CI at the end of the lease.
There is no BPO since the purchase option allows CI to purchase at the
FV.
The term of the lease is only 12 years, which is less than 75% of the
economic life of 20 years.
The PVMLP is as follows:
$150,000 X 7.16073 = $1,074,110
$1,074,110/$1,900,000 = 56.5% which is less than 90%

Therefore, it would appear, on the surface that the lease was an operating lease.
On the other hand, given that the asset is manufactured specifically for CI, there
is no other possible use for the machine, and AL likely does not want the
machine back, it would appear to be common sense that the lease is indeed a
capital lease that represents a purchase in substance by CI. The written
agreement should not be reviewed in isolation but rather within the context of the
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CA 20-1 (CONTINUED)
reporting environment (management bias) and the additional unwritten
agreement to purchase.
The principle hinges on the transfer of the risk and rewards of ownership. In this
case, both the auditor and the client know that the substance is such that the
lease has been used as alternative financing in order to obtain off-balance-sheet
financing; however, the client will argue that it is not a capital/finance lease since
it does not meet the criteria if numerical thresholds are used as a benchmark.
Note that under ASPE the numerical thresholds are often used but under IFRS
the analysis does not hinge upon this. The key is on assessing the substance of
the arrangement.
Minor differences from the perspective of the lessee include:
- Terminology IFRS refers to capital leases as finance leases
- Discount rates ASPE requires the use of the lower of the IR and IBR if
IR known whereas IFRS requires the use of IR if known (otherwise IBR).
Recommendation: As an auditor, there is an overriding concern that the financial
statements are fairly presented, the implication being that the substance of all
transactions is appropriately reflected in the financial statements. In this case, the
evidence is too strong that this is a capital/finance lease and, therefore, the
auditor should argue to capitalize the lease, especially if the amounts are
material.

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CA 20-2 KELLYS SHOES


Overview
-

Not clear whether GAAP is a constraint but users will likely want GAAP
financial statements since they provide more useful information.
Differences between IFRS and ASPE are provided as requested.
Landlords in particular might want to see the financial statements in order
to help negotiate the restructuring.
In addition, creditors and shareholders would be interested in transparent
statements.
As management would want to show a realistic picture of the state of
affairs. May be biased to make the situation look at bit worse so as to be
in a better negotiating situation.

Analysis and Recommendations


Issue: How to account for the three months bonus of free rent/costs of
cancellation. Not clear as to whether operating or capital leases (termination of a
capital lease would result in removal of assets/liabilities with a gain/loss
recognized).
Accrue costs
- If likely that the costs would be
incurred and measurable. Per
IAS 37 present obligation as a
result of past transaction,
probable outflow and
measurable (essentially the
same as ASPE).
- In this case the leases are
non-cancellable and therefore, it
is likely that there would be
costs to break the lease.
- The key would be whether these
are measurable would depend
on stage that negotiations were
in.

Do not
- Measurement may be an issue
since each landlord might make
a different deal.
- Some landlords may even be
willing to provide financial
support to the company to keep
the stores open as long as
possible cannot accrue this
benefit until received
(contingency accounting).
- An exit plan by itself does not
necessarily create an obligation.
- Would wait until contracts are
actually terminated.

Recommendation: It would appear that the negotiations were at a very


preliminary stage and that the landlords might have been willing to offer some
inducements/concessions to the company to stay longer. Therefore, the outcome
of the uncertainty was not yet determinable and recognition would not be
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CA 20-2 (CONTINUED)
recommended. This would be further supported since, even if it were argued that
the costs were likely, it is difficult to measure the cost. At the one end of the
spectrum, the landlords could require the full commitment to the end of the lease
be honoured. At the other end, the landlord might agree to a lesser amount, i.e.,
the company would pay rent until a new tenant is found.

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TIME AND PURPOSE OF WRITING ASSIGNMENTS


WA 20-1 (Time 1525 minutes)
Purposeto provide the student with an ethics case involving the capitalization
criteria applied to technology that is fast becoming obsolete for the capitalization
and contract-based approaches. The student must assess the validity of the
arguments given for not capitalizing equipment and make recommendations.

WA 20-2 (Time 2535 minutes)


Purposeto provide the student with an understanding of the different impacts of
the current ASPE and IFRS lease treatments on financial statements and the
proposed contract-based approach. The student must describe the changes in
basic financial ratios under these different standards. The student is also
required to use the conceptual framework to explain the contract-based approach
for leases, which appears to gain more support from the joint FASB-IASB study
group.

WA 20-3 (Time 4045 minutes)


Purposeto provide the student with an understanding of the two approaches
being considered for lessor accounting derecognition approach and the
performance obligation approach. It also requires students to demonstrate their
understanding of the initial recording of a lease under the two alternatives.

WA 20-4 (Time 40 45 minutes)


Purposeto provide the student with an understanding of the theoretical reasons
for requiring certain leases to be capitalized by the lessee. It also requires
students to demonstrate their 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.

WA 20-5 (Time 30 35 minutes)


Purposeto provide the student with an opportunity to compare and contrast the
accounting for leases under ASPE, IFRS and the contract based approach and
to understand the underlying concepts for these different treatments.

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SOLUTIONS TO WRITING ASSIGNMENTS


WA 20-1
(a)

The ethical issues relate to fairness and integrity of financial reporting


versus profits and possibly misleading financial statements. On one hand, if
Koba can substantiate her position, it is possible that the agreement should
be considered an operating lease arguing that this is not a bargain
purchase option, in reality, since the value of the photocopiers will likely be
below this price. On the other hand, if Koba cannot or will not provide
substantiation, she would appear to be trying to manipulate the financial
statements for some reason such as a debt covenant or minimum levels of
certain ratios.

(b)

If Koba has no particular expertise in copier technology, she has no rational


case for her suggestion. If she has expertise, then her suggestion may be
rational and would not be merely a means to manipulate the statement of
financial position to avoid recording a liability. Another explanation may be
based on Kobas past experience, where photocopy manufacturers or
lessors have approached Koba before the expiration of past leases to
upgrade existing equipment with more modern and cost effective models in
order to keep good customer relations. Under those circumstances, Koba
would expect that this trend would continue in the future, justifying her
position that this is not a bargain purchase option that will be exercised,
and to treat the lease as an operating lease.

(c)

Beckert, the ethical accountant, must decide whether the situation


presents a legitimate difference of opinion where professional judgment
could take the answer either way, or as an attempt by Koba to mislead
reporting on the financial statements. Beckert must decide whether he
wishes to argue with Koba or simply accept Kobas position. Beckert should
assess the consequences of both alternatives.
If the ethical accountant determines that this is an attempt by Koba to
mislead users of the financial statements then he will need to decide what
to do next. Assuming that calling the leases operating when they are
actually finance leases is material to users decisions, then he should
approach Koba and inform her about his concerns. As the CFO, assuming
that the controller reports to him, the ethical accountant should then ensure
that the financial statements properly represent the underlying leases, and
account for them as finance leases.

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WA 20-1 (Continued)
(d)

Under the contract-based approach, the contractual lease obligation will be


reported on the statement of financial position regardless of whether a
bargain purchase option is seen to exist or not. The only difference will be
how the asset will be recognized. If the bargain purchase option does not
exist, based on Kobas arguments, then the contractual lease rights are
recognized as an intangible asset. This intangible asset would be amortized
on some systematic pattern of usage over the lease term. If the bargain
purchase option is likely to be exercised, then the lease agreement is, in
substance, an acquisition, and the copiers would be recorded as
equipment. In this case, the equipment would be depreciated over their
useful lives.

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WA 20-2
(a)

The retail outlet leases: Based on the lease terms and conditions for the
retail outlets noted in the question, these leases represent operating
leases. Leases that are operating leases are recognized and reported in
the same manner under both ASPE and IFRS: the monthly lease
payments and contingent rental payments are all expensed as incurred.
Building Lease: The information notes that the building lease has been
assessed against the capitalization criteria under private enterprise
accounting standards, and found to qualify as an operating lease.
However, there are a few differences in these criteria under IFRS that
might change the final conclusion as noted below:
1. Transfer of benefits and risks: In assessing the transfer of risks and
rewards, IFRS also requires an assessment of the degree to which an
asset is specialized and of use only to the lessee without major expense
to the lessor. If it is found on review, that the new facility is so specialized
that the lessor would have difficulty leasing to another tenant without a lot
of extra costs, then the lease contract transfers substantially all of the
benefits and risks of property ownership, and should be capitalized.
Considering that the building was designed specifically for Sporons
needs, substantial amounts of benefits may be transferred to Sporon.
Thus, careful review of the lease contract is required to identify any
substantial transfer of risks, including the requirement to pay property tax
increases.
2. Depending on which interest rate was used to test the minimum lease
payment criterion, Sporon may need to account for the lease as a finance
lease under IFRS. While CICA Handbook Part II, Section 3065 specifies
the use of the lower of the interest rate implicit in the lease and the
lessee's incremental borrowing rate, IAS 17 specifies use of the interest
rate implicit in the lease when it is practicably determinable; otherwise, the
lessee's incremental borrowing rate is used.

(b)

To Louise Bren,
Subject: Accounting Treatment for Leases under the approach of the
FASB-IASB joint project.
The IASB and FASB, through a Joint International Working Group, issued
an Exposure Draft changing the accounting for leases in 2010, and based
on the comments received are currently looking at a variety of options
related to financial reporting for leases. As indicated in the 2010 Exposure
Draft, the contract based approach is being considered as they intend to
choose a model that will rely on asset and liability definitions in the
conceptual framework. This approach is based on the idea that all
arrangements that provide one party the right to use an item of another
party should be accounted for similarly.

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WA 20-2 (Continued)
The contract based approach is expected to be more useful to users as
some entities are not recognizing a substantial amount of lease obligations
that meet the definition of liabilities under the conceptual framework. Under
the contract based approach, the capital (or finance) and operating lease
distinction would disappear and most leases would qualify for recognition as
assets and liabilities by the lessee.
Retail outlet leases:
Based on feedback received, the IASB and FASB are considering allowing
the straight-line approach for leases in certain circumstances. This
approach would be similar to what is used for operating leases currently.
However, if the lease is for a major part of the economic life of underlying
asset then the lease would need to be capitalized. If this latter approach is
adopted, these leases will be shown on the statement of financial position.
An intangible asset for the contractual lease rights will be recognized, and
amortized over a systematic period, likely a straight-line basis over the
lease term. A liability for the contractual lease obligation will be recognized
and amortized using the appropriate discount rate over the lease term. As
payments are made, the obligation will be reduced and interest expense
will be recognized. There are three issues with respect to these leases that
would have to be assessed:
1. What is the lease term? The lease term should be the longest lease
term that is more likely than not to occur. This would be 10 years for the
current retail leases the initial term and the renewal period.
2. What are the payments to be included in the contractual obligations? In
this case, the monthly payments and the contingent payments would be
included in determining the value of the obligation. The value for the
contingent rental payments would be determined using probability weighted
expected values over the term of the lease. The value of these contingent
payments would have to be reassessed at each reporting period, with any
changes related to the current and past period contingencies being
reported immediately into income and any impact on future periods would
change the amount of the obligation.
3. What discount rate should be used in determining the amount of the
obligation and asset? Sporons incremental borrowing rate would be used
to discount the payments to determine the contractual obligation.
Overall, if the Company is leasing relatively new buildings, it may end up
being able to account for the retail outlet leases as straight-line leases as
they may not be long enough to represent a major part of the economic life
of the property.

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WA 20-2 (Continued)
Building lease: For the building lease, the first assessment that needs to
be made is whether substantially all of the risks and rewards have been
transferred since the building is unique to Sporons purposes and the
lease, by design, perhaps earns the lessor a fixed return. If this is the
case, then the lease would be seen to be a purchase in substance, and the
value of the contractual obligation and the building as an asset would be
recognised. The building would be depreciated over its useful life, and the
obligation would be reduced as payments are made, and interest is
expensed. If it is found that the lease does not substantially transfer the
risks and rewards, then an intangible asset is recognized instead and
amortized over some systematic basis likely straight-line over the 20 year
term of the lease. The amount of the obligation would be the same in
either case. For this assessment, the lease term would be 20 years, and
the discount rate would be Sporons incremental borrowing rate. Lastly,
depending on how long the overall life of the building is, the Company may
end up being able to account for the retail outlet leases as straight-line
leases as they may not be long enough to represent a major part of the
economic life of the property. However, given a 20 year lease, the building
lease is more likely to be required to be capitalized than the retail leases.
The impact of capitalization of the leases on the cash flow statement would
be to remove the lease payments from operating cash flows, and instead,
the portion of the payment that represents interest would be shown as
either operating or financing (depending on the companys policy) and the
reduction in the obligation would be recorded as a financing activity. This
would cause the operating cash flow to be higher under the contract based
approach.

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WA 20-2 (Continued)
(c)

Appendix: If the leases were all considered straight-line leases, than there
would be little or no impact on the Companys ratios. However, if the
leases are capitalized, it would have the following impact on these basic
ratios.

Profitability
Profit margin

Return on
assets

Return on
equity

The ratio will be lower in the earlier years and


higher in the later years under the contract-based
lease treatment because 1) operating leases
recognize lease expenses evenly during the lease
term; and 2) interest expense and amortization
expenses, which are recorded under a capital
lease, are higher in the earlier years.
Lower: Assets, the denominator, would increase by
the value of the intangible assets. The net income
will be lower in the earlier years due to the higher
interest and amortization expenses. As a result,
the return on assets will be lower. Over time, this
will increase as the asset is reduced and net
income is higher with the lower amounts charged
for interest and amortization expenses.
Lower: The return would decrease in the earlier
years and so would retained earnings in equity for
the same reasons noted above

Risk
Debt-to-equity
Times interest
earned

Higher: Debt would increase by the contractual


lease obligation amount while equity (retained
earnings) would decrease (in the earlier years).
EBIT would increase because although there is an
amortization expense this may be lower than the
rent expense that would disappear. However, the
denominator, interest expense, would increase as
well. So it is difficult to assess the overall impact
without further details.

Solvency
Operating cash As cash outflows for the principal balance of the
flows to total
lease obligation would be reported under financing
debt
activities, the cash flow from operating activities
would be higher. At the same time, the amount of
total debt, which is the denominator of this ratio,
would increase by the lease obligation and later get
smaller as the obligation gets repaid. So it is
difficult to assess the exact impact without further
details.

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WA 20-3
(a)

The performance obligation approach is discussed in the text book under


the contract-based approach. In this approach, the lessor is granting the
right to use the asset to the lessee over the term of the lease. The lessor
does not lose control of the asset, which continues to be reflected on the
statement of financial position. In this case, the lessor has the right to
receive the lease payments, and an unconditional obligation to permit the
use of the asset over the term of the lease. As a consequence, at the time
the lease is entered into, a lease receivable is recorded as an asset and a
performance obligation is recorded as the offsetting liability. The receivable
and obligation are calculated to be the present value of the lease
payments. As the lessor discharges the performance obligation, leasing
income is recognized into income. As payments are received from the
lessee, interest income is recognized and the receivable is reduced.
Finally, the asset would continue to be depreciated over its useful life, On
the statement of financial position, the asset, the lease receivable and the
performance obligation are shown as a net liability or asset. On the
statement of comprehensive income, the lessor would report leasing
income, interest income and depreciation expense.

(b)

The derecognition approach assumes that a portion of the leased asset is


sold when the rights of use are transferred to the lessee under the lease
agreement. This requires that the leased assets be derecognized. The
lease contract is a promise to transfer the asset to the lessee and so once
delivery is completed, the performance obligation has been met and no
longer exists. In derecognizing the leased asset, a receivable for the
present value of the lease payments and a residual value are recognized.
The residual value is a non-financial asset which represents the rights to
economic benefits from the asset arising after the lease term. These
economic benefits would arise from subsequent sale of the asset or releasing the asset under a new contract. The company will recognize
revenue on the sale of the asset, and then interest income on the
receivable as the lease payments are received. The impact on the
statement of financial position will be a receivable and a residual value as
assets. The impact on the statement of comprehensive income will show
revenue from the sale of the leased asset, and interest income over the
term of the lease.

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WA 20-3 (Continued)
(c)

Using the information given, below is what would be shown on the


statement of financial position for assets and liabilities on initial recognition
of the lease:

Leased asset
Lease receivable
Residual value
Performance obligation
Net assets

Performance obligation
$100,000
$92,900
($92,900)
$100,000

Derecognition
$92,900
$7,100
$100,000

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Intermediate Accounting, Tenth Canadian Edition

WA 20-4
(a)

In addition to triggering a gain, most likely Truttman was motivated to sell


and leaseback equipment to generate some much needed cash flow. The
interest rate offered by the leasing company was most likely favourable
from the point of view of Truttman, in comparison to other sources of
financing.

(b)

1.

A lease is categorized as a finance lease if, at the date of the lease


agreement, it meets any one of three criteria under ASPE or four
criteria under IFRS. As the lease has no provision for Truttman to
reacquire ownership of the equipment, it fails the criteria of transfer of
ownership at the end of the lease under both IFRS and ASPE; there is
no bargain purchase option. Truttmans lease payments, with a
present value equalling 75% of the equipments fair value, fails the
criterion for a present value equalling or exceeding 90% of the
equipments fair value for ASPE. However, under IFRS, since there
are no bright lines one would have to judgementally determine if the
present value of the payments allows the lessor to recover
substantially all of its investment in the property with an appropriate
rate of return. This criteria is likely not to be met under IFRS either.
Under ASPE, the final criterion is whether its term allows the lessee to
substantially use the building for its economic useful life. In this case,
73% is below the 75% threshold and therefore the criteria would not
be met. In this case, under ASPE the lease would be classified as an
operating lease. However, under IFRS, since there are again no bright
lies, one could conclude that 73% of the economic life is long enough
to receive substantially all of the economic benefits. In this case, the
lease might be recorded as a finance lease. The final criteria under
IFRS would look at whether or not the asset is specialized for the
lessees use, which in this case, does not seem to be the case.

2.

Comparisons of equipments 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 instalment sale and is therefore a
finance lease. If the fair value test or the useful life test is met, there is
an indication that the lessee is obtaining most of the benefits that the
asset has to offer.

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WA 20-4 (Continued)
(c)

Operating lease treatment under ASPE: Truttman should account for the
sale portion of the sale-leaseback transaction at October 31, 2014, by
increasing cash for the sale price for $13 million, decreasing building (and
related accumulated depreciation) by the carrying amount of $10 million,
and recognizing a deferred gain on sale of $3 million for the excess of the
equipments carrying amount over its sale price. The deferred gain will be
recognized over the term of the lease. If the sale price is $1 million greater
than the fair value, the total gain deferred would be $4 million. All of the
gain over the carrying value is deferred and amortized over the operating
lease term. The operating lease payments are then recorded as an
expense as made.
Operating lease treatment under IFRS: IFRS recognizes that if an operating
lease is taken back, then the asset has been technically sold, and therefore
all of the gain of $3 million, representing the difference between fair value
($13 million) and the carrying value ($10 million) is fully recognized into
income at the time of the sale on October 31, 2014. If, as proposed in the
question, the selling price was actually greater than its fair value, then the
portion of the selling price greater than fair value of $1 million would be
recognized as a deferred gain and amortized over the term of the lease,
and the $3 million gain would be recognized immediately. The operating
lease payments are then recorded as an expense as made during
November and December, 2014.

(d)

Capital lease treatment under ASPE: Truttman should account for the sale
portion of the sale-leaseback transaction at October 31, 2014, by
increasing cash for the sale price for $13 million, decreasing building (and
related accumulated depreciation) by the carrying amount of $10 million,
and recognizing a deferred gain on sale of $3 million for the excess of the
equipments carrying amount over its sale price. The deferred gain will be
recognized on the same basis as depreciation of the leased asset. At the
same time, a capital leased asset and an offsetting capital lease obligation
will be recognized and will equal the present value of the lease payments.
At the end of the year, December 31, 2014, Truttman would recognize
interest expense on the obligation at the effective interest rate, principal
reduction in the obligation, and depreciation expense on the building
(depreciated over the term of the lease).
Accrued interest on the obligation for the period from November 1, to
December 31, 2014, will appear in the current liabilities section of the
statement of financial position along with the principal portion of the first
lease payment due October 30, 2015.

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WA 20-4 (Continued)
(d) (Continued)
The remaining portion of the principal to be repaid beyond 2015 will be
reported as a non-current liability. The cash flow statement for the year
ended December 31, 2014, will show proceeds from the sale of the
equipment as a source of cash in the investing section of the cash flow
statement. For the operating activities section, prepared using the indirect
format, the gain on the sale of the equipment and the depreciation expense
will be added back to income as well as the increase in the interest payable
(for the accrual recorded for the lease at the end of the year).
Finally the capital lease and the related obligation under capital lease from
the leaseback transaction are a non-cash financing and investing
transaction that will not appear on the face of the cash flow statement but
will be reported in the notes to the financial statements.
Capital lease treatment under IFRS: Truttman should account for the sale
portion of the sale-leaseback transaction at October 31, 2014, by
increasing cash for the sale price for $13 million, decreasing building (and
related accumulated depreciation) by the carrying amount of $10 million,
and recognizing a deferred gain on sale of $3 million for the excess of the
equipments carrying amount over its sale price. The deferred gain will be
recognized over the term of the lease (which differs from ASPE). At the
same time, a capital leased asset and an offsetting capital lease obligation
will be recognized and equal to the present value of the lease payments.
At the end of the year, December 31, 2014, Truttman would recognize
interest expense on the obligation at the effective interest rate, principal
reduction in the obligation, and depreciation expense on the building
(depreciated over the term of the lease).
Accrued interest on the obligation for the period from November 1, to
December 31, 2014, will appear in the current liabilities section of the
statement of financial position along with the principal portion of the first
lease payment due October 30, 2015.
The remaining portion of the principal to be repaid beyond 2015 will be
reported as a non-current liability. The cash flow statement for the year
ended December 31, 2014, will show proceeds from the sale of the
equipment as a source of cash in the investing section of the cash flow
statement. For the operating activities section, if prepared using the indirect
format, the gain on the sale of the equipment and the depreciation expense
will be added back to income as well as the increase in the interest payable
for the accrual recorded on the lease at the end of the year.

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WA 20-4 (Continued)
(d) (Continued)
Finally the capital lease and the related obligation under capital lease from
the leaseback transaction are a non-cash financing and investing
transaction that will not appear on the face of the cash flow statement but
will be reported in the notes to the financial statements.

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WA 20-5
There are many differences between IFRS and ASPE and the contract
based approach with respect to measurement and reporting for leases.
Primarily, ASPE has been written to follow historical Canadian practice.
ASPE has also been designed with the primary user in mind of being the
creditor, rather than outside shareholders and creditors. Given that
generally creditors have access to management; the disclosure has also
been simplified. The contract based approach has been designed to
eliminate the requirement to arbitrarily classify a lease into operating or
capital. Under this approach, all leases are treated the same and will impact
the statement of financial position and the statement of comprehensive
income in the same manner. Any perceived manipulation to keep leases off
the balance sheet is eliminated.
In most areas of lease accounting at the time of writing of this book, IFRS
and ASPE are converged. There are some subtle differences that are
highlighted below:
a) ASPE and IFRS use the classification approach for leases either
operating or capital. ASPE refers to capital leases and operating
leases for lessees, and operating, sales-type or direct financing leases
for lessors. IFRS uses the term finance leases or operating leases
for lessees or lessors. In contrast, the contract based approach does
not require classification of leases, since they are all treated the same.
b) ASPE has three criteria to assess for determining lease treatment and
numerical thresholds are provided to assist with this. IFRS requires
that the criteria be applied more judgmentally, with no bright lines of
numerical thresholds provided. In addition, IFRS has one more criteria
to assess which looks at the uniqueness of the asset specifically
designed for use by only the lessee. The only aspect that the contract
based approach would assess is to determine if the lease is in
substance a purchase or sale, and if so, would not be recognized
under the lease recognition and measurement standards.
c)For an operating lease, both ASPE and IFRS would recognize the lease
payments as they are made, either to income or expense for the lessor
and lessee, respectively.
d)For the contract based approach for the lessee, the rights to use the
asset are recognized as an intangible asset and contractual lease
obligations are recognized as a liability. Both of these amounts are
determined using the present value of the lease payments.
Amortization of the intangible right and interest expense on the
obligation is recognized over the term of the lease. The concept
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WA 20-5 (Continued)
(d) (Continued)
behind the contract based approach is that a contractual obligation has
been entered into on the signing of the lease, and this obligation
should be reported on the statement of financial position. As the right
to the asset is used, amortization is reported; and as the obligation is
paid, the obligation is reduced. In this way, it does not matter what
type of lease is entered into, and judgment is no longer required to
determine if the lease should be treated as operating or a finance
lease. The contract based approach uses the lessees incremental
borrowing rate. For the contract based approach for the lessor, the
treatment is similar as described above except a lease receivable and
offsetting performance obligation is reported.
e)For capital (finance) leases, both IFRS and ASPE recognize the present
value of the lease payments as a lease obligation and leased asset for
the lessee. As the lease term progresses, the asset is amortized and
interest expense is recognized on the lease obligation. Payments
reduce the lease obligation. IFRS uses the interest rate implied in the
lease when it can be reasonably determined, or the lessees
incremental borrowing rate. ASPE uses the lower of the implied lease
rate or the lessees incremental borrowing rate. Under the contract
based approach, the treatment is the same as described above since
no differentiation is made between operating and finance leases.
However, when the IASB issues its new Exposure Draft (expected in
2013) this may change. In particular, IFRS is considering allowing
some leases to qualify as straight-line leases (with accounting similar
to operating leases).
f)For the lessor, ASPE has two other recognition criteria which IFRS does
not specifically require under the lease standards, but does by default
under revenue recognition. Accounting treatment is the same under
both standards.
g)There are differences in what would be included in the lease payments.
IFRS and ASPE have similar standards, but the contract approach
would also require that contingent payments under the lease
agreements be estimated.
h)Disclosure is minimized for ASPE. For IFRS, more extensive disclosure
is required including reconciliations and additional information about
terms of the leases.

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RESEARCH AND FINANCIAL ANALYSIS


RA20-1

SHOPPERS DRUG MART.

(a) As indicated in note 3 (o) of Shoppers financial statements, the Company


leases most of its store locations and office space. Leases that transfer
substantially all the risks and benefits of ownership are recorded as financing
leases, and are included with property and equipment, accounts payable and
accrued liabilities and other long-term liabilities as applicable. All other leases are
considered operating leases and the related rent is expensed on a straight-line
basis over the term of the lease, any rent-free periods are also amortized on a
straight-line basis. Landlord inducements are also deferred and amortized on a
straight-line basis and reduce rent expense.
The Company has sale-leaseback arrangements for some of its stores. The
leases are accounted for as financing or operating based on their nature. Any
gains realized on disposal of sale-leasebacks that are financing in nature, are
deferred and amortized on a straight-line basis over the shorter of the estimated
useful life of the leased asset and the lease term. Executory costs, such as
payments for real estate taxes, maintenance and insurance are expensed in the
period to which they relate.
(b)

As discussed in part (a) above, leases that transfer substantially all the
risks and benefits of ownership are recorded as financing leases, and are
included with property and equipment, accounts payable and accrued
liabilities and other long-term liabilities as applicable. Per note 3 (o) of
Shoppers financial statements, other accounts affected by leases include
those related gains realized on the disposal of the real estate properties
related to (financing) sale-leaseback transactions. Gains realized on the
disposal of real estate properties done at fair value and that are operating
in nature, are recognized within operating and administrative expenses in
the consolidated statements of earnings. Executory costs such as real
estate taxes, maintenance and insurance. These amounts are expensed in
the period to which they relate (presumably in the related statement of
earnings accounts). There are no dollar amounts reported separately for
the year ended Dec. 31, 2011 on the consolidated statement of financial
position and the consolidated statement of earnings.

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RA20-1 (Continued)
(c)

(d)

Lease payments for finance leases are included in two types of activities
on the statement of cash flows: operating activities and financing activities.
The portion that represents interest expense is reported in finance
expenses of $64,038 thousand of which $6,859 thousand relates to
financing leases (per note 12, prior to the amount that may have been
netted off as part of finance expense capitalized.) Also included in
operating activities (via Net earnings) would be the operating lease costs
and executory costs paid. Under financing activities, the repayment of
financing lease obligations representing the reduction of principle of
$2,173 thousand is shown.
(in thousands)
Net earnings
Average total assets
Return on total assets
Total liabilities
Shareholders equity
Total debt-to-equity ratio

(e)

Dec. 31, 2011


$ 613,934______
($7,300,310 + $7,044,197) 2
8.6%
$3,032,480
4,267,830
0.71

Under the contract based approach, the asset that is acquired by a lessee
is not the physical property that is leased; rather, it is an intangible asset
that represents the right to use the asset that is conveyed under the lease
agreement. The liability is the contractual obligation to make lease
payments. The asset and the obligation are initially recorded at the present
value of the lease payments. For the lessee, the intangible asset is then
amortized over the term of the lease on some systematic basis to earnings,
and obligation is reduced by payments less the interest charge.

In the case of Shoppers, we will look at each of the leases individually:


1. Finance leases for leases that are equivalent to in-substance
acquisitions, accounting would be similar to present-day finance leases.
2. Other operating leases as lessee - Some leases that are currently
operating leases may end up being capitalized, with the related leased
assets representing a right under intangible assets, rather than as
property, plant and equipment. However, leases of property (land or a
building or both) would typically be accounted for using the straight-line
approach, which is similar to current operating leases. This would occur
unless the related lease term is for the major portion of the economic life
of the underlying building, or where the value of the lease accounts for
substantially all of the buildings fair value.

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RA20-2
CANADIAN NATIONAL RAILWAY COMPANY AND
CANADIAN PACIFIC RAILWAY LIMITED
(a)

Canadian National Railway (CNR) discloses the cost, accumulated


depreciation, and net book value of properties held under capital leases in
Note 5, Properties totalling a net carrying value of $1,376 million. This
note also indicates that such properties consist primarily of track and
roadway, rolling stock, buildings, and other. As footnote to this schedule,
CNR also indicates that included in track and roadway is the cost of land
of which $108 million is a right of way and has been recorded as a capital
lease.CNR discloses in Note 9 an amount of capital lease obligations and
other in its long-term debt note of $957 million. In Note 17, CNR discloses
the amount of future minimum lease payments for its operating leases,
capital leases and in total in its major commitments and contingencies
note. The note also identifies that the company has operating and capital
leases, mainly for locomotives, freight cars, and intermodal equipment. It
also discloses the amount of imputed interest on its capital leases ranging
from 0.7% to 11.8% and the present value of the minimum lease payments
at current rate included in debt of $955 million. Also in this note, CNR
indicates that under some of its capital leases, it has the option to purchase
the asset at a fixed amount. We are also told that automotive equipment is
leased under operating leases with one year, non-cancellable terms and
that the estimated rental payment is $30 million. Finally, rent expense for
all operating leases was $143 million for the 2011 fiscal year.
Canadian Pacific Railway (CPR) discloses in Note 15 the net amount of
assets under capital lease and the amount of related accumulated
depreciation in its net properties note totalling a net carrying value of $351
million. CPR discloses in Note 20, the amount of obligations under capital
leases of $288 million, the amount of minimum payments for its capital
leases, the amount of related imputed interest and present value of these
payments, and the related current portion of the obligations in its long-term
debt note. Interest rates used for the capital lease obligations range from
4.90% to 7.63% In note 29, the amount of minimum payments for its
operating leases is included in its commitments and contingencies note.
Detailed accounts and amounts for both companies are presented below.

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RA20-2 (Continued)
CNR ( $ in millions)
Capital Lease Arrangements
Capital leases included in properties, cost
Accumulated depreciation
Net book value of assets under capital lease
Capital lease obligations and other

$ 1,772
396
1,376
957

Minimum lease payments - capital


Imputed interest on capital leases
Present value of minimum lease payments at
current rate included in debt
Operating Lease Arrangements
Minimum lease payments - operating

1,254
299
955

665

518
167
351
288

CPR in millions of $'s


Capital Lease Arrangements
Net properties under capital lease
Related accumulated depreciation
Net book value
Obligations under capital leases
Total minimum lease payments (capital)
Imputed interest
Present value of minimum lease payments
capital
Current portion
Long-term portion

427
139
288
8
280

Operating Lease Arrangements


Minimum payments under operating leases

813

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RA20-2 (Continued)
(a) Yes, they appear to have provided all the lease disclosures required by
the accounting standards.
(b)

The leases of both companies are long term. CNRs operating and
capital leases extend at least seven years from the balance sheet date,
since the note refers to 2017 and thereafter. CPRs operating leases
extend to at least 2016 and the capital leases extend to 2026 and 2031.

(c) The future minimum annual rental commitments under each type of
lease for each company are presented below. Even though the
companies are in the same industry, there is a difference with respect to
how they provide for capacity as evidenced by the fact that they have
different proportions of operating versus capital leases measured in
terms of minimum lease payments. CNR has a higher proportion of
capital leases than CPR, and CPR has a higher proportion of operating
leases than does CNR.
In millions of C$
Minimum lease payments operating
Minimum lease payments capital

CNR

CPR

$665

34.7%

$813

65.6%

1,254

65.3%

427

34.4%

(d) The debt-to-total assets ratios for each company at December 31, 2011,
are presented below.

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RA20-2 (Continued)
(e) CNR presents as part of its Management Discussion & Analysis an
estimate of the present value of its operating lease commitments as
$542 million. CPR does not provide a similar estimate, but by using a
6% discount rate, the capitalized value of the off-balance-sheet
operating leases can be estimated. (Note: the schedule below assumes
that all of the thereafter payments would be made in year 2017, which
is likely not correct.)

year

period

2012
2013
2014
2015
2016
Thereafter

1.0
2.0
3.0
4.0
5.0
6.0

Total payments

(f)

CPR CPR PV of payments@6%


Payments
136.8
$145
131
116.6
96
80.6
83
65.7
65
48.6
293
206.6
$813

$654.9

These operating leases would be recorded as: Increase to intangible


assets for the right of use and an increase to contractual lease obligations.
To make an accurate adjustment for the contract-based approach, we
would have needed details of the payments for each year after 2017.
Some of these leases may be due much later than 2017, which would
change the calculation of the present values. We have also had to make
assumptions about the effective interest rates that might not be correct.
Also, the contract based approach would include any renewal terms that
were likely to be used and any contingent rents. And, if the revised IASB
Exposure Draft allows for straight-line leases in some circumstances, we
would need to assess whether any companies leases would qualify as
straight-line leases. Finally, we were unable to make adjustments on the
statement of earnings. In this case, the annual lease expense would be
eliminated, and its place would be amortization of the intangible asset on a
straight-line basis over the term of the lease and the interest charge on the
lease obligation for the year.

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RA20-2 (Continued)
(g)

The debt-to-total assets ratios, recalculated to include the capitalized value


of the operating leases, are presented below. By including the capitalized
amount of the operating leases in the liabilities calculation, the debt-to-total
assets ratios of both companies are somewhat higher. For CNR, the ratio
has increased from 59.0% to 61.0%, which is only a 3.4% increase.
However, for CPR, that uses predominantly more operating lease than
CNR, the ratio has increased from 67.1% to 71.7%, which represents a
6.9% increase.

Liabilities as reported
Capitalized value of operating leases
Revised Liabilities (including capitalized
value of operating leases)
Total Assets
Debt/Total Assets ratio

(h)

CNR
$15,346
542

CPR
$9,461.0
654.9

15,888
26,026
61.0%

10,115.9
14,110.0
71.7%

In the case of CNR and CPR above, the companies use different
percentages of owned versus leased assets. In order to properly compare
the companies with respect to debt ratios and asset turnover ratios, it is
important to reflect all the assets being used along with the obligations
incurred to use those assets. Consequently, the contract based approach
would ensure that the assets and related obligations are recognized and
measured appropriately on the statement of financial position. In trying to
make the adjustments from the current notes for CNR and CPR, some
assumptions were made as to the lease terms and the interest rates which
might not be correct. And as noted above, we are also missing information
to make all of the adjustments required. If the companies adopted contract
based approaches, these adjustments would no longer be required.

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RA20-3
(a)

Intermediate Accounting, Tenth Canadian Edition

INDIGO BOOKS & MUSIC INC.

As disclosed in Note 4, Summary of Significant Accounting Policies, the


company explains that it conducts all of its business from leased
premises. These leases have renewal terms, over which the company
depreciates the leasehold improvements when renewal is reasonably
assured. All of its leases of premises are considered operating. In this
note, we also see that the leasehold improvements are depreciated over a
maximum term of 10 years. Finally, any lease inducements are amortized
over the lease term.
The primary lease arrangements indicated in the companys financial
statements are the operating leases for stores, offices, and equipment
identified in Note 19, Commitments and Contingencies. The operating
leases expire between 2012 and 2021 and are subject to renewal terms in
some cases (although the term and amounts are not disclosed). There are
also contingent rents based on sales as part of some of these operating
leases.
As disclosed in Note 13, the company has finance lease obligations
outstanding of $2.2 million at March 31, 2012 which are included in long
term debt. For the capital leases related to equipment, Note 8, Property,
Plant and Equipment discloses that the gross carrying amount and
accumulated depreciation to date for this leased equipment is $6,146
thousands and $3,932 thousands, respectively for a net balance of $2,214
thousands. This equipment is depreciated over 3 to 5 years (see Note 4).
For the operating leases, the only amounts on Indigos balance sheet would
be prepaid or accrued lease payments, which are not separately identified.
On the income statement, the annual lease payments would be included in
the operating and administrative expenses line. For the capital leases,
equipment under capital leases at an amount of $2,214 thousands is
included in the property, plant and equipment line of the financial
statements (net of accumulated amortization). There is an offsetting
amount of $1.1 million being shown as current portion of long-term debt,
and $1.1 million being shown as part of the non-current portion of long-term
debt.
On the consolidated statement of earnings, net earnings disclosed are
presumably after a charge for lease expense for the operating leases, and
depreciation expense and interest expense on the capital leases.

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RA20-3 (Continued)
(b)

Ratios for Indigo are presented below.

A
B
C
D
E
F
1
2
3
4

(c)

( $ in thousands)

Amount

Property, plant and equipment


Total Assets
Total Liabilities
Total Equity
Revenues
Net earnings
Debt/Equity ratio (C/D)
Capital asset turnover ratio (E/A)
Total asset turnover ratio (E/B)
Return on assets (F/B)

$ 67,464
592,536
236,904
355,632
933,990
66,189
0.67
13.8 X
1.58X
11.2%

To adopt the contract based approach, the following adjustments are


required:
1. Capital leases Under the contract based approach, one of the
differences in this analysis would be if there were contingent rents to be
paid. Since the notes make no mention of this with respect to the capital
leases, we can assume that there are none. Leased assets set up under
the existing standard would likely continue to be set up as leased assets
(and classified are part of property, plant and equipment (PPE). The only
other adjustment would be that for additional leased assets that were not
previously required to be capitalized, a right-of-use asset would be
included as part of intangible assets. There are no adjustments required
on the income statement provided we assume that the amortization of
the intangible asset would be consistent with the depreciation of the
equipment, which is likely the case.
2. To capitalize the operating lease commitments, one needs the following:
a) The amount and timing of the annual payments and the effective interest
rate for capitalization for the opening balance and the closing balance of
the obligation:

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RA20-3 (Continued)
(c) 2. (Continued)
Assuming an interest rate of 6%, and using the minimum operating lease
payment amounts disclosed in Note 13, an estimate of the capitalized value is
provided below for the 2012 fiscal year. Although there are contingent rents,
without some information on these amounts, the value of these have not been
included in the present value of the obligation. Furthermore, although we know
that some of the leases have renewal periods, without adequate information, we
were unable to include these in the following calculations. Consequently, we
have assumed no renewal periods and no contingent rents.
We have assumed that the lease term is 6 years (based on the forecasted cash
flows) and therefore the intangible right of use will be amortized over the
remaining lease term of 6 years.
(millions of $)

year

Post-2012
payments

present
value
@ 6%

2013
2014
2015
2016
2017
2018+
Total

$58.5
46.4
31.0
22.0
15.0
22.8
$195.7

$55.2
41.3
26.0
17.4
11.2
16.1
$167.2

Based on the above information, the next step is to calculate the implied interest
charge for the year: 167.2 X 6% = 10.0 million.
Amortization of the intangible asset for the 2012 fiscal year -- assuming that the
new leases arose half way through the year, the amortization on the intangible
asset is assumed to be: (167.2/ 6) = 27.9 million. Net book value of intangible
assets at 2012 would be: 167.2 - 27.9 = 139.3
Impact on net earnings will be:
Add back lease payment+ 58.5
Deduct Amortization on new intangible assets - 27.9
Deduct Interest on lease obligation- 10.0
Net change+20.6

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RA20-3 (Continued)
(c) (Continued)
(Note: this calculation overstates the positive impact on earnings. Since
the leases are relatively short term in nature, new leases would be signed
each year, increasing related interest and amortization charges whereas a
significant portion of the related rent expense would be in the years 2014
and beyond).
(d)

Adjustments required to the balance sheet, income statement and cash flow
statement are summarized as follows:

(in millions $)
Total assets
Total liabilities
Total equity
Net earnings

As reported
$592.5
236.9
355.6
66.2

($ in thousands)
Debt/Equity ratio
Total asset turnover

Adjustments
$139.4
167.2
20.6
+20.6

Revised balance
$731.9
404.1
376.2
86.8

Original
amount

Revised

0.67
1.58 X

1.07
1.28

As can be seen from the above table, the debt/equity and total asset turnover
ratios will worsen if the operating leases are recognized under the contract based
approach (Note: the analysis is based on the 2010 Exposure Draft, and therefore
assumes that all operating leases would result in right-of-use assets; if the IASB
modifies their exposure draft to exclude many short term leases of buildings, the
portion of operating leases relating to the Companys premises would likely not
be required to be capitalized).
This example illustrates how significantly the capitalization of all operating leases
would affect the financial statements, and emphasizes why there is sometimes
an incentive for management to keep leases off the balance sheet. To compare
Indigos financial statements with competitors who purchase their buildings and
equipment outright, one should use the revised figures presented above to
enhance the comparability of the companies. Without doing so, Indigos results
might appear more favourable than they really are which could be misleading.
As a result, adopting the contract based approach would make all the companies
comparative without the need to make numerous assumptions in order the make
the appropriate adjustments.
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RA20-4RESEARCH AN AUTOMOBILE LEASE


(a)

The terms and conditions associated with the lease of a vehicle include:
1. Lease costs which include
a) leased vehicle price, which include price of accessories,
dealer installed options, freight and pre-delivery inspection,
and all applicable taxes such as federal air conditioning tax,
provincial gas consumption tax, tire tax, etc., but excludes
HST/GST and PST;
b) optional extended warranty;
c) optional life insurance;
d) optional disability insurance;
e) other (specify);
f) less cash down payment;
g) less trade-in allowance (net of amount owing on trade-in);
and
h) less end value of vehicle, to arrive at the amount to be
amortized. (See item 8 below)
2. Total lease charges, representing interest, and annual lease rate,
stated as a percentage (the latter being provided in the majority of
cases).
3. The lease term, expressed in the number of months.
4. Amount of monthly payments (annuity due) including:
a) number of monthly payments,
b) base monthly payment,
c) plus GST or HST,
d) plus PST (where applicable), to arrive at the total monthly
payment.
5. Total of monthly payments arrived at by multiplying the monthly
payment by the number of monthly payments.
6. Summary of amounts due on delivery including:
a) net cash down payment,
b) net trade-in allowance,
c) GST, PST or HST
d) vehicle licence fee,
e) registration fee,
f) other (specified),
g) first monthly payment, and
h) refundable security deposit.

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RA20-4 (Continued)
7. Specification concerning the kilometre charge for kilometres driven
beyond a set limit negotiated and specified in the lease to fit the
customers particular needs.
8. Lease end purchase based on the estimated fair market value of
the vehicle at the end of the term of the lease. This option price
would have HST (or GST and PST) added as well as licence fee,
registration fee, and charges related to certification of the vehicle.
9. Other conditions of the lease include:
a) insurance;
b) maintenance repairs and operating expenses;
c) taxes, registration and other charges;
d) excess wear clauses;
e) fines, liens and encumbrances;
f) early termination clauses;
g) defaults;
h) warranties;
i) guarantees; and
j) clauses concerning modification or relocation of the vehicle.
(b)

The cash flows associated with the lease include the amounts specified
under the amounts due on delivery of the vehicle (item 6 of part (a)
above); the monthly payments under the lease, as calculated above; and
the lease end purchase (described in item 8 above), should the lessee
choose the option price at the end of the term of the lease, to purchase
the vehicle.

(c)

The purchase option is often the better choice. In the car lease, all of the
risks associated with ownership are passed on to the lessee. The amount
provided as the option price to purchase the vehicle at the end of the term
of the lease is a conservative amount arrived at by the lessor to reduce
the risk to them from the realization of the value of the vehicle through
resale or through an additional lease transaction, should the option to
purchase not be exercised.

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