Chapter 19

ACCOUNTING FOR
INCOME TAXES
The Leasing Environment

A lease is a contractual agreement between a lessor and a

lessee, that gives the lessee the right to use specific property,
owned by the lessor, for a specified period of time.

Largest group of leased equipment involves:

u Information technology equipment
u Transportation (trucks, aircraft, rail)

u Construction
u Agriculture
The Leasing Environment

Advantages of Leasing—Lessees

1. 100% financing at fixed rates.

2. Protection against obsolescence.

3. Flexibility.

4. Less costly financing.

Lease Accounting
Conveys the right to control the use of identified property,
plant or equipment (an identified asset) for a period of time
in exchange for consideration.”

The various views on capitalization of leases are as follows.

1. Do not capitalize any leased assets.

2. Capitalize leases that are similar to installment

purchases.

3. Capitalize all long-term leases.

4. Capitalize firm leases where the penalty for non-

performance is substantial.
Lease Accounting

IASB requires lessees to capitalize all leases.

Only exceptions:

u leases covering a term of less than one year or

u lease of property with a value less than $5,000.

Right to use property under the lease is an

u asset, and

u lessee’s obligation to make payments is a liability.

Lease Accounting

The lessee
u recognizes interest expense on the lease liability using
the effective-interest method and

u records depreciation expense on the right-of-use asset.

This accounting (finance lease) is applied whether the lease

is effectively
u a purchase of the asset or

u when the lessee only controls the use of the asset.

Measurement of the Lease Liability and
Lease Asset

Lease Term
u The fixed, non-cancelable term of the lease.

u Bargain-renewal option can extend this period.

l At the commencement of the lease, the difference

between the renewal rental and the expected fair rental
must be great enough to make exercise of the option to
renew reasonably certain.
Lease Term

Illustration: Carrefour (FRA) leases Lenovo (CHN) PCs for

two years at a rental of $100 per month per computer and
subsequently can lease them for $10 per month per computer
for another two years. The lease clearly offers a bargain-
renewal option; the lease term is considered to be four years.
Measurement of the Lease Liability and
Lease Asset

Lease Payments
l Fixed payments.

l Variable payments that are based on an index or a rate.

l Guaranteed residual value.

l Payments related to purchase or termination options

that the lessee is reasonably certain to exercise.
Measurement of the Lease Liability and
Lease Asset

Discount Rate
Lessee should compute the present value of the lease
payments using the implicit interest rate.

► This rate, at commencement of the lease, which causes

the aggregate present value of the lease payments and
unguaranteed residual value to be equal to the fair value
of the leased asset.

In the event that it is impracticable to determine the implicit

rate, the lessee uses its incremental borrowing rate.
Subsequent Lease Accounting

To illustrate the accounting for a lease using the finance

lease method, assume that CNH Capital (NLD) (a subsidiary
of CNH Global) and Ivanhoe Mines Ltd. (CAN) sign a lease
agreement dated January 1, 2019, that calls for CNH to
lease a backhoe to Ivanhoe beginning January 1, 2019.

The terms and provisions of the lease agreement and other

pertinent data are as follows.
Terms and provisions of the lease agreement:
• The term of the lease is five years. The lease agreement is non-cancelable, requiring equal
rental payments of €20,711.11 at the beginning of each year (annuity-due basis).
• The backhoe has a fair value at the commencement of the lease of €100,000, an estimated
economic life of five years, and a guaranteed residual value of €5,000. (Ivanhoe expects that
it is probable that the expected value of the residual value at the end of the lease will be
greater than the guaranteed amount of €5,000.)
• The lease contains no renewal options. The backhoe reverts to CNH Capital at the
termination of the lease.
• Ivanhoe’s incremental borrowing rate is 5 percent per year.
• Ivanhoe depreciates its equipment on a straight-line basis.
• CNH sets the annual rental rate to earn a rate of return of 4 percent per year; Ivanhoe is
aware of this rate.
Lessee Accounting: Example 1
Ivanhoe computes the lease liability and the amount capitalized
as a right-of-use asset as follows:

Payment € 20,711.11
Present value factor (i=4%,n=5) x 4.62990
PV of lease payments €95,890.35 *

Ivanhoe uses CNH's implicit interest rate of 4 percent instead of its

incremental borrowing rate of 5 percent because it is known to
Ivanhoe.
* Rounded by €0.02.
Lessee Accounting: Example 1

Ivanhoe records the finance lease on its books on January 1, 2019,

as:

Right-of-Use Asset 95,890.35

Lease Liability 95,890.35

Ivanhoe records the first lease payment on January 1, 2019, as

follows.

Lease Liability 20,711.11

Cash 20,711.11
ILLUSTRATION 21.7
Lease Amortization Schedule—Lessee
 ILLUSTRATION 21.7

Prepare the entry to record accrued interest at Dec. 31, 2019.

Interest Expense 3,007.17

Lease Liability 3,007.14

* rounding
Lessee Accounting: Example 1

Depreciation of the right-of-use asset over the five-year lease

term, applying Ivanhoe’s normal depreciation policy (straight-line
method), results in the following entry at December 31, 2019.

Depreciation Expense 19,178.07

Right-of-Use Asset (€95,890.35 ÷ 5 years) 19,178.07
 Lessee Accounting: Example 1
The statement of financial position as it relates to lease
transactions at December 31, 2019.
ILLUSTRATION 21.8
Statement of Financial
Position Presentation

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

ILLUSTRATION 21.9
Income Statement
presentation
 ILLUSTRATION 21.7

Ivanhoe records the second lease payment as follows.

Lease Liability (€3,007.17 + €17,703.95) 20,711.11

Cash 20,711.11
* rounding
 ILLUSTRATION 21.7

If Ivanhoe purchases the equipment from CNH at the termination of the

lease at a price of €5,000 and the estimated remaining life of the
equipment is two years, it makes the following entry.

Equipment 5,000
Cash 5,000
* rounding
 Lessee Accounting: Example 2

To illustrate a situation where the expected residual value is below the guaranteed
residual value, assume in the earlier CNH/Ivanhoe example that it is probable that
the residual value will be €3,000 instead of the guaranteed amount of €5,000. If
Ivanhoe estimates the residual value of the backhoe at the end of the lease to be
€3,000, Ivanhoe includes €2,000 (€5,000 − €3,000) as an additional lease payment
in determining the lease liability and right-of-use asset.
Lessee Accounting: Example 2

Ivanhoe computes the lease liability and the amount capitalized

as a right-of-use asset as follows:

Payment € 20,711.11
Present value factor (i=4%,n=5) x 4.62990
PV of lease payments € 95,890.35 *
Probable residual value € 2,000,00
PV factor (i=4,n=5) x .82193
PV of probable residual value 1,643.86
Lessee’s lease liability/right-of-use asset € 97,534.21
* Rounded by €0.02.
Lessee Accounting: Example 2

Ivanhoe makes the following entries to record the lease and the
first payment on January 1, 2019, as:

Right-of-Use Asset 97,534.21

Lease Liability 97,534.21

Lease Liability 20,711.11

Cash 20,711.11
ILLUSTRATION 21.11
Lease Amortization Schedule—Lessee
ILLUSTRATION 21.12
Journal Entries—Guaranteed Residual Value
Referensi Utama
• Intermediate Accounting
Kieso, Weygandt, Walfield, IFRS edition, John Wiley

• Standar Akuntansi Keuangan

Dewan Standar Akuntansi Keuangan, IAI

• International Financial Reporting Standards – Certificate Learning Material

The Institute of Chartered Accountants, England and Wales