Ch21 Initial

CHAPTER 21
Accounting for Leases

LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the environment 3. Explain the accounting for
related to leasing transactions. leases by lessors.
2. Explain the accounting for 4. Discuss the accounting and
leases by lessees. reporting for special features
of lease arrangements.
21-1
Does Cathay Pacific Own the
Planes?
21-2
A New Lease Standard
IFRS 16 (Effective date: January 1, 2019)
Why the new lease standard?

Short answer: To eliminate off-balance sheet financing
 Under the old standard (IAS 17), lessees needed to classify the
lease as either finance or operating. If it’s operating, the lessee
did not show asset and liability in their balance sheet – just the
lease payments as an expense in profit or loss.
 Some operating leases were non-cancellable and therefore
represented a liability (and an asset) for the lessee.
 New IFRS 16 removes this discrepancy and puts more leases

on the balance sheet.
21-3 LO 1
** Leases previously classified as
operating leases are accounted for in a
similar manner to finance leases under
accounting standards. The majority of
operating leases in the above table are
within the scope of HKFRS 16
21-4
CHAPTER 21
LEARNING OBJECTIVES
related to leasing leases by lessors.
transactions.
4. Discuss the accounting and
2. Explain the accounting for reporting for special features
leases by lessees. of lease arrangements.
21-5
LEARNING OBJECTIVE 1
The Leasing Environment Describe the environment
related to leasing transactions.
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:

 Information technology equipment
 Transportation (trucks, aircraft, rail)
 Construction
 Agriculture
21-6 LO 1
ILLUSTRATION 21.2
What Do Companies Lease?
21-7
The Leasing Environment
Advantages of Leasing—Lessees
1. 100% financing at fixed rates.
2. Protection against obsolescence. can rent a new one after end of contract
3. Flexibility.
4. Less costly financing.
21-8 LO 1
A Look at the Lessor

Captive Leasing
Banks Independents Companies
• Credit Suisse • International • CNH Capital
(CHE) Lease Finance (NLD) (for CNH
Corp. (USA)
• Chase (USA) Global),
• Barclays (GBR) • BMW Financial

Services (DEU)
• Deutsche Bank (for BMW)
(DEU)
14% • IBM Global
Financing
(USA) (for IBM)
55% Market Share 31%
21-9 LO 1
Advantages of Leasing—Lessor
1. Often provides profitable interest margins.
2. It can stimulate sales of a lessor’s product.
3. It often provides tax benefits to various parties in the

lease.
4. It can provide a high residual value to the lessor.
21-10 LO 1
CHAPTER 21
LEARNING OBJECTIVES
21-11
Lease Accounting Explain the accounting for
leases by lessees.
A lease is a contract, or part of a contract, that 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.
A common debate on lease accounting is whether the lessee

should capitalize the leased assets.
• No: The lessee does not own the property.
• Yes: Leases might have similar characteristics as installment

purchases. If companies capitalize installment purchases, they
should also capitalize leased assets.
capitalize means putting leasing asset/property on the asset side of the balance sheet
equity side, it has depreciation expense and interest expense incurred ftom the leased asset
21-12 LO 2
Lease Accounting
IASB requires lessees to capitalize all leases.
Only exceptions:
 leases covering a term of less than one year or
 lease of property with a value less than $5,000.
Right to use property under the lease is an

 asset, and
 lessee’s obligation to make payments is a liability.
21-13 LO 2
Lease Accounting
The lessee
 recognizes interest expense on the lease liability using
the effective-interest method and
 records depreciation expense on the right-of-use asset.
This accounting (finance lease) is applied whether the lease

is effectively
 a purchase of the asset or
 when the lessee only controls the use of the asset.
21-14 LO 2
Measurement of the Lease Liability and
Lease Asset
At commencement of the lease, lessees record a right-

of-use asset and lease liability.
 The lease liability is the present value of the lease
payments.
 Based on the lease term, lease payments, and the discount
rate.
 The asset representing the right-of-use of the underlying

asset (i.e., the right-of-use asset) is equal to the lease
liability.
21-15 LO 2
Lease Asset
Lease Term
 The fixed, non-cancelable term of the lease.
 Bargain-renewal option can extend this period.

 Bargain-renewal option gives the lessee an option to
renew the lease.
 The lease term should include the bargain renewal

periods if at the commencement of the lease, the
difference between the renewal rental and the expected
fair rental is great enough to make it reasonably certain for
the lessee to exercise the option to renew.
21-16 LO 2
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 4 4
YERSS
years.
21-17 LO 2
Lease Asset
Lease Payments
 Fixed payments.
 Variable payments that are based on an index or a rate.
 Guaranteed residual value.
 Payments related to purchase or termination options

that the lessee is reasonably certain to exercise.
21-18 LO 2
Lease Payments: Variable payments
Variable payments that are based on an index or a

rate
 Include variable lease payments in the value of the
lease liability at the level of the index/rate at the
commencement date.
 Any difference in the payments due to changes in the

index or rate is expensed in the period incurred.
21-19 LO 2
Facts: On January 1, 2019, Jose Shipping leases an airplane for 6

years. The annual lease payments are $1,000,000 per year, payable at
the beginning of each year (annuity-due basis). In addition, the lease
agreement specifies that the lease payment increases by $30,000
every year.
Question: What are the lease payments in 2020?

Solution: On January 1, 2020, the lease payment is $1,030,000 ($1,000,000 +
$30,000), which is considered a variable payment. Given that the amount of the
variable payment is known from year to year (the rate is set at commencement
of the lease and in substance fixed), such variable payments are included in
calculating the present value of the lease liability.
ILLUSTRATION 21.3
Variable Lease Payments
21-20
Any difference in the payments due to changes in the index or rate is expensed
in the period incurred.
Facts: Assume the same information as in Illustration 21.3, except that the
lease payments are adjusted each year by a change in a price index.
Question: If the price index is 100 at January 1, 2019, and increases to

104 on January 1, 2020, what is the payment on January 1, 2020?
Solution: The variable payment on January 1, 2020, is $1,040,000 ($1,000,000
× 1.04). Because the amount of the variable payment from year to year is not
known at the lease commencement date, this payment is not included in
determining the present value of the lease liability. This additional payment
($40,000) is recognized as an expense in the period it is incurred. Similarly,
when lease payments vary with a performance measure (e.g., sales at a store
location, asset usage), the variable amounts will be expensed in the period
21-21
incurred.
Lease Payment: Guaranteed Residual
Value
Residual value
 The expected value of the leased asset at the end of the
lease term.
 In a guaranteed residual value, the lessee has an

obligation to not only return the leased asset at the end
of the lease term but also to guarantee that the residual
value will be a certain amount. lessee has to pay for the diffference
 In an unguaranteed residual value, the lessee does not

have any obligation to the lessor at the end of the lease,
except to return the leased asset to the lessor.
21-22 LO 2
Value
Guaranteed residual value

 Include in the lease payments only to the extent that the
guaranteed amount exceeds the expected residual
value of the underlying asset at the end of the lease.
 An unguaranteed residual value is not included in the

lease payment.
21-23 LO 2
Value
Termination option
 If the lease contains a purchase or termination options

that the lessee is reasonably certain to exercise, the
cost of the option should be considered part of the lease
payments.
21-24 LO 2
Lease Payments: Termination Option
Facts: Cabrera Company leases a building and land from Worldwide Leasing
for 6 years with monthly payments of $10,000. The lease contract allows
Cabrera to terminate the lease after 2 years for a total payment of $140,000. At
the commencement of the lease, it is reasonably certain that Cabrera will not
continue the lease beyond 2 years.
Question: What are Cabrera’s lease payments?

Solution: In this case, Cabrera should include the cost of the termination option
in its calculation of the present value of its lease liability. The total lease
payments are therefore $380,000 [($10,000 × 24) + $140,000].
(10000x24 +140000)
ILLUSTRATION 21.5
Termination Option
21-25
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 total
present value of (the lease payments plus 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.
► The rate of interest the lessee would have to pay on a similar lease or
the rate that, at commencement of the lease, the lessee would incur
to borrow over a similar term the funds necessary to purchase the
21-26 asset. LO 2
Subsequent Lease Accounting
Accounting for a lease
Illustration: 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.
21-27 LO 2
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. lessee
• 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. lessor
whatever rate lessor rate and the lessee knows, we use the lessor rate, otherwise we use the lessee incremental rate
21-28 LO 2
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.
21-29 * Rounded by €0.02. LO 2

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 liability total aont goes down, so we debit it 20,711.11

Cash 20,711.11
21-30 LO 2
annual lease payment is fixed interest pament depends on we clear right away at year 1
the carrying value of the lease liability
ILLUSTRATION 21.7
Lease Amortization Schedule—Lessee
21-31 LO 2
ILLUSTRATION 21.7
Prepare the entry to record accrued interest at Dec. 31, 2019.
Interest Expense 3,007.17

21-32 * rounding LO 2
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
accrue interest and depreciation expense on 31 december of each year
pay next year
21-33 LO 2
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
21-34
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
clear the accrual
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
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.
21-37 LO 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
21-38 * Rounded by €0.02. LO 2

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


Cash 20,711.11
21-39 LO 2
ILLUSTRATION 21.11
21-40 LO 2
ILLUSTRATION 21.12
Journal Entries—Guaranteed Residual Value
21-41 LO 2
Example 2: Residual Value Loss
Assume that due to poor maintenance of the backhoe, Ivanhoe

and CNH agree that the fair value of the asset is zero upon
returning the backhoe to CNH on January 1, 2024. In this case,
Ivanhoe reports a loss of €3,000. Under the expected payment
scenario, Ivanhoe makes the following entry.
Loss on Lease (€5,000 − €2,000) 3,000

Cash 3,000
Under the no expected payment scenario, Ivanhoe makes the

following entry.
Loss on Lease (€5,000 − €0) 5,000
Cash 5,000
21-42 LO 2
Example 2: Bargain Purchase Option
need to pay money for it
Bargain purchase option allows the lessee to purchase the
leased property for a future price that is substantially lower than
the asset’s expected future fair value.
 Lessee must increase the present value of the lease

payments by the present value of the option price.
 Affects the accounting in the same way as a guaranteed

residual value with a probable amount to be owed.
 The only difference is the lessee depreciates the right-of-

use asset over the economic life of the underlying asset,
given that the lessee takes ownership of the asset.
21-43 LO 2
Unguaranteed Residual Value: Assume that Hathaway Disposal

(lessor) and Marks and Spencer plc (M&S) (GBR) (the lessee)
sign a lease agreement dated January 1, 2019. The lease
agreement specifies that Hathaway will grant right-of-use of one
of its standard cardboard compactors for use at one of M&S’s
stores. Information relevant to the lease is as follows.
 Lease term is three years, non-cancelable, requires rental

payments of £17,620.08 at the beginning of each year.
 Compactor has a cost and fair value at commencement of

the lease of £60,000, an estimated economic life of seven
years, and an expected residual value of £12,000, which is
unguaranteed.
21-44 LO 2
Unguaranteed Residual Value: Assume that Hathaway Disposal

(lessor) and Marks and Spencer plc (M&S) (GBR) (the lessee)
sign a lease agreement dated January 1, 2019. The lease
agreement specifies that Hathaway will grant right-of-use of one
of its standard cardboard compactors for use at one of M&S’s
stores. Information relevant to the lease is as follows.
 Lease contains no renewal options, the compactor reverts

to Hathaway at the termination of the lease.
 Implicit rate of the lessor is not known by M&S. M&S’s

incremental borrowing rate is 6 percent.
21-45 LO 2
The present value of the lease payments for M&S in this situation
is £49,924.56 (£17,620.08 × 2.83339 (PVF = AD 3,6%)).
The lease liability of £49,924.56 does not include any payments

related to the unguaranteed residual value.
M&S makes the following entries.
January 1, 2019

Cash 17,620.08
21-46 LO 2
ILLUSTRATION 21.14
21-47 LO 2
21-48 ILLUSTRATION 21.15 Journal Entries by Lessee LO 2
Low-Value and Short-Term Leases
IASB provided an exception to required capitalization of all

leases:
1. Low-Value Leases (underlying assets with values of
$5,000 or less), lessee may elect to expense lease
payments as incurred.
2. Short-Term Leases (lease term of 12 months or less),
lessee may elect to expense lease payments as
incurred.
21-49 LO 2
In-class Exercise: P21.1
The following facts pertain to a non-cancellable lease agreement
between Faldo Leasing and Vance plc, a lessee.
• Commencement date January 1, 2019

• Annual lease payment due at the beginning of each year, beginning
with January 1, 2019 £113,864
• Residual value of equipment at end of lease term, guaranteed by the
lessee £50,000
• Expected residual value of equipment at end of lease term
£45,000
• Lease term 6 years
• Economic life of leased equipment 6 years
• Fair value of asset at January 1, 2019 £600,000
• Lessor’s implicit rate 8%
•
21-50
Lessee’s incremental borrowing rate 8%
The asset will revert to the lessor at the end of the lease term. The
lessee uses the straight-line amortization for all leased equipment.
Instructions
a. Prepare an amortization schedule that would be suitable for the
lessee for the lease term.
b. Prepare all of the journal entries for the lessee for 2019 and 2020
to record the lease agreement, the lease payments, and all
expenses related to this lease. Assume the lessee’s annual
accounting period ends on December 31.
21-51
Solution:
21-52
21-53
21-54
21-55
CHAPTER 21
LEARNING OBJECTIVES
21-56
Lessor Accounting Explain the accounting for
leases by lessors.
Economics of Leasing
Lessor determines the amount of the rental payment, not
the lessee.
 Determines payment using rate of return (implicit rate).
 Considers credit standing of lessee.
 Length of the lease.
 Status of the residual value (guaranteed versus
unguaranteed).
21-57 LO 3
Recall that for lessees…
Discount Rate
Lessee should compute the present value of the lease

payments using the implicit interest rate.
In the event that it is impracticable to determine the implicit

rate, the lessee uses its incremental borrowing rate.
21-58 LO 2
Lessor Accounting
Economics of Leasing for lessor, nned to deduct the fv of residual value from
fv of equipment
In Examples 1 and 2, CNH determined the implicit rate to be 4

percent, the fair value of the equipment to be €100,000, and the
residual value to be $5,000. CNH then computes the lease
payment as shown.
Fair value of leased equipment €100,000.00

Less: Present value of the residual value
(€5,000 × .82193 (PVF 5,4%)) 4,109.65
Amount to be recovered by lessor through
lease payments € 95,890.35
Five beginning-of-year lease payments to earn a
4% return (€95,890.35 ÷ 4.62990) (PVF-AD 5,4%)) € 20,711.11
21-59 LO 3
Classification of Leases by the Lessor
For accounting purposes, the lessor classifies leases as a

 Finance lease or an, MORE LIKE SALES Objectively lease it for earning profit,
not essential for its own production of
product or service
 Operating lease. MORE LIKE RENTING OUT
For a finance lease, it must be non-cancelable and meet at least

one of five tests in Illustration 21.18.
To meet one of these five tests, the lessor must transfer

control of a substantial portion of the underlying asset to the
lessee or provide ownership of the underlying asset to the lessee.
21-60 LO 3
For a finance lease,
• must be non-
cancelable and
• meet at least one
of the five tests.
ILLUSTRATION 21.218
Lease Classiﬁcation Tests
21-61 LO 3
1. Transfer of Ownership Test

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

 The lease purchase option allows the lessee to
purchase the property for a price that is significantly
lower than the underlying asset’s expected fair value
at the date the option becomes exercisable (bargain
purchase option).
21-62 LO 3
3. Lease Term Test

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

economic life of the leased asset, the lease meets the lease
term test.
21-63 LO 3
4. Present Value Test

 If the present value of the lease payments is
reasonably close to the fair value of the asset, the
lessor should use the finance method.
 Guideline: if the present value of the lease payments

equals or exceeds 90 percent of the fair value of the
asset, then a lessee should use the finance method.
21-64 LO 3
Lease Payments
Generally include:
1. Fixed payments.
2. Variable payments.
3. Residual values (guaranteed or not).
4. Payments the lessee is reasonably certain to exercise.
21-65 LO 3
Discount Rate
 Implicit rate should be used to determine the present
value of the payments.
 Defined as the discount rate that, at commencement

of the lease, causes the present value of the lease
payments and unguaranteed residual value to be
equal to the fair value of the leased asset.
21-66 LO 3
5. Alternative Use Test
If at the end of the lease term the lessor does not have an
alternative use for the asset, the lessor classifies the lease
as a finance lease.
The assumption is that the lessee uses all the benefits from
the leased asset and therefore the lessee has essentially
purchased the asset.
21-67 LO 3
Finance leases are subdivided into:

 Sales-type leases (our focus in this chapter).
 Manufacturers or dealers use leasing as a means of
marketing their products.
 Record sales revenue, cost of goods sold, and interest

revenue.
 Direct financing leases.

 Arrangements with lessors that are engaged in financing
operations (e.g., banks and insurance companies).
 Record only interest revenue.

21-68 LO 3
Accounting Measurement and Presentation

For a sales-type lease,
 the lessor accounts for the lease in a manner similar to the
sale of an asset.
 the lessor generally records a Lease Receivable and

eliminates the leased asset.
 the lease receivable is computed as shown.

lease receivable equals to the sum of PV of rents and PV of residual payment
21-69 ILLUSTRATION 21.19 LO 3

A: Lease receivable E: Revenue; Cost of Good Sold
Finance (Sales-Type) Lease Example
Lessor lessee
Illustration: CNH Financial Services Corp. (a subsidiary of CNH) and Ivanhoe
Construction sign a lease agreement dated January 1, 2019, that calls for CNH
to lease a backhoe to Ivanhoe beginning January 1, 2019. The terms and
provisions of the lease agreement, and other pertinent data, are as follows.
• The term of the lease is five years. The lease agreement is non-cancelable,
requiring equal rental payments at the beginning of each year (annuity-due
basis).
• The backhoe has a fair value at the commencement of the lease of €100,000,
an estimated economic life of five years, and a guaranteed residual value of
€5,000 (which is less than the expected residual value of the backhoe at the
end of the lease). Further, assume the underlying asset (the backhoe) has an
€85,000 cost to the dealer, CNH.
• The lease contains no renewal options. The backhoe reverts to CNH at the
termination of the lease.
• Collectibility of payments by CNH is probable.
21-70 LO 3
Illustration: CNH Financial Services Corp. (a subsidiary of CNH) and Ivanhoe

Construction sign a lease agreement dated January 1, 2019, that calls for CNH
to lease a backhoe to Ivanhoe beginning January 1, 2019. The terms and
provisions of the lease agreement, and other pertinent data, are as follows.
• CNH sets the annual rental payment to earn a rate of return of 4 percent per
year (implicit rate) on its investment as shown in Illustration 21.20.
ILLUSTRATION 21.20
Lease Payment Calculation
21-71 LO 3
The lease meets the criteria for classification as a finance

(sales-type) lease because
1. Lease term is equal to the economic life of the asset.
2. Present value of the lease payments is €100,000*, which is

100% (greater than or equal to 90%) of the fair value of the
backhoe.
That is, Ivanhoe will consume substantially the entire

underlying asset over the lease term.
21-72 LO 3
CNH computes the lease receivable as shown. ILLUSTRATION 21.22

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

Lease Receivable 100,000
Sales Revenue 100,000
Cost of Goods Sold 85,000
Inventory 85,000
21-73 LO 3
ILLUSTRATION 21.23
Lease Amortization Schedule
receivable are generating interest revenue for the lessor
21-74 LO 3
ILLUSTRATION 21.23
On January 1, 2019, CNH records receipt of the first year’s lease

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

lease receivable during the first year through the following entry.

Interest Revenue 3,171.56
The balance sheet as it relates to lease transactions at December

31, 2019.
ILLUSTRATION 21.24
Balance Sheet
Presentation
On its December 31, 2019, income statement, CNH reports,
ILLUSTRATION 21.25
Income Statement
presentation
21-77 LO 3
ILLUSTRATION 21.23
The following entries record receipt of the second year’s lease

payment and recognition of the interest revenue in 2020.
Jan. 1 Cash 20,711.11

Ivanhoe records accrued interest on December 31, 2019
Dec. 31 Lease Receivable 2,469.97
Interest Revenue 2,469.97
ILLUSTRATION 21.23
CNH makes the following entry on December 31, 2023.
Ivanhoe records accrued interest on December

Lease Receivable 192.1931, 2019
Lease Revenue 192.19
ILLUSTRATION 21.23
At January 1, 2024, when the leased asset is returned to CNH.
Inventory (Returned Asset) 5,000

Lease Receivable 5,000
Lessor—Guaranteed Residual Value
In the Ivanhoe/CNH example, Ivanhoe guaranteed a residual value of

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

unguaranteed.
21-81 LO 3
Lessor—Unguaranteed Residual Value
In this case, there is less certainty that the unguaranteed residual

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

when a guaranteed residual value exists.
21-82 LO 3
To compare a sales-type lease with a guaranteed residual value

to one with an unguaranteed residual value, assume the same
facts as in the CNH/Ivanhoe lease situation. That is:
1. The sales price is €100,000.
2. The expected residual value is €5,000 (the present value of

which is €4,109.65).
3. The leased equipment has an €85,000 cost to the dealer,

CNH.
21-83 LO 3
Computation of Lease Amounts by CNH

Financial—Sales-Type Lease
ILLUSTRATION 21.27 lower sales price and lower cogs

Computation of Lease Amounts by CNH—Sales-Type Lease
if unguaranteed
21-84 LO 3
lessor loses money by $2000
ILLUSTRATION 21.28
21-85 Entries for Guaranteed and Unguaranteed Residual Values — Sales-Type Lease LO 3
Lessor Accounting for Operating Leases
The following data relates to a lease agreement between Hathaway Disposal
Ltd. and M&S for the use of one of Hathaway’s standard cardboard
compactors. Information relevant to the lease is as follows.
• The term of the lease is three years. The lease agreement is non-
cancelable, requiring three annual rental payments of £17,620.08, with the
first payment on January 1, 2019 (annuity-due basis).
• The compactor has a cost and fair value at commencement of the lease of
£60,000, an estimated economic life of five years, and a residual value at
the end of the lease of £12,000 (unguaranteed).
• The lease contains no renewal options. The compactor reverts to
Hathaway at the termination of the lease.
• The implicit rate of the lessor is known by M&S. M&S’s incremental
borrowing rate is 6 percent. Hathaway sets the annual rental rate to earn a
rate of return of 6 percent per year (implicit rate) on its investment.
21-86 LO 3
Hathaway classifies the lease as an operating lease because none of

the finance lease tests are met.
ILLUSTRATION 21.30
Lease Classification Tests
21-87 LO 3
Under the operating method, Hathawary (the lessor)
 continues to recognize the asset on its statement of

financial position and recognizes lease revenue (generally
on a straight-line basis) in each period.
 continues to depreciate the leased asset.
21-88 LO 3
To illustrate the operating method for the Hathaway/M&S lease,

Hathaway records the lease payment on a straight-line basis on
January 1, 2019, 2020, and 2021, as follows.
Cash 17,620.08
Unearned Lease Revenue 17,620.08
On December 31, 2019, 2020, and 2021, Hathaway records the

recognition of the revenue each period as follows.
Unearned Lease Revenue 17,620.08

Lease Revenue 17,620.08
21-89 LO 3
Hathaway also records depreciation expense on the leased

equipment (assuming double-declining-balance, given a cost basis
of £60,000, and a five-year economic life), as follows.
Depreciation Expense (£60,000 × 40%) 24,000.00

Accumulated Depreciation—Equipment 24,000.00
Hathaway records other costs related to the lease arrangement,

such as insurance, maintenance, and taxes in the period incurred.
21-90 LO 3
CHAPTER 21
LEARNING OBJECTIVES
21-91
Presentation
Lessee’s Perspective
Summary of how the lessee reports the information related to

finance and operating leases in the financial statements.
ILLUSTRATION 21.35
Presentation in Financial Statements—Lessee
21-92 LO 4
Presentation
Lessor’s Perspective
Summary of how the lessor reports the information related to
sales-type and operating leases in the financial statements.
ILLUSTRATION 21.36
Presentation in Financial Statements—Lessor
21-93 LO 4
In-class Exercise: E21.5
Morgan Leasing Group signs an agreement on January 1, 2019, to lease

equipment to Cole plc. The following information relates to this agreement.
1. The term of the non-cancellable lease is 6 years with no renewal option.

The equipment has an estimated economic life of 6 years.
2. The cost of the asset to the lessor is £245,000. The fair value of the asset
at January 1, 2019, is £245,000.
3. The asset will revert to the lessor at the end of the lease term, at which
time the asset is expected to have a residual value of £24,335, none of
which is guaranteed.
4. The agreement requires equal annual rental payments, beginning on
January 1, 2019.
5. Collectability of the lease payments by Morgan is probable.
21-94
Instructions
(Round all numbers to the nearest pound.)
a. Assuming the lessor desires an 8% rate of return on its investment,
calculate the amount of the annual rental payment required.
(Round to the nearest pound.)
b. Prepare an amortization schedule that is suitable for the lessor for
the lease term.
c. Prepare all of the journal entries for the lessor for 2019 and 2020 to
record the lease agreement, the receipt of lease payments, and the
recognition of revenue. Assume the lessor’s annual accounting
period ends on December 31, and it does not use reversing entries.
21-95
21-96
21-97
21-98
21-99

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CHAPTER 21

Accounting for Leases

Why the new lease standard?

 New IFRS 16 removes this discrepancy and puts more leases

A lease is a contractual agreement between a lessor and a

Largest group of leased equipment involves:

4. Less costly financing.

A Look at the Lessor

• Barclays (GBR) • BMW Financial

55% Market Share 31%

2. It can stimulate sales of a lessor’s product.

3. It often provides tax benefits to various parties in the

4. It can provide a high residual value to the lessor.

A lease is a contract, or part of a contract, that conveys the

A common debate on lease accounting is whether the lessee

• No: The lessee does not own the property.

• Yes: Leases might have similar characteristics as installment

IASB requires lessees to capitalize all leases.

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

Right to use property under the lease is an

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

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

This accounting (finance lease) is applied whether the lease

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

At commencement of the lease, lessees record a right-

 The asset representing the right-of-use of the underlying

 Bargain-renewal option can extend this period.

 The lease term should include the bargain renewal

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

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

 Guaranteed residual value.

 Payments related to purchase or termination options

Variable payments that are based on an index or a

 Any difference in the payments due to changes in the

Facts: On January 1, 2019, Jose Shipping leases an airplane for 6

Question: What are the lease payments in 2020?

Question: If the price index is 100 at January 1, 2019, and increases to

 In a guaranteed residual value, the lessee has an

 In an unguaranteed residual value, the lessee does not

Guaranteed residual value

 An unguaranteed residual value is not included in the

 If the lease contains a purchase or termination options

Question: What are Cabrera’s lease payments?

In the event that it is impracticable to determine the implicit

Accounting for a lease

Illustration: assume that CNH Capital (NLD) (a subsidiary of

The terms and provisions of the lease agreement and other

• Ivanhoe depreciates its equipment on a straight-line basis.

Ivanhoe computes the lease liability and the amount capitalized

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

21-29 * Rounded by €0.02. LO 2

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

Right-of-Use Asset 95,890.35

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

Lease Liability liability total aont goes down, so we debit it 20,711.11

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

Interest Expense 3,007.17

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

Depreciation Expense 19,178.07

accrue interest and depreciation expense on 31 december of each year

pay next year

The statement of financial position as it relates to lease

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

Ivanhoe records the second lease payment as follows.