Ch.

21 Leases
In Class Discussion
15th ed
P21-1, P21-4, E21-11 and E21-12
P21- 1 ( Lessee- Lessor Entries, Sales- Type Lease)
Glaus Leasing Company agrees to lease machinery to Jensen
Corporation on January 1, 2014. The following information relates
to the lease agreement.
1. The term of the lease is 7 years with no renewal option, and the
machinery has an estimated economic life of 9 years.
2. The cost of the machinery is $ 525,000, and the fair value of the
asset on January 1, 2014, is $700,000.
3. At the end of the lease term, the asset reverts to the lessor and
has a guaranteed residual value of $100,000. Jensen
depreciates all of its equipment on a straight- line basis.
4. The lease agreement requires equal annual rental payments,
beginning on January 1, 2014.
5. The collectibility of the lease payments is reasonably
predictable, and there are no important uncertainties surrounding
the amount of costs yet to be incurred by the lessor.
6. Glaus desires a 10% rate of return on its investments. Jensens
incremental borrowing rate is 11%, and the lessors implicit rate is
unknown. Instructions ( Assume the accounting period ends on
December 31.)
( a) Discuss the nature of this lease for both the lessee and the
lessor.
( b) Calculate the amount of the annual rental payment required.
( c) Compute the present value of the minimum lease payments.
( d) Prepare the journal entries Jensen would make in 2014 and
2015 related to the lease arrangement.
1

( e) Prepare the journal entries Glaus would make in 2014 and

2015.

PROBLEM 21-1
(a) This is a capital lease to Jensen 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.
This is a capital lease to Glaus because collectibility of the
lease payments is reasonably predictable, there are no
important uncertainties surrounding the costs yet to be
incurred by the lessor, and the lease term is greater than
75% of the assets economic life. Since the fair value
($700,000) of the equipment exceeds the lessors cost
($525,000), the lease is a sales-type lease.
(b) Calculation of annual rental payment:
$700,000 ($100,000 X .51316)*
5.35526**

= $121,130

**Present value of $1 at 10% for 7 periods.

**Present value of an annuity due at 10% for 7 periods.
(c) Computation of present value of minimum lease payments:
PV of annual payments:$121,130 X 5.23054** =
PV of guaranteed residual value:$100,000 X .48166** =
48,166
**Present value of an annuity due at 11% for 7 periods.
**Present value of $1 at 11% for 7 periods.

(d) 1/1/14
681,741

121,130
12/31/14

83,106

61,667
1/1/15
121,130
12/31/15
83,106

55,126

Leased Equipment................................
Lease Liability...............................

681,741

Lease Liability.......................................
Cash...............................................

121,130

Depreciation Expense..........................
Accumulated Depreciation
Capital Leases
($681,741 $100,000) 7..........

83,106

Interest Expense...................................
Interest Payable
($681,741 $121,130) X .11......

61,667

Lease Liability.......................................
Interest Payable....................................
Cash...............................................

59,463
61,667

Depreciation Expense..........................
Accumulated Depreciation
Capital Leases..........................

83,106

Interest Expense...................................
Interest Payable.............................

55,126

[($681,741 $121,130
$59,463) X .11]

ACC 326: You will NOT be Tested on the Journal Entries for the
Lessor
(e) 1/1/14
700,000
525,000
121,130
12/31/14
57,887
1/1/15
63,243
57,887
12/31/15

51,563

Lease Receivable..................................
Cost of Goods Sold..............................
Sales Revenue...............................

700,000
525,000

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

121,130

Interest Receivable...............................
Interest Revenue
[($700,000 $121,130) X .10]....

57,887

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

121,130

Interest Receivable.......................
Interest Receivable...............................
Interest Revenue
($700,000 $121,130
$63,243) X .10...............................

51,563

P21- 4 ( Balance Sheet and Income Statement Disclosure Lessee)

The following facts pertain to a non-cancelable lease agreement between Alschuler
Leasing Company and McKee Electronics, a lessee, for a computer system.
Inception date
October 1, 2014
Lease term
6 years
Economic life of leased equipment
6 years
Fair value of asset at October 1, 2014
$ 300,383
Residual value at end of lease term
0
Lessors implicit rate
10%
Lessees incremental borrowing rate
10%
Annual lease payment due at the beginning of each year, beginning with October 1, 2014
$ 62,700.
The collectibility of the lease payments is reasonably predictable, and there are no
important uncertainties surrounding the costs yet to be incurred by the lessor. The lessee
assumes responsibility for all executory costs, which amount to $ 5,500 per year and are
to be paid each October 1, beginning October 1, 2042. ( This $ 5,500 is not included in
the rental payment of $ 62,700.) The asset will revert to the lessor at the end of the lease
term. The straight- line depreciation method is used for all equipment.
The following amortization schedule has been prepared correctly for use by both the
lessor and the lessee in accounting for this lease. The lease is to be accounted for properly
as a capital lease by the lessee and as a direct- financing lease by the lessor.

Annual
Lease
Balance of
Payment/
Date
Receipt
Receivable
10/ 01/ 14
10/ 01/ 14
$ 62,700

Interest ( 10%)

Reduction

on Unpaid
of Lease
Lease
Liability/ Receivable Liability/ Receivable Liability/
$ 62,700

$ 300,383
237,683
198,751
155,926
108,819
57,001

10/ 01/ 15
10/ 01/ 16
10/ 01/ 17
10/ 01/ 18

62,700
62,700
62,700
62,700

$ 23,768
19,875
15,593
10,822

38,932
42,825
47,107
51,818

10/ 01/ 19

62,700
$ 376,200

5,699*
$ 75,817

57,001
$ 300,383

* Rounding error is $ 1.
Instructions
( Round all numbers to the nearest cent.)
( a) Assuming the lessees accounting period ends on September 30, answer the
following questions with respect to this lease agreement.
( 1) What items and amounts will appear on the lessees income statement for the
year ending September 30, 2015?
( 2) What items and amounts will appear on the lessees balance sheet at
September 30, 2015?
( 3) What items and amounts will appear on the lessees income statement for the
year ending September 30, 2016?
( 4) What items and amounts will appear on the lessees balance sheet at
September 30, 2016?

( b) Assuming the lessees accounting period ends on December 31, answer the following
questions with respect to this lease agreement.
( 1) What items and amounts will appear on the lessees income statement for the
year ending December 31, 2014?
( 2) What items and amounts will appear on the lessees balance sheet at
December 31, 2014?
( 3) What items and amounts will appear on the lessees income statement for the
year ending December 31, 2015?
( 4) What items and amounts will appear on the lessees balance sheet at
December 31, 2015?

PROBLEM 21-4

( a) Assuming the lessees accounting period ends on September

30, answer the following questions with respect to this lease
agreement.
( 1) What items and amounts will appear on the lessees
income statement for the year ending September 30, 2015?
(a) 1.$ 23,768
$ 5,500
$ 50,064

Interest expense (See amortization schedule)

Lease executory expense
Depreciation expense ($300,383 6 = $50,064)

( a) Assuming the lessees accounting period ends on September 30, answer the following
questions with respect to this lease agreement.
( 2) What items and amounts will appear on the lessees balance sheet at
September 30, 2015?

2.

$ 38,932
$ 23,768

Current liabilities:
Lease liability
Interest payable

$198,751

Long-term liabilities:
Lease liability

$300,383
($50,064)

Property, plant, and equipment:

Leased equipment
Acc. depreciationcapital leases

( a) Assuming the lessees accounting period ends on September 30, answer the following
questions with respect to this lease agreement.
( 3) What items and amounts will appear on the lessees income statement for the
year ending September 30, 2016?

3.
$ 19,875
$ 5,500
$ 50,064

Interest expense (See amortization schedule)

Lease executory expense
Depreciation expense ($300,383 6 = $50,064)
8

( a) Assuming the lessees accounting period ends on September 30, answer the following
questions with respect to this lease agreement.
( 4) What items and amounts will appear on the lessees balance sheet at
September 30, 2016?

4.

$ 42,825
$ 19,875

Current liabilities:
Lease liability
Interest payable

$155,926

Long-term liabilities:
Lease liability

$300,383
($100,128)

Property, plant, and equipment:

Leased Equipment
Acc. depreciationcapital leases

( b) Assuming the lessees accounting period ends on December 31, answer the following
questions with respect to this lease agreement.
( 1) What items and amounts will appear on the lessees income statement for the
year ending December 31, 2014?

(b) 1.$ 5,942 Interest expense ($23,768 X 3/12 = $5,942)

$ 1,375 Lease executory expense ($5,500 X 3/12 = $1,375)
$ 12,516 Depreciation expense
($300,383 6 = $50,064;
($50,064 X 3/12 = $12,516)

( b) Assuming the lessees accounting period ends on December 31, answer the following
questions with respect to this lease agreement.
( 2) What items and amounts will appear on the lessees balance sheet at
December 31, 2014?

2.
$ 38,932
$ 5,942

Current liabilities:
Lease liability
Interest payable

$198,751

Long-term liabilities:
Lease liability

$300,383
($12,516)
$

4,125

Property, plant, and equipment:

Leased equipment
Acc depreciationcapital leases
Current assets:
Prepaid lease executory costs
($5,500 X 9/12 = $4,125)

( b) Assuming the lessees accounting period ends on December 31, answer the following
questions with respect to this lease agreement.
( 3) What items and amounts will appear on the lessees income statement for the
year ending December 31, 2015?

3.
$ 22,795
=
$ 5,500
$ 50,064

Interest expense
[($23,768 $5,942) + ($19,875 X 3/12)
[$17,826 + $4,969 = $22,795]
Lease executory expense
Depreciation expense
($300,383 6 = $50,064)

10

( b) Assuming the lessees accounting period ends on December 31, answer the following
questions with respect to this lease agreement.
( 4) What items and amounts will appear on the lessees balance sheet at
December 31, 2015?

4.
$ 42,825
$ 4,969

$155,926
$300,383
($62,580)

4,125

Current liabilities:
Lease liability
Interest payable
($19,875 X 3/12 = $4,969)
Long-term liabilities:
Lease liability
Property, plant, and equipment:
Leased equipment
Acc depreciationcapital leases
($12,516 + $50,064 = $62,580)

Current assets:
Prepaid lease executory costs
($5,500 X 9/12 = $4,125)

11

E21- 11 (Amortization Schedule and Journal Entries for Lessee)

Laura Leasing Company signs an agreement on January 1, 2014, to lease equipment to
Plote Company. The following information relates to this agreement.
1. The term of the noncancelable lease is 5 years with no renewal option. The equipment
has an estimated economic life of 5 years.
2. The fair value of the asset at January 1, 2014, is $ 80,000.
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 $ 7,000, none of which is guaranteed.
4. Plote Company assumes direct responsibility for all executory costs, which include the
following annual amounts: ( 1) $ 900 to Rocky Mountain Insurance Company for
insurance and ( 2) $ 1,600 to Laclecde County for property taxes.
5. The agreement requires equal annual rental payments of $ 18,142.95 to the lessor,
beginning on January 1, 2014.
6. The lessees incremental borrowing rate is 12%. The lessors implicit rate is 10% and
is known to the lessee.
7. Plote Company uses the straight- line depreciation method for all equipment.
8. Plote uses reversing entries when appropriate.
Instructions (Round all numbers to the nearest cent.)
( 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 2014 and 2015 to record the lease
agreement, the lease payments, and all expenses related to this lease. Assume the lessees
annual accounting period ends on December 31.

12

EXERCISE 21-11 (2030 minutes)

Note: This lease is a capital lease to the lessee because the
lease
term
(five years) exceeds 75% of the remaining economic life of the asset
(five 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
(a)

PLOTE COMPANY (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 Interest (10%)

Payment
on Liability
$18,142.95
18,142.95
18,142.95
18,142.95
18,142.95
$90,714.75

0
5,751.06
4,511.87
3,148.76
1,649.50*
$15,061.19

*Rounding error is 15 cents.

13

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

Lease
Liability
$75,653.56
57,510.61
45,118.72
31,487.64
16,493.45
0

(b) 1/1/14
75,653.56
1/1/14
18,142.95

Leased Equipment.......................
Lease Liability.......................

75,653.56

Lease Liability..............................
Cash.......................................

18,142.95

During 2014

900.00

1,600.00
12/31/14
5,751.06

15,130.71

Insurance Expense......................
Cash.......................................

900.00

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

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

1,600.00

Interest Expense...............................
Interest Payable........................

5,751.06

Depreciation Expense......................
Accumulated Depreciation
Capital Leases.......................

15,130.71

($75,653.56 5 = $15,130.71)

Note:
Difference in treatment of guaranteed residual value vs.
unguaranteed residual value
Unguaranteed residual value is not deducted from cost to arrive
at depreciable cost.
14

Guaranteed residual value is deducted from cost to arrive at

depreciable cost.

1/1/15
5,751.06

Interest Payable............................................
Interest Expense.......................

5,751.06

Interest Expense...............................
Lease Liability...................................
Cash...........................................

5,751.06
12,391.89

18,142.95

During 2015

900.00

1,600.00
12/31/15
4,511.87

15,130.71

Insurance Expense...........................
Cash...........................................

900.00

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

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

1,600.00

Interest Expense...............................
Interest Payable........................

4,511.87

Depreciation Expense......................
Accumulated Depreciation
Capital Leases.......................

15,130.71

15

Note
1. The lessor sets the annual rental payment as follows:
Fair value of leased asset to lessor
Less: Present value of unguaranteed
residual value $7,000 X .62092
(present value of 1 at 10% for 5 periods)
Amount to be recovered through lease
$75,653.56
Five periodic lease payments
$75,653.56 4.16986*

payments

*Present value of annuity due of 1 for 5 periods at 10%.

2.

The unguaranteed residual value is not subtracted when

depreciating the leased asset.

16

E21- 12 ( Accounting for an Operating Lease) On January 1, 2014, Doug Nelson Co.
leased a building to Patrick Wise Inc. The relevant information related to the lease is as
follows.
1. The lease arrangement is for 10 years.
2. The leased building cost $ 4,500,000 and was purchased for cash on January 1, 2014.
3. The building is depreciated on a straight- line basis. Its estimated economic life is 50
years with no salvage value.
4. Lease payments are $ 275,000 per year and are made at the end of the year.
5. Property tax expense of $ 85,000 and insurance expense of $ 10,000 on the building
were incurred by Nelson in the first year. Payment on these two items was made at the
end of the year.
6. Both the lessor and the lessee are on a calendar- year basis.
Instructions
( a) Prepare the journal entries that Nelson Co. should make in 2014.
( b) Prepare the journal entries that Wise Inc. should make in 2014.
( c) If Nelson paid $ 30,000 to a real estate broker on January 1, 2014, as a fee for finding
the lessee, how much should be reported as an expense for this item in 2014 by
NelsonCo.?

17

EXERCISE 21-12
(a) Entries for Doug Nelson are as follows:
1/1/14
4,500,000
12/31/14
275,000

90,000

95,000

Buildings.........................................
Cash.............................................

4,500,000

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

275,000

Depreciation Expense....................
Accumulated Depreciation
Buildings.............................

90,000

($4,500,000 50)
Property Tax Expense....................
Insurance Expense.........................
Cash.........................................

18

85,000
10,000

(b) Entries for Patrick Wise are as follows:

12/31/14
275,000

Rent Expense..................................
Cash.........................................

275,000

(c) The real estate brokers fee should be capitalized and

amortized equally over the 10-year period. As a result, real
estate fee expense of $3,000 ($30,000 10) should be reported
in each period.

19

20