LO 17-6, 17-7, 17-8

LO 17-6
Determine lease type and account
for a basic sales-type lease for a
lessor
• Lessors classify leases as operating lease or as
sales type lease (there is a 3rd type—direct
financing– that we will not discuss)
• As noted earlier, GAAP specifies a five-part lease
classification test
• If a lease meets any of the five classification
criteria AND collectability of payments from Lessee
is probable, the lease is classified as sales-type
lease by Lessor
• If none of the five criteria is met, the lease is
classified as operating lease by Lessor
 LO 17-6
Determine lease type and account for a basic sales-
type lease for a lessor
• Accounting for sales-type lease
• Lessor recognizes lease receivable in amount of present
value of lease payments + present value of residual
value
• Lessor removes the leased asset from its accounting
records (usually recorded in either Inventory or PPE
asset accounts, depending upon Lessor’s accounting
system)
Lease receivable x
Inventory/PPE (whichever is applicable) x

• If leased asset carried in Inventory and the amount of

recognized lease receivable > book value of the leased
asset, then Lessor recognizes revenue and cost of sales
• If leased asset carried in PPE and amount of recognized
lease receivable > book value of the leased asset, then
Lessor recognizes gain/loss on sale
Lease receivable x
Cost of goods sold x
Sales revenue x
Inventory x
(Lessor's entry to record lease if lease receivable>book value and
asset carried in inventory)

• Review 17-6
 Review 17-6

First, must classify lease

1. Title transfer -> NO
2. Purchase option reasonably certain to be exercised
-> NO
3. Economic life test: does lease term (4 years)
represent “major part” of remaining economic life of
asset (4 years)?
1. 4/4=100%.
2. 100% is certainly a “major part” of remaining
economic life of the asset -> YES.
Stop. Economic life test is met. Assuming collectability
of payments by Lessor is probable, this is sales type
lease.
 Review 17-6

Since this is sale lease, Lessor must recognize a lease

receivable for present value of lease payments (PVLP)
+ present value of residual value (PVRV).

Lessor must also prepare lease receivable

amortization schedule.

PVLP = payment amount × PVAD(n=4, i=.06)

PVLP=$21,236 ×3.67301=78,000
 Review 17-6

PVLP=78,000 (from prior slide)

PVRV = 0 (there is no residual value)
Amount of note receivable to recognize = PVLP+PVRV
= 78,000+0 = 78,000

Prepare amortization schedule for note receivable of

$78,000:
 Review 17-6

Lessor’s 1/1/Y1 entry to record lease receivable and to

remove the leased asset from lessor’s accounting
records.
 Review 17-6

Lessor’s 1/1/Y1 entry to record Lessor’ receipt of first

lease payment
 Review 17-6

12/31/Y1 AJE to accrue interest revenue on the note

receivable
 Review 17-6

1/1/Y2 entry to record receipt of second lease

payment
 Review 17-6

12/31/Y2 AJE to accrue interest revenue

 LO 17-7
Account for an operating lease for
a lessor
• The leased asset remains on Lessor’s books
• Lessor depreciates the leased asset
• Lessor recognizes lease revenue on income
statement
• Lessor capitalizes initial direct costs and amortizes
over the lease term.
• Review 17-7
 Review 17-7

Lease classification:
1. Title transfer-> NO
2. Purchase option reasonably certain to be exercised? ->NO
3. Lease term span “major part” of remaining economic life?
1. Lease term/remaining life = 7/50
2. Does 7/50 represent “major part”? -> NO because
7/50<0.75
4. Does present value of lease payments (PVLP) + present
value of guaranteed residual value (PVGRV) represent
substantially all of fair market value? See next slide
5. Specialized use asset with no alternative use to Lessor-
>NO
 Review 17-7

Lease classification:
1. Does present value of lease payments (PVLP) + present
value of guaranteed residual value (PVGRV) represent
substantially all of fair market value?
1. PVLP=5.91732×180,000 =1,065,118
2. PVGRV=0
3. Is 1,065,118 “substantially all” of $3,000,000? ->NO
because 1,065,118 <90% of $3,000,000
 Review 17-7

Lease classification:

failed to meet any of the 5 lease classification criteria.

Lease will be operating lease for Lessor

 Review 17-7

Entries for Year 1

 Review 17-7

In operating lease, Lessor capitalizes initial direct costs

and amortizes the costs over lease term on straight-line
basis.

Entry for year 1 as follows

 LO 17-8
Account for complex sales-type
lease for a lessor
• In sales-type lease, Lessor’s treatment of initial
direct costs depend upon whether the Lessor
recognizes gross profit (i.e., whether amount of
lease receivable > book value of leased asset)
• If gross profit is recognized, initial direct costs are
expensed
• If no gross profit recognized, initial direct costs are
capitalized and amortized over lease term.
• If unguaranteed residual value and gross profit
recognized (i.e., lease receivable>book value of
leased asset), credit to sales and debit to cost of
goods sold are both reduced by present value of
unguaranteed residual value.
• Review 17-8
 Review 17-8

Determining lease payment

1. What is the value today of the asset? $300,000
2. What is the value today of what the asset will be worth at
the end of the lease? Equals residual value discounted back
to present: $60,000×0.79383=47,630
3. Lessor needs to set lease payments so that Lessor will
recoup the loss in today’s value of the asset occurring over
the lease term, which is 300,000 – 47,630 = 252,370
4. So, Lessor thinks:
1. pmt × PVAD(n=3, i=.08) = 252,370
2. Pmt × 2.78326 = 252,370
3. Pmt=252,370/2.78326 = 90,674

0.79383 = PVSS(n=3,i=.08)
 Review 17-8

Lease receivable to be capitalized by Lessor = PVLP + PVRV

PVLP = pmt × PVAD(n=3, i=.08) =90,674× 2.78326=252,370

PVRV = residual value × PVSS(n=3,i=.08) = 60,000

×0.79383=47,630

Lease receivable = PVLP+PVRV=252,370+47,630=300,000

 Review 17-8

Lease receivable amortization schedule:

16,746=.08×209,326
 Review 17-8
Remainder of entries over life of lease
 Review 17-8
Remainder of entries over life of lease
 Review 17-8
Remainder of entries over life of lease

See next slide before discussing this entry

 Review 17-8
• Balance in Lease receivable immediately before
return of leased asset

Lease receivable
$ 300,000 1/1/Y1 entry to record lease
$ 90,674 1/1/Y1 first payment
$ 16,746 12/31/Y1 AJE to accrue interest
$ 90,674 1/1/Y2 second payment
$ 10,832 12/31/Y2 AJE to accrue interest
$ 90,674 1/1/Y3 to third (final) payment
$ 4,444 12/31/Y3 AJE to accrue interest
$ 60,000 12/31/Y3 adjusted balance before return of leased asset

Entry: record receipt of cash, remove lease receivable from

accounts, and record the returned asset as an item of
inventory.

See last entry on prior slide.