(a) Identify the lease type from the standpoint of the (1) lessee and (2) lessor.

(b) Prepare a lease amortization schedule for the lessee and lessor. Explain why they can both use the same schedule in this situation. Also, draw a timeline for the lessor.

(c) Prepare the journal entry to record the inception of the lease on the lessee's books.

(d) Prepare the journal entry to record the inception of the lease on the lessor's books.

(e) Indicate the amount(s) that will appear on the lessee's December 31, 2015 statement of financial position for this lease. Also indicate the portion that will appear in the current liability section, and the portion that will appear in the non-current liability section. Explain how to determine these amounts.

(f) Indicate the amount(s) that will appear on the lessor's December 31, 2015 statement of financial position for this lease. Also indicate the portion that will appear in the current asset section and the portion that will appear in the non-current asset section. Show the gross investment in lease (lease receivable) and unearned interest components of each net investment amount. Explain how to determine these amounts.

(a) The lease is a capital lease for the lessee because title to the equipment automatically transfers to the lessee at the end of the lease term. (The lease also meets the two other criteria for a capital lease.) For the lessor, under ASPE, two additional revenue-recognition based criteria must be met in order for the lease to be treated as a non-operating lease. Assuming that credit risk associated with the lease is normal and that the amounts of any unreimbursable costs that are likely to be incurred by the lessor are reasonably estimable, the lessor should record the lease as a non-operating lease. Fair value of the equipment ($100,000) is equivalent to cost of the equipment to the lessor ($100,000); therefore, the lease is a direct financing lease.

(b) Calculations:

$25,981.62 − $2,000.00 executory costs = $23,981.62 annual lease payment (excluding executory costs)

$23,981.62 × present value factor for an annuity due of 1 for n = 5, i = 10% = net investment

$23,981.62 × 4.16986 = $100,000.00 net investment

The lessor and the lessee can use the same lease amortization schedule in this situation because they are using the same interest rate to account for the lease (10%), and because there is no unguaranteed residual value that will accrue to the lessor at the end of the lease. For these same reasons, both parties have the same timeline for the lease, which is depicted as follows:

(e) Equipment under Lease will appear in the property, plant, and equipment section of the lessee's statement of financial position (at $100,000). Accumulated depreciation of $38,000 will also appear in that section. To calculate annual depreciation, residual value is deducted from capitalized cost of the equipment under lease to arrive at depreciable amount, and depreciable amount is depreciated over useful life of the asset (because title to the asset will transfer to the lessee at the end of the lease term). Thus, annual depreciation is calculated as ($100,000 − $5,000) ÷ 5 years = $19,000. The amounts that will appear on the lessee's December 31, 2015 statement of financial position under current liabilities and non-current liabilities are as follows:

To determine these amounts, refer to the lease amortization schedule. Find the date on the schedule that is relevant to the statement of financial position date (December 31, 2015). If the reporting date is not on the schedule (as is the case here), find the date that most recently precedes the statement of financial position date (January 1, 2015, in this exercise). As of the statement of financial position date, current liabilities include interest payable to date ($5,963.86 due on 1/1/16) and current obligation under lease ($18,017.76 due on 1/1/16), and non-current liabilities include non-current obligation under lease ($19,819.54 + $21,801.30 = $41,620.84).

(f) Net investment in lease at December 31, 2015, is $65,602.46 ($59,638.60 + $5,963.86 = $65,602.46). This will be reflected on the lessor's December 31, 2015 statement of financial position as follows:

To determine these amounts, refer to the lease amortization schedule. Find the date on the schedule that is relevant to the statement of financial position date (December 31, 2015). If the reporting date is not on the schedule (as is the case here), find the date that most recently precedes the statement of financial position date (January 1, 2015, in this exercise). The lease payment on the following line is the amount of gross investment in lease (lease receivable) to be classified as a current asset. The unearned interest portion of that lease payment (as of the statement of financial position date) is deducted to arrive at net investment in lease. In this exercise, no portion of the $5,963.86 interest due on 1/1/16 is unearned as of 12/31/15 because it was all earned during 2015; therefore $0 of unearned interest income is reflected in the current assets section. The total of lease payments (and other receipts) appearing on all subsequent lines of the lease amortization schedule ($23,981.62 + $23,981.62 = $47,963.24) is the amount of gross investment in lease (lease receivable) to be classified as a non-current asset. The unearned interest portion of those lease payments (as of the statement of financial position date) is deducted to arrive at net investment in lease. In this exercise, ($4,162.08 + $2,180.32 = $6,342.40) is deducted from lease receivable to arrive at non-current net investment in lease.

EXERCISE 20-2

PURPOSE: This exercise is a comprehensive illustration of the accounting procedures for a lease in which the leased asset reverts back to the lessor and still has some value at the end of the lease term. This exercise illustrates (1) how the lessor determines the amount of the periodic lease payment, (2) the lessor's calculations for recording the transactions associated with the lease, (3) the meaning of the terms “gross investment in lease” and “net investment in lease,” (4) the lessee's calculations for recording the transactions associated with the lease, (5) the journal entries on the lessor's books, and (6) the journal entries on the lessee's books.

On January 1, Year 1, Leaseco has a piece of equipment with a cost of $80,000 and a fair value of $80,000. On that date, Leaseco leases the piece of equipment to Rentco for a five-year term at an implicit rate of 10%. The annual lease payment is due at the beginning of each year, and the first payment is due on the lease inception date. The leased equipment will revert back to Leaseco at the end of the lease term; its fair value at that date is estimated to be $7,000. Both Leaseco and Rentco have a calendar-year reporting period, and both companies prepare financial statements in accordance with IFRS. Rentco is aware of Leaseco's implicit rate; Rentco's incremental borrowing rate is 12%.

Instructions

Assuming the lease is a finance lease to the lessee and a finance lease to the lessor:

Solution to Exercise 20-2

(j) Even though the lessee and the lessor both use the same interest rate in this exercise, the lessee's lease amortization schedule differs from the lessor's lease amortization schedule because the $7,000 unguaranteed residual value must be included only on the lessor's lease amortization schedule. The lessor and the lessee can use the same lease amortization schedule if they are using the same interest rate and if one of the following conditions exists: (1) an automatic transfer of title at the end of the lease term, or (2) a bargain purchase option, or (3) a residual value guaranteed by the lessee to the lessor, or (4) an unguaranteed residual value for the lessor of zero.

(m) (1) At lease inception, the lessor records the total gross amount to be received in a receivable account (Lease Receivable), whereas the lessee records the total present value amount to be paid in a payable account (Obligations under Lease). Since receivables and payables are generally reported at present value, the lessor sets up a contra receivable account (Unearned Interest Income) to reduce carrying value of the net receivable to present value of all future cash flows associated with the lease.

(2) The lessor accounts for interest as a deferral of income, but the lessee accounts for interest as an accrual of expense. Therefore, the lessor records interest income only at the end of an accounting period, with an adjusting entry. The lessee records interest expense when a lease payment is made and at the end of an accounting period (with an adjusting entry) if the accounting period ends on a date other than a lease payment date. The lessor's adjusting entry to record recognition of interest earned is never reversed; the lessee's adjusting entry to accrue interest expense can be reversed.

(3) The lessor's entry to record a lease payment received is the same each period. (Debit Cash and credit Lease Receivable for the entire lease payment.) The lessee's entry to record a lease payment is different each period because the amount attributed to interest expense and the amount attributed to reduction of lease obligation differ for each lease payment.

(4) Both the lessor and the lessee record interest, but only the lessee records depreciation in this lease arrangement.

(a) Prepare the lease amortization schedule and draw the timeline for the lessor.

(b) Answer the following questions from the standpoint of the lessor:

1. What is the gross investment in lease at lease inception?
2. What is the net investment in lease at lease inception?
3. What amount of gross profit should be reported on the income statement for 2014?
4. What amount of gross profit should be reported on the income statement for 2015?
5. What amount should be reported as interest income on the income statement for 2014?
6. What amount should be reported as interest income on the income statement for 2015?

(c) Prepare the following journal entries for the lessor:

1. lease inception on May 1, 2014
2. lease payment received on May 1, 2014
3. adjusting entry at December 31, 2014
4. lease payment received on May 1, 2015
5. adjusting entry at December 31, 2015

(d) If the lessee has an incremental borrowing rate of 9%, could the lessee use the same lease amortization schedule as the lessor in this situation?

(e) Explain how the entry in part (c) (1) would be different for the lessor if there was no purchase option and if the estimated residual value to the lessor (unguaranteed) at the end of the lease term was $2,000. Also, explain whether or not the lessee could use the same lease amortization schedule as the lessor in this situation.

4.  None. All of the gross profit attributable to a sales-type lease is recognized in the year of lease inception (in this exercise, in the year 2014).

5.  $3,294.04 × 8/12 = $2,196.03 interest for 2014

There are eight months between May 1, 2014, and December 31, 2014. Interest income for those eight months is included on the 5/1/15 payment line of the lease amortization schedule. Interest income of $3,294.04 showing on the 5/1/15 payment line is for the 12-month period preceding 5/1/15. Therefore, interest for the last eight months of 2014 is calculated as 8/12 × $3,294.04.

(a) Explain how the lessor's accounting procedures for a lease with a $2,000 guaranteed residual value will differ from the accounting procedures for a lease with a $2,000 bargain purchase option.

(b) Explain how the lessee's accounting procedures for a lease requiring the lessee to guarantee a residual value of $2,000 will differ from the accounting procedures for a lease with a $2,000 bargain purchase option.

(a) From the lessor's standpoint, there is no difference in calculations, timeline, or journal entries between a lease with a $2,000 guaranteed residual value and a lease with a $2,000 bargain purchase option. Thus, the Solution to Exercise 20-3, parts (a) through (c), would not change if the lease included a $2,000 guaranteed residual value instead of a $2,000 bargain purchase option (except that “bargain purchase option” or “BPO” would be replaced with “guaranteed residual value” or “GRV”).

(b) From the lessee's standpoint, the timeline, journal entries, and most calculations are the same for a lease with a guaranteed residual value as with a lease with a bargain purchase option. However, there is a major difference in the calculation of depreciation:

• If the lease contains a bargain purchase option, the cost of the asset under capital lease (reduced by any residual value available to the lessee at the end of the asset's useful life) is depreciated over the remaining useful life of the asset because the lessee is assumed to acquire the asset at the end of the lease term.
• If the lease contains a guaranteed residual value, cost of the asset under capital lease reduced by the guaranteed residual value is depreciated over the lease term because the asset will revert to the lessor.

(a) The amount of gross investment in lease to be reported in the current asset section of the lessor's statement of financial position at December 31, 2015, is $_________________.

(b) The amount of net investment in lease to be reported in the current asset section of the lessor's statement of financial position at December 31, 2015, is $_________________.

(c) The amount to be reported in the current liability section of the lessee's statement of financial position at December 31, 2015, by the caption “Interest Payable” is $___________.

(d) The amount to be reported in the current liability section of the lessee's statement of financial position at December 31, 2015, by the caption “Obligations under Capital Leases” is $_____________________.

(e) The amount to be reported in the non-current liability section of the lessee's statement of financial position at December 31, 2015, by the caption “Obligations under Capital Leases” is $_____________________.

(a) The amount of gross investment in lease to be reported in the current asset section of the lessor's statement of financial position at December 31, 2015, is $10,000.

The most recent payment prior to the statement of financial position date (December 31, 2015) was May 1, 2015. The payment line following that line shows a receipt of $10,000 due on May 1, 2016, which is within one year of the statement of financial position date.

(b) The amount of net investment in lease to be reported in the current asset section of the lessor's statement of financial position at December 31, 2015, is $9,125.52.

The interest portion of the lease payment due to be received on May 1, 2016, is $2,623.45. That amount is for the 12 months that precede May 1, 2016. Thus, at December 31, 2015, four months of the $2,623.45 amount remains unearned.

(c) The amount to be reported in the current liability section of the lessee's statement of financial position at December 31, 2015, by the caption “Interest Payable” is $1,748.97.

(d) The amount to be reported in the current liability section of the lessee's statement of financial position at December 31, 2015, by the caption “Obligations under Capital Leases” is $7,376.55.

The payment line that follows the statement of financial position date (12/31/15) is 5/1/16. The principal portion of the lease payment due on that date ($7,376.55) represents the current portion of the lessee's obligation under capital lease [excluding any accrued interest calculated in part (c)] at 12/31/15.

(e) The amount to be reported in the non-current liability section of the lessee's statement of financial position at December 31, 2015, by the caption “Obligations under Capital Leases” is $18,857.93.

(This figure is the present value balance on the 5/1/16 lease payment line.)

(a) Calculate rent expense for the lessee for (1) 2014 and (2) 2015.

(b) Calculate the lessor's operating profit (loss) on the leased asset for (1) 2014 and (2) 2015.

(a) 1. $71,000

 2. $71,000

EXPLANATION: Both IFRS and ASPE agree that for an operating lease under the classification approach, minimum lease payments should be expensed by the lessee on a straight-line basis over the lease term, unless another systematic basis better represents the pattern of the benefits received. Thus, the lessee amortizes lease bonus and scheduled rent increases on a straight-line basis over the lease term.

EXPLANATION: Both IFRS and ASPE agree that for an operating lease under the classification approach, an equal (straight-line) amount of rent revenue is recognized in each accounting period regardless of the lease provisions, unless another systematic and rational basis better represents the pattern in which the leased asset provides benefits. Thus, the lessor amortizes the lease bonus and scheduled rent increases on a straight-line basis over the lease term. Initial direct costs paid to independent third parties, such as appraisal fees, finder's fees, commissions, and legal fees, are amortized over the lease term. Executory costs (such as insurance and property taxes) are expensed in the period in which they are incurred.

1.  Wells Ltd. leases an airplane from Kitson Corp. under an agreement that meets the criteria for a capital lease for Wells Company. The 10-year lease requires lease payments of $34,000 at the beginning of each year, including $5,000 per year for maintenance, insurance, and taxes. The incremental borrowing rate for the lessee is 15%; the lessor's implicit rate is 12% and is known by the lessee. The present value factor of an annuity due of 1 for 10 years at 15% is 5.77158. The present value factor of an annuity due of 1 for 10 years at 12% is 6.32825. According to ASPE, the lessee should record the leased asset at:

1. $29,000 × 5.77158 = $167,376.
2. $29,000 × 6.32825 = $183,519.
3. $34,000 × 5.77158 = $196,234.
4. $34,000 × 6.32825 = $215,161.

EXPLANATION: Think through the steps involved in accounting for a lease for a lessee (see Illustration 20-2). The lessee should record the leased asset at present value of minimum lease payments (excluding executory costs). Under ASPE, present value of minimum lease payments should be calculated using the lower of the lessee's incremental borrowing rate and the rate implicit in the lease. In this example, the annual $5,000 executory cost is deducted from the $34,000 lease payment to arrive at a $29,000 lease payment excluding executory costs. The lessor's implicit rate of 12% is known by the lessee and is lower than the lessee's incremental borrowing rate of 15%; hence, the 12% implicit rate is used to calculate present value of minimum lease payments. Present value of minimum lease payments is calculated by multiplying the lease payment (excluding executory costs) by the factor for present value of an annuity due of 1 for n = 10, i = 12%. There is no indication that the asset's fair value may be lower than the calculated present value of minimum lease payments; therefore, the asset is recorded at this present value. (Solution = b.)

2.  The amount to be recorded by a lessee as cost of an asset under finance (or capital) lease is equal to:

1. present value of minimum lease payments.
2. present value of minimum lease payments or fair value of the asset, whichever is lower.
3. present value of minimum lease payments plus present value of any unguaranteed residual value.
4. carrying value of the asset on the lessor's books.

EXPLANATION: For a finance (or capital) lease, the lessee records an asset under capital lease and an obligation under capital lease at the lower of (1) present value of minimum lease payments or (2) fair value of the leased asset at lease inception. An unguaranteed residual value is not relevant to the lessee; the lessee does not account for it. The lessor's carrying value is also irrelevant to the lessee. (Solution = b.)

3.  The following list of items relates to accounting for leases:

1. annual lease payments
2. bargain purchase option
3. guaranteed residual value
4. unguaranteed residual value

From a lessee's perspective, minimum lease payments associated with a finance (or capital) lease would include items:

1. I and II only.
2. I, II, and III only.
3. I, III, and IV only.
4. I, II, III, and IV.

EXPLANATION: List the components of minimum lease payments and compare with the above selections. From a lessee's perspective, minimum lease payments include:

• minimum rental payments
• guaranteed residual value (if any)
• bargain purchase option (if any)

Thus, minimum lease payments include only items I, II, and III. (Solution = b.)

4.  On December 31, 2013, Ryan Corporation leased a yacht from François Company for an eight-year period expiring December 31, 2021. Equal annual payments of $80,000 are due on December 31 of each year, beginning on December 31, 2013. The lease is properly classified as a finance lease on Ryan's books. At December 31, 2013, present value of the eight lease payments over the lease term discounted at 10% is $469,474. Assuming all payments are made on time, the amount that should be reported by Ryan Corporation as the total obligation under finance lease on its December 31, 2014 statement of financial position is:

1. $348,421.
2. $400,063.
3. $436,421.
4. $480,000.

EXPLANATION: Calculate the amounts for the first three journal entries on the lessee's lease amortization schedule. The schedule would appear as follows: (Solution = a.)

5.  The following facts pertain to a lease:

(1) The lease provides that the asset will revert back to the lessor at the end of the seven-year lease term.

(2) Present value of minimum lease payments is equal to $54,000 and fair value of the asset at lease inception is $60,000.

(3) The remaining economic life of the leased asset is estimated to be 10 years.

(4) For the lessor, credit risk associated with the lease is normal.

(5) The lessor guarantees the asset against obsolescence.

(6) Fair value of the asset exceeds its cost on the lessor's books.

(7) Both the lessee and lessor prepare financial statements in accordance with ASPE.

How should the lease be classified on the books of the lessee and lessor, respectively?

EXPLANATION: Review the facts and determine how the lease should be classified on the books of the lessee. Repeat the process and determine how the lease should be classified on the books of the lessor. Refer to Illustration 20-1. Present value of minimum lease payments equals 90% or more of the fair value of the asset, which is one of the ASPE criteria for classification of a lease as a capital lease. Thus, the lease should be classified as a capital lease on the books of the lessee. However, the lessor guarantees the asset against obsolescence, which means that the amounts of any unreimburseable costs that are likely to be incurred by the lessor under the lease cannot be reasonably determined, and the lease should be classified as an operating lease on the books of the lessor. Further analysis of the details of the lease is shown below:

(1) The asset will be returned to the lessor at the end of the lease; therefore, the lease does not meet the first criteria for classification of a lease as a capital lease.

(2) Present value of minimum lease payments ($54,000) is equal to 90% of the fair value of the asset at lease inception ($60,000); thus, the lease meets the third ASPE criteria for classification of a lease as a capital lease.

(3) The lease term is seven years, which is only 70% of the remaining economic life of the asset; hence, the lease does not meet the second ASPE criteria for classification of a lease as a capital lease.

(4) The lessor's credit risk associated with the lease is normal; therefore, the lease meets the first revenue-recognition based ASPE criteria for classification of a lease as a non-operating lease.

(5) The lessor guarantees the asset against obsolescence, which means that the amounts of any unreimburseable costs that are likely to be incurred by the lessor under the lease cannot be reasonably determined. Therefore, under ASPE, the second revenue-recognition based criteria for classification of a lease as a non-operating lease is not met.

(6) If fair value of the asset exceeds its cost on the lessor's books, the lease would be a sales-type lease on the books of the lessor if, under ASPE, the lease meets at least one criteria for classification of a lease as a capital lease on the lessee's books, and both revenue-recognition criteria for classification of a lease as a non-operating lease on the lessor's books. (Solution = b.)

6.  Digger Corporation is a lessee with a finance lease. The asset is recorded at a cost of $180,000 and has a useful life of eight years. The lease term is five years. The asset is expected to have a fair value of $60,000 at the end of five years, and a fair value of $20,000 at the end of eight years. The lease agreement provides for automatic transfer of title of the asset to the lessee at the end of the lease term. What depreciable amount and what service life should the lessee use to calculate depreciation for the first year of the lease?

EXPLANATION: Select the option that will provide the best matching of costs with revenues. Because title will automatically be transferred, the lessee is expected to hold and use the asset for eight years. The benefit to be consumed over the eight years is the difference between the asset's recorded cost ($180,000) and its expected value at the end of its useful life to the lessee ($20,000). (Solution = b.)

7.  Three different lease situations are described below:

Under IFRS, in which of the above cases can the lessor and lessee use the same lease amortization schedule?

1. 1 and 2 only.
2. 2 and 3 only.
3. 1 and 3 only.
4. 1, 2, and 3.

APPROACH AND EXPLANATION: The lessee and lessor can use the same lease amortization schedule when both of the following conditions exist: (1) the lessee and lessor use the same interest rate to account for the lease, and (2) the lessor does not have an unguaranteed residual value to account for. The lessee and lessor use the same interest rate in all cases because under IFRS, the lessor uses the implicit rate and the lessee uses the implicit rate whenever it can be reasonably determined (otherwise the incremental borrowing rate is used). In case 1, the asset reverts to the lessor at the end of the lease term when the asset has a fair value of $60,000, which means that an unguaranteed residual value will be reflected in the lessor's lease amortization schedule that will not be reflected in the lessee's lease amortization schedule. Therefore, both parties cannot use the same lease amortization schedule for case 1. In cases 2 and 3, both parties can use the same lease amortization schedule. (Solution = b.)

8.  A lessee with a capital (or finance) lease containing a bargain purchase option should depreciate the leased asset over the:

1. asset's remaining useful life to the lessee.
2. term of the lease.
3. useful life of the asset to the lessee or the term of the lease, whichever is shorter.
4. useful life of the asset to the lessee or the term of the lease, whichever is longer.

EXPLANATION: Depreciation is a cost allocation process undertaken to comply with the matching principle; that is, to match expenses with revenues. The appropriate depreciation period is the period the asset will be used in operations. If the lease agreement provides for automatic transfer of title of the asset to the lessee at the end of the lease term or for a bargain purchase option, the assumption is that the lessee will use the asset for its remaining useful life to the lessee, which would be the period appropriate for depreciation. If the lease does not provide for automatic transfer of title of the asset or for a bargain purchase option, the assumption is that the lessee will use the asset only for the lease term, which would be the period appropriate for depreciation. The leased asset should be depreciated over either the asset's remaining useful life to the lessee, or the term of the lease, whichever period the asset will be used in operations. The length of the useful life of the asset to the lessee and the length of the term of the lease are not compared to determine the depreciation period. (Solution = a.)

9.  A lessor has a direct financing lease. The end of the lessor's accounting period does not coincide with a lease payment date. At the end of the lessor's accounting period, the journal entry to record interest earned since the last rental payment date would be:

EXPLANATION: In a non-operating lease, the lessor accounts for interest as a deferral of income. Thus, at date of lease inception, the lessor includes all amounts to be received under the lease (gross investment in lease) in the Lease Receivable account. These amounts include interest to be earned over the term of the lease; hence, a contra account called “Unearned Interest Income” is established in order to reduce the carrying value of Lease Receivable down to the present value of the components of gross investment in lease (called “net investment in lease”). As interest is earned, it is transferred from Unearned Interest Income to an earned interest account (Interest Income). Note that the lessee uses an accrual approach to accounting for interest expense. At lease inception, the lessee records only the present value of the lease obligation in the Obligations under Lease account. Therefore, at a statement of financial position date, an adjusting entry on the lessee's books will include a debit to Interest Expense and a credit to Interest Payable. (Solution = c.)

10. At the inception of a finance (or capital) lease, a residual value guaranteed by the lessee should be included as part of minimum lease payments on the books of the:

EXPLANATION: The components of minimum lease payments are: (a) minimum rental payments (excluding executory costs), (b) bargain purchase option, if any, and (c) guaranteed residual value, if any. If the lessor has a guaranteed residual value, it is included in the lessor's calculation of minimum lease payments, regardless of whether the lessee or a third party is the guarantor. The lessee includes a guaranteed residual value in its calculation of minimum lease payments only if the lessee is the party providing the guarantee. (Solution = a.)

11. A lessor has an operating lease with a five-year term that requires lease payments of $100,000 in 2014, $120,000 in 2015, $140,000 in 2016, $160,000 in 2017, and $180,000 in 2018. In 2016, compared with 2015, the lease will cause the following types of revenue/income to increase:

EXPLANATION: In an operating lease, the lessor recognizes rent revenue on a straight-line basis over the lease term, regardless of the lease provisions, unless another systematic and rational basis is more representative of the pattern in which the leased asset provides benefits. In this situation, an average amount of $140,000 would be recognized as rent revenue in each of the five years of the lease. The lessor does not earn interest income in an operating lease. Thus, under an operating lease, the lessor has no increase in rent revenue or interest income from one year to another. (Solution = d.)

12. Hanks Leasing Co. has an operating lease. Rents are a constant amount each year. Rent payments collected in 2014 that pertain to use of the leased asset in 2015 should be reported as:

1. rent revenue in 2014.
2. accrued rent revenue on the December 31, 2014 statement of financial position.
3. unearned rent revenue on the December 31, 2014 statement of financial position.
4. rent receivable on the December 31, 2014 statement of financial position.

EXPLANATION: Rent revenue received in advance represents a liability at the December 31, 2014 statement of financial position date. Revenue received in advance is usually called “unearned rent revenue.” (Solution = c.)

13. A lessor with a manufacturer or dealer (or sales-type) lease involving an unguaranteed residual value available to the lessor at the end of the lease term will report sales revenue in the period of lease inception at which of the following amounts?

1. Minimum lease payments plus any unguaranteed residual value.
2. Present value of minimum lease payments.
3. Cost of the asset to the lessor, less present value of any unguaranteed residual value.
4. Present value of minimum lease payments, plus present value of any unguaranteed residual value.

EXPLANATION: Unguaranteed residual value is considered a portion of the asset that is not yet sold. Therefore, sales revenue is the present value (today's cash equivalent) of all future cash flows expected to be received by the lessor for the leased asset except for the unguaranteed residual value. Therefore, sales revenue is calculated by determining the present value of minimum lease payments. Answer selection (a) describes the gross investment in lease calculation, answer selection (c) describes the lessor's cost of goods sold calculation, and answer selection (d) describes the lessor's net investment in lease amount. (Solution = b.)

14. A lease has an eight-year term and the related asset has a remaining useful life of 10 years. The lease is appropriately classified as a manufacturer or dealer lease on the books of the lessor. Gross profit related to this lease should be:

1. recognized wholly in the period of lease inception.
2. amortized evenly over eight years.
3. amortized evenly over 10 years.
4. amortized over eight years using the effective interest method.

EXPLANATION: Gross profit related to a manufacturer or dealer lease is recognized wholly in the period of lease inception. The lessor's journal entry at the date of lease inception includes a credit to Sales Revenue (for present value of minimum lease payments) and a debit to Cost of Goods Sold (for the asset's carrying value less present value of any unguaranteed residual value). When these two amounts are reported on the income statement, the resulting difference is the amount of gross profit earned on the lease. (Solution = a.)

15. Tharmarajan Corporation sold a greenhouse to Laventhall Company for $800,000 and realized a gain of $300,000. Laventhall immediately leased the asset back to the seller under a finance lease arrangement for the remainder of the asset's useful life of 10 years. The lessee uses the straight-line depreciation method. Under IFRS, profit on the sale of the greenhouse should be:

1. recognized in full in the year of sale.
2. deferred and amortized over the lease term.
3. deferred and recognized in full at the end of the lease term.
4. deferred and amortized on the same basis as the depreciation of the leased asset.

EXPLANATION: The lease meets the criteria to be classified as a finance lease, therefore the seller-lessee accounts for the transaction as a sale, and the lease as a finance lease. In this situation, under IFRS, any profit on the sale of assets that are leased back is deferred and amortized over the lease term. Note that under ASPE, any profit on the sale of assets that are leased back is deferred and amortized on the same basis as the depreciation of the leased assets. On the statement of financial position, the balance of the deferred gain is reported as Unearned Profit on Sale-Leaseback. (Solution = b.)

16. Mary Corporation entered into a lease agreement under which it does not gain control over the underlying asset and it does not receive the risks and benefits associated with ownership of the underlying asset. As the lessee, Mary Corporation calculates two amounts: (1) minimum lease payments discounted at the rate implicit in the lease—$17,656, and (2) minimum lease payments, including contingent rentals and possible payments under guarantees, all discounted using Mary Corporation's incremental borrowing rate over the longest possible term that is more likely than not to occur—$23,769. Under the contract-based approach to accounting for leases, the initial entry to recognize the lease agreement should be:

EXPLANATION: The contract-based approach to accounting for leases covers leases that do not transfer control over the underlying asset, or risks and benefits associated with ownership of the underlying asset, to the lessee. Under the contract-based approach, the initial entry to recognize a lease contract is a debit to Contract Asset and a credit to Contract Liability, for the amount of minimum lease payments, including contingent rentals and possible payments under guarantees, all discounted using the lessee's incremental borrowing rate over the longest possible term that is more likely than not to occur. (Solution = c.)