Kế toán tài chính - Accounting for leases

PREVIEW OF CHAPTER 21Intermediate Accounting16th EditionKieso ● Weygandt ● Warfield Explain the nature, economic substance, and advantages of lease transactions.Describe the accounting for leases by lessees.LEARNING OBJECTIVESDescribe the accounting for leases by lessors.Describe the accounting and reporting for special features of lease arrangements.After studying this chapter, you should be able to:Accounting for Leases21LO 1Largest group of leased equipment involves: Information technology equipmentTransportation (trucks, aircraft, rail)ConstructionAgricultureA 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.THE LEASING ENVIRONMENTLO 1LO 1ILLUSTRATION 21-2What Do Companies Lease?BanksWho Are the Players?Captive Leasing CompaniesIndependentsWells FargoChaseCitigroup PNCCaterpillar Financial Services Corp.Ford Motor Credit (Ford)IBM Global FinancingMarket Share55%14%31%LO 1International Lease Finance Corp.THE LEASING ENVIRONMENT100% financing at fixed rates. Protection against obsolescence.Flexibility.Less costly financing.Tax advantages.Off-balance-sheet financing.Advantages of LeasingLO 1THE LEASING ENVIRONMENTLO 1As shown in our opening story, airlines use lease arrangements extensively. This results in a great deal of off-balance-sheet financing. The following chart indicates that many airlines that lease aircraft understate debt levels by a substantial amount. Airlines are not the only ones playing the off-balance-sheet game. A recent study estimates that for S&P 500 companies, off-balance-sheet lease obligations total more than one-half trillion dollars, or roughly three percent of market value. Thus, analysts must adjust reported debt levels for the effects of non-capitalized leases. WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? OFF-BALANCE-CHEET FINANCINGA methodology for making this adjustment is discussed in Eugene A. Imhoff, Jr., Robert C. Lipe, and David W. Wright, “Operating Leases: Impact of Constructive Capitalization,” Accounting Horizons (March 1991).Source: D. Zion and A. Varshney, “Leases Landing on Balance Sheets,” Credit Suisse Equity Research (August 17, 2010).Capitalize a lease that transfers substantially all of the benefits and risks of property ownership, provided the lease is noncancelable.Conceptual Nature of a LeaseLeases that do not transfer substantially all the benefits and risks of ownership are operating leases.LO 1THE LEASING ENVIRONMENTExplain the nature, economic substance, and advantages of lease transactions.Describe the accounting for leases by lessees.LEARNING OBJECTIVESDescribe the accounting for leases by lessors.Describe the accounting and reporting for special features of lease arrangements.After studying this chapter, you should be able to:Accounting for Leases21LO 2If the lessee capitalizes a lease, the lessee records an asset and a liability generally equal to the present value of the rental payments.Records depreciation on the leased asset.Treats the lease payments as consisting of interest and principal.ACCOUNTING BY THE LESSEEJournal Entries for Capitalized LeaseILLUSTRATION 21-2LO 2For a capital lease, the FASB has identified four criteria.Lease transfers ownership of the property to the lessee.Lease contains a bargain-purchase option.Lease term is equal to 75 percent or more of the estimated economic life of the leased property.One or more must be met for capital lease accounting.The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90 percent of the fair value of the leased property. LO 2ACCOUNTING BY THE LESSEELease AgreementLeases that DO NOT meet any of the four criteria are accounted for as Operating Leases.ILLUSTRATION 21-4Diagram of Lessee’s Criteria for Lease ClassificationLO 2ACCOUNTING BY THE LESSEECapitalization CriteriaTransfer of Ownership TestIf the lease transfers ownership of the asset to the lessee, it is a capital lease.Bargain-Purchase Option TestAt the inception of the lease, the difference between the option price and the expected fair market value must be large enough to make exercise of the option reasonably assured.LO 2ACCOUNTING BY THE LESSEEEconomic Life Test (75% Test)Lease term is generally considered to be the fixed, noncancelable term of the lease. Bargain-renewal option can extend this period. At the inception of the lease, the difference between the renewal rental and the expected fair rental must be great enough to make exercise of the option to renew reasonably assured.Capitalization CriteriaLO 2ACCOUNTING BY THE LESSEEIllustration: Home Depot leases Dell PCs for two years at a rental of $100 per month per computer and subsequently can lease them for $10 per month per computer for another two years. The lease clearly offers a bargain-renewal option; the lease term is considered to be four years. LO 2ACCOUNTING BY THE LESSEERecovery of Investment Test (90% Test)Minimum Lease Payments:Minimum rental paymentGuaranteed residual valuePenalty for failure to renew or extend the leaseBargain-purchase optionExecutory Costs:InsuranceMaintenanceTaxesExclude from present value of Minimum Lease Payment CalculationCapitalization CriteriaLO 2ACCOUNTING BY THE LESSEEDiscount RateCapitalization CriteriaLessee computes the present value of the minimum lease payments using its incremental borrowing rate, with one exception.If the lessee knows the implicit interest rate computed by the lessor and it is less than the lessee’s incremental borrowing rate, then lessee must use the lessor’s rate.LO 2ACCOUNTING BY THE LESSEEAsset and Liability Recorded at the lower of:present value of the minimum lease payments (excluding executory costs) orfair-market value of the leased asset at the inception of the lease.Asset and Liability Accounted for DifferentlyLO 2ACCOUNTING BY THE LESSEEDepreciation PeriodIf lease transfers ownership, depreciate asset over the economic life of the asset.If lease does not transfer ownership, depreciate over the term of the lease.Asset and Liability Accounted for DifferentlyLO 2ACCOUNTING BY THE LESSEEEffective-Interest MethodUsed to allocate each lease payment between principal and interest.Depreciation ConceptDepreciation and the discharge of the obligation are independent accounting processes.Asset and Liability Accounted for DifferentlyLO 2ACCOUNTING BY THE LESSEEIllustration: Caterpillar Financial Services Corp. (a subsidiary of Caterpillar) and Sterling Construction Corp. sign a lease agreement dated January 1, 2017, that calls for Caterpillar to lease a front-end loader to Sterling beginning January 1, 2017. 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 noncancelable, requiring equal rental payments of $25,981.62 at the beginning of each year (annuity-due basis).The loader has a fair value at the inception of the lease of $100,000, an estimated economic life of five years, and no residual value.Sterling pays all of the executory costs directly to third parties except for the property taxes of $2,000 per year, which is included as part of its annual payments to Caterpillar.The lease contains no renewal options. The loader reverts to Caterpillar at the termination of the lease.Sterling’s incremental borrowing rate is 11 percent per year.Sterling depreciates, on a straight-line basis, similar equipment that it owns.Caterpillar sets the annual rental to earn a rate of return on its investment of 10 percent per year; Sterling knows this fact.LO 2ACCOUNTING BY THE LESSEEWhat type of lease is this? Capitalization Criteria:Transfer of ownershipBargain purchase optionLease term = 75% of economic life of leased propertyPresent value of minimum lease payments => 90% of FMV of propertyNONOLease term = 5 yrs.Economic life = 5 yrs. PV = $100,000 FMV = $100,000.Capital Lease?LO 2YESYESACCOUNTING BY THE LESSEEPayment $ 25,981.62Property taxes (executory cost) - 2,000.00Minimum lease payment 23,981.62Present value factor (i=10%,n=5) x 4.16986PV of minimum lease payments $100.000.00Compute present value of the minimum lease payments.LO 2** Present value of an annuity due of 1 for 5 periods at 10% (Table 6-5)Sterling uses Caterpillar’s implicit interest rate of 10 percent instead of its incremental borrowing rate of 11 percent because (1) it is lower and (2) it knows about it.ACCOUNTING BY THE LESSEELeased Equipment (under capital leases) 100,000 Lease Liability 100,000LO 2Sterling records the capital lease on its books on January 1, 2017, as:Property Tax Expense 2,000.00Lease Liability 23,981.62 Cash 25,981.62Sterling records the first lease payment on January 1, 2017, as follows.ACCOUNTING BY THE LESSEELO 2ILLUSTRATION 21-6Lease Amortization Schedule for Lessee—Annuity-Due BasisILLUSTRATION 21-6Sterling records accrued interest on December 31, 2017 Interest Expense 7,601.84 Interest Payable 7,601.84Prepare the entry to record accrued interest at Dec. 31, 2017.LO 2* roundingDepreciation Expense (capital leases) 20,000 Accumulated Depreciation—Capital Leases 20,000LO 2Prepare the required on December 31, 2017, to record depreciation for the year using the straight-line method ($100,000 ÷ 5 years).The liabilities section as it relates to lease transactions at December 31, 2017.ILLUSTRATION 21-7Reporting Current and Noncurrent Lease LiabilitiesACCOUNTING BY THE LESSEEILLUSTRATION 21-6Sterling records the lease payment of January 1, 2018, as follows.LO 2Property Tax Expense 2,000.00Interest Payable 7,601.84Lease Liability 16,379.78 Cash 25,981.62Operating Method (Lessee)The lessee assigns rent to the periods benefiting from the use of the asset and ignores, in the accounting, any commitments to make future payments.Illustration: Assume Sterling accounts for the lease as an operating lease. Sterling records the payment on January 1, 2017, as follows.LO 2Rent Expense 25,981.62 Cash 25,981.62ACCOUNTING BY THE LESSEEAccounting for operating leases would appear routine, so it is unusual for a bevy of companies in a single industry—restaurants—to get caught up in the accounting rules for operating leases. Getting the accounting right is particularly important for restaurant chains because they make extensive use of leases for their restaurants and equipment. The problem stems from the way most property (and equipment) leases cover a specific number of years (the so-called primary lease term) as well as renewal periods (sometimes referred to as the option term). In some cases, companies were calculating their lease expense for the primary term but depreciating lease-related assets over both the primary and option terms. This practice resulted in understating the total cost of the lease and thus boosted earnings. For example, the CFO at CKE Restaurants Inc., owner of the Hardee’s and Carl’s Jr. chains, noted that CKE ran into trouble because it was not consistent in calculating the lease and depreciation expense. Correcting the error at CKE reduced earnings by nine cents aWHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? RESTATEMENTS ON THE MENU(continued)LO 2share in fiscal 2002, nine cents a share in fiscal 2003, and 10 cents a share in fiscal 2004. The company now uses the shorter, primary lease terms for calculating both lease expense and depreciation. The change increases depreciation annually, which in turn decreases total assets. CKE was not alone in improper operating lease accounting. Notable restaurateurs who ran afoul of the lease rules included Brinker International Inc., operator of Chili’s; Darden Restaurants Inc., which operates Red Lobster and Olive Garden; and Jack in the Box. To correct their operating lease accounting, these restaurants reported restatements that resulted in lower earnings and assets. These lease restatements spurred a renewed focus on restatements—both their causes and their consequences— and have led the SEC to modify its review practices to root out accounting errors that lead to restatements.Sources: Steven D. Jones and Richard Gibson, Wall Street Journal (January 26, 2005), p. C3; and O. Usvyatsky, “Restatements: Where They Come From,” (August 2, 2013).WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? RESTATEMENTS ON THE MENULO 2ILLUSTRATION 21-8Comparison of Charges to Operations—Capitalvs. Operating LeasesDifferences using a capital lease instead of an operating lease.Increase in amount of reported debt.Increase in amount of total assets (specifically long-lived assets).Lower income early in the life of the lease.ACCOUNTING BY THE LESSEELO 2Under current accounting rules, companies can keep the obligations associated with operating leases off the balance sheet. (For example, see the “What Do the Numbers Mean?” box on page 1199 for the effects of this approach for airlines.) This approach may change depending on the FASB’s new lease accounting rule. The current plans for a new rule in this area should result in many more operating leases on balance sheets. Analysts have estimated the expected impact of a new rule. As shown in the table to the right, if the FASB (and IASB) issue a new rule on operating leases, a company like Walgreen could see its liabilities jump a whopping 216 percent.WHAT’S YOUR PRINCIPLEEVOLVING ISSUE ARE YOU LIABLE?(continued)LO 2And it is not just retailers who would be impacted. A J.P. Morgan study estimates the following impacts for several industries.WHAT’S YOUR PRINCIPLEEVOLVING ISSUE ARE YOU LIABLE?(continued)LO 2As indicated, the expected effects are significant, with all industries expecting an increase in their debt levels and some (retail and travel and leisure) seeing a more than 10 percent increase in leverage ratios. This is not a pretty picture, but investors need to see it if they are to fully understand a company’s lease obligations.Sources: Nanette Byrnes, “You May Be Liable for That Lease,” BusinessWeek (June 5, 2006), p. 76; J. E. Ketz, “Operating Lease Obligations to Be Capitalized,” Smartpros (August 2010), and P. Elwin and S. C. Fernandes, “Leases on B/S from 2017? Retailers and Transport Will Be Hit Hard in Leverage Terms,” Global Equity Research, J.P. Morgan Securities (May 17, 2013). WHAT’S YOUR PRINCIPLEEVOLVING ISSUE ARE YOU LIABLE?LO 2Explain the nature, economic substance, and advantages of lease transactions.Describe the accounting for leases by lessees.LEARNING OBJECTIVESDescribe the accounting for leases by lessors.Describe the accounting and reporting for special features of lease arrangements.After studying this chapter, you should be able to:Accounting for Leases21LO 3Interest revenue.Tax incentives.High residual value.Benefits to the LessorLO 3ACCOUNTING BY THE LESSORA lessor determines the amount of the rental, basing it on the rate of return—the implicit rate—needed to justify leasing the asset.If a residual value is involved (whether guaranteed or not), the company would not have to recover as much from the lease payments.Economics of LeasingLO 3ACCOUNTING BY THE LESSOROperating leases.Direct-financing leases.Sales-type leases.Classification of Leases by the LessorLO 3ACCOUNTING BY THE LESSORA sales-type lease involves a manufacturer’s or dealer’s profit, and a direct-financing lease does not.Classification of Leases by the LessorILLUSTRATION 21-10LO 3ACCOUNTING BY THE LESSORILLUSTRATION 21-11Diagram of Lessor’s Criteria for Lease ClassificationClassification of Leases by the LessorA lessor may classify a lease as an operating lease but the lessee may classify the same lease as a capital lease.LO 3ACCOUNTING BY THE LESSORIn substance the financing of an asset purchase by the lessee.Lessor records:A lease receivable instead of a leased asset. Receivable is the present value of the minimum lease payments. Direct-Financing Method (Lessor)LO 3ACCOUNTING BY THE LESSORIllustration: Caterpillar Financial Services Corp. (a subsidiary of Caterpillar) and Sterling Construction Corp. sign a lease agreement dated January 1, 2017, that calls for Caterpillar to lease a front-end loader to Sterling beginning January 1, 2017. The terms and provisions of the lease agreement, and other pertinent data, are as follows.The term of the lease is five years beginning January 1, 2017, noncancelable, and requires equal rental payments of $25,981.62 at the beginning of each year. Payments include $2,000 of executory costs (property taxes).The equipment (front-end loader) has a cost of $100,000 to Caterpillar, a fair value at the inception of the lease of $100,000, an estimated economic life of five years, and no residual value.Caterpillar incurred no initial direct costs in negotiating and closing the lease transaction.The lease contains no renewal options. The equipment reverts to Caterpillar at the termination of the lease.Collectibility is reasonably assured and Caterpillar incurs no additional costs (with the exception of the property taxes being collected from Sterling).Caterpillar sets the annual lease payments to ensure a rate of return of 10 percent (implicit rate) on its investment.LO 3Direct-Financing Method (Lessor)Computation of Lease PaymentsLO 3Direct-Financing Method (Lessor)ILLUSTRATION 21-12The lease meets the criteria for classification as a direct-financing lease for several reasons. The lease term exceeds 75 percent of the equipment’s estimated economic life.The present value of the minimum lease payments exceeds 90 percent of the equipment’s fair value.Collectibility of the payments is reasonably assured.Caterpillar incurs no further costs. It is not a sales-type lease because there is no difference between the fair value ($100,000) of the loader and Caterpillar’s cost ($100,000). Direct-Financing Method (Lessor)LO 3Leased Receivable 100,000 Equipment 100,000Caterpillar records the lease of the asset and resulting receivable on January 1, 2017, as follows:Direct-Financing Method (Lessor)Computation of Lease ReceivableTotal payment $ 25,981.62Property taxes (executory cost) - 2,000.00Payment net of executory cost 23,981.62Present value factor (i=10%,n=5) x 4.16986Lease receivable $100.000.00LO 3ILLUSTRATION 21-14Lease Amortization Schedule for Lessor—Annuity-Due BasisLO 3ILLUSTRATION 21-14Cash 25,981.62 Lease Receivable 23,981.62 Property Tax Expense/Property Taxes Payable 2,000.00 On January 1, 2017, Caterpillar records receipt of the first year’s lease payment as follows. LO 3ILLUSTRATION 21-14Interest Receivable 7,601.84 Interest Revenue (leases) 7,601.84On December 31, 2017, Caterpillar recognizes the interest revenue during the first year through the following entry.LO 3Illustration 21-15 shows the assets section as it relates to lease transactions at December 31, 2017.ILLUSTRATION 21-15Reporting Lease Transactions by LessorDirect-Financing Method (Lessor)LO 3LO 3ILLUSTRATION 21-14Cash 25,981.62 Lease Receivable 16,379.78 Interest Receivable 7,601.84 Property Tax Expense/Property Taxes Payable 2,000.00On January 1, 2018, Caterpillar records the following. ILLUSTRATION 21-14Interest Receivable 5,963.86 Interest Revenue (leases) 5,963.86 On December 31, 2018, Caterpillar accrues interest as follows. LO 3Records each rental receipt as rental revenue. Depreciates leased asset in the normal manner.Operating Method (Lessor)ACCOUNTING BY THE LESSORLO 3Illustration: Assume Caterpillar accounts for the lease as an operating lease. It records the cash rental receipt as follows:Cash 25,981.62 Rental Revenue 25,981.62Depreciation is recorded as follows: $100,000 ÷ 5 years = $20,000Depreciation Expense 20,000 Accumulated Depreciation 20,000ACCOUNTING BY THE LESSORLO 3Explain the nature, economic substance, and advantages of lease transactions.Describe the accounting for leases by lessees.LEARNING OBJECTIVESDescribe the accounting for leases by lessors.Describe the accounting and reporting for special features of lease arrangements.After studying this chapter, you should be able to:Accounting for Leases21LO 4Residual values.Sales-type leases (lessor).Bargain-purchase options.Initial direct costs.Current versus noncurrent classification.Disclosure.SPECIAL LEASE ACCOUNTING PROBLEMSLO 4Meaning of Residual Value - Estimated fair value of the leased asset at the end of the lease term.Guaranteed versus Unguaranteed – A guaranteed residual value is when the lessee agrees to make up any deficiency below a stated amount that the lessor realizes in residual value at the end of the lease term.Residual ValuesLO 4SPECIAL LEASE ACCOUNTING PROBLEMSLease Payments - Lessor may adjust lease payments because of the increased certainty of recovery of a guaranteed residual value.Lessee Accounting for Residual Value - The minimum lease payment includes a guaranteed residual value but excludes an unguaranteed residual value.Residual ValuesLO 4SPECIAL LEASE ACCOUNTING PROBLEMSIllustration: Caterpillar Financial Services Corp. (a subsidiary of Caterpillar) and Sterling Construction Corp. sign a lease agreement dated January 1, 2017, that calls for Caterpillar to lease a front-end loader to Sterling beginning January 1, 2017. 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 noncancelable, requiring equal rental payments of $25,981.62 at the beginning of each year (annuity-due basis).The loader has a fair value at the inception of the lease of $100,000, an estimated economic life of five years, and an estimated residual value of $5,000.Sterling pays all of the executory costs directly to third parties except for the property taxes of $2,000 per year, which is included as part of its annual payments to Caterpillar.The lease contains no renewal options. The loader reverts to Caterpillar at the termination of the lease.Sterling’s incremental borrowing rate is 11 percent per year.Sterling depreciates, on a straight-line basis, similar equipment that it owns.Caterpillar sets the annual rental to earn a rate of return on its investment of 10 percent per year; Sterling knows this fact.LO 4SPECIAL LEASE ACCOUNTING PROBLEMSIllustration: Caterpillar assumes a 10 percent return on investment (ROI), whether the residual value is guaranteed or unguaranteed. Caterpillar would compute the amount of the lease payments as follows.ILLUSTRATION 21-16Lessor’s Computation of Lease PaymentsLO 4SPECIAL LEASE ACCOUNTING PROBLEMSGuaranteed Residual Value (Lessee Accounting)Computation of Lessee’s capitalized amount assuming a guaranteed residual value.LO 4SPECIAL LEASE ACCOUNTING PROBLEMSILLUSTRATION 21-17Computation of Lessee’s Capitalized Amount— Guaranteed Residual ValueLO 4Guaranteed Residual Value (Lessee)ILLUSTRATION 21-18Lease Amortization Schedule for Lessee— Guaranteed Residual ValueAt the end of the lease term, before the lessee transfers the asset to Caterpillar, the lease asset and liability accounts have the following balances.ILLUSTRATION 21-19LO 4Assume that Sterling depreciated the leased asset down to its residual value of $5,000 but that the fair market value of the residual value at December 31, 2021, was $3,000. Sterling would make the following journal entry.Guaranteed Residual Value (Lessee)Loss on Capital Lease 2,000.00Interest Expense (or Interest Payable) 454.76Lease Liability 4,545.24Accumulated Depreciation—Capital Leases 95,000.00 Leased Equipment (under capital leases) 100,000.00 Cash 2,000.00LO 4ILLUSTRATION 21-19Guaranteed Residual Value (Lessee)Assume the same facts as those above except that the $5,000 residual value is unguaranteed instead of guaranteed. Caterpillar will recover the same amount through lease rentals—that is, $96,895.40. Sterling would capitalize the amount as follows:LO 4Unguaranteed Residual Value (Lessee Accounting)SPECIAL LEASE ACCOUNTING PROBLEMSILLUSTRATION 21-20Computation of Lessee’s Capitalized Amount— Unguaranteed Residual ValueUnguaranteed Residual Value (Lessee)LO 4ILLUSTRATION 21-21Lease Amortization Schedule for Lessee— Unguaranteed Residual ValueAt the end of the lease term, before Sterling transfers the asset to Caterpillar, the lease asset and liability accounts have the following balances.LO 4Unguaranteed Residual Value (Lessee)ILLUSTRATION 21-22Account Balances on Lessee’s Books at End of Lease Term— Unguaranteed Residual ValueLO 4Comparative EntriesILLUSTRATION 21-23Comparative Entries for Guaranteed and Unguaranteed Residual Values, Lessee CompanyIllustration: Assume a direct-financing lease with a residual value (either guaranteed or unguaranteed) of $5,000. Caterpillar determines the payments as follows.Lessor Accounting for Residual ValueThe lessor works on the assumption that it will realize the residual value at the end of the lease term whether guaranteed or unguaranteed.LO 4SPECIAL LEASE ACCOUNTING PROBLEMSILLUSTRATION 21-24Computation of Direct-Financing Lease PaymentsLO 4Lessor Accounting for Residual ValueILLUSTRATION 21-25Lease Amortization Schedule, for Lessor— Guaranteed or Unguaranteed Residual ValueLO 4ILLUSTRATION 21-25Caterpillar would make the following entry on January 1, 2017.Lease Receivable 100,000.00 Equipment 100,000.00LO 4ILLUSTRATION 21-25Cash 25,237.09 Lease Receivable 23,237.09 Property Tax Expense/Property Taxes Payable 2,000.00Caterpillar would make the following entry on January 1, 2017.LO 4ILLUSTRATION 21-25Caterpillar would make the following entry on December 31, 2017.Lease Receivable 7,676.29 Interest Revenue 7,676.29As you have learned, residual value profits are an important driver for the popularity of leasing for lessors, especially for leases of equipment and vehicles. However, the profitability of equipment leasing hinges on the lessors’ ability to accurately estimate the residual value of the leased asset at the end of the lease so as to resell the asset at a profit when returned by the lessee. However, General Motors (GM) has learned that residual value profits are not guaranteed. Here is what happened. GM took advantage of a government subsidy for electric vehicles of $7,500 to help drive down the cost of a lease for its electric car, the Chevy Volt. The taxpayer subsidies along with other GM incentives provided for low monthly lease payments, given the estimated residual value, and led to a full two-thirds of all Volt “sales” being attributed to leases. That’s about three times the lease rate for the overall industry. WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? RESIDUAL VALUE REGRET(continued)LO 4The problems for GM started when the Volts came back at the end of the lease. Unfortunately for GM and other electric car enthusiasts, demand for electric cars without the incentives (which expired) has not been sustained, and resale values for Volts have plummeted. As a result, rather than reaping residual value profits, GM sustained losses for the Volt lease returns that sold for less than the original expected residual values. It’s a double whammy for GM as the already low sales numbers for new Volts will be further hurt by the supply of low-priced Volts on the used car lot. Although it appears that GM made a bad bet on residual value profits on the Volt, there may be beneficiaries as those looking for a good deal on a Volt now have a supply of low-priced, used models to choose from.Source: M. Modica, “Chevy Volt Resale Values Plunge as Lease Returns Hit Market,” ’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? RESIDUAL VALUE REGRETLO 4Primary difference between a direct-financing lease and a sales-type lease is the manufacturer’s or dealer’s gross profit (or loss).Lessor records the sale price of the asset, the cost of goods sold and related inventory reduction, and the lease receivable.There is a difference in accounting for guaranteed and unguaranteed residual values.Sales-Type Leases (Lessor)LO 4SPECIAL LEASE ACCOUNTING PROBLEMSILLUSTRATION 21-27Sales-Type Leases (Lessor)LO 4Direct-Financing versus Sales-Type LeasesLO 4Sales-Type Leases (Lessor)Illustration: To illustrate a sales-type lease with a guaranteed residual value and with an unguaranteed residual value, assume the same facts as in the preceding direct-financing lease situation. The estimated residual value is $5,000 (the present value of which is $3,104.60), and the leased equipment has an $85,000 cost to the dealer, Caterpillar. Assume that the fair market value of the residual value is $3,000 at the end of the lease term.LO 4Sales-Type Leases (Lessor)Computation of Lease Amounts by Caterpillar Financial—Sales-Type LeaseILLUSTRATION 21-28LO 4Sales-Type Leases (Lessor)LO 4ILLUSTRATION 21-29Entries for Guaranteed and Unguaranteed Residual Values, Lessor Company— Sales-Type LeaseXerox derives much of its income from leasing equipment. Reporting such leases as sales leases, Xerox records a lease contract as a sale, thereby recognizing income immediately. One problem is that each lease receipt consists of payments for items such as supplies, services, financing, and equipment. The SEC accused Xerox of inappropriately allocating lease receipts, which affects the timing of income that it reports. If Xerox applied SEC guidelines, it would report income in different time periods. Xerox contended that its methods were correct. It also noted that when the lease term is up, the bottom line is the same using either the SEC’s recommended allocation method or its current method. Although Xerox can refuse to change its method, the SEC has the right to prevent a company from selling stock or bonds to the public if the agency rejects financial fi lings of the company. Apparently, being able to access public markets is very valuable to Xerox. The company agreed to change its accounting according to SEC wishes, and Xerox paid $670 million to settle a shareholder lawsuit related to its lease transactions. Its former auditor, KPMG LLP, paid $80 million.Sources: Adapted from “Xerox Takes on the SEC,” Accounting Web (January 9, 2002), www.account-ingweb.com; and K. Shwiff and M. Maremont, “Xerox, KPMG Settle Shareholder Lawsuit,” Wall Street Journal Online (March 28, 2008), p. B3WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? XEROX TAKES ON THE SECLO 4Lessee must increase the present value of the minimum lease payments by the present value of the option.Only difference between the accounting treatment for a bargain-purchase option and a guaranteed residual value of identical amounts is in the computation of the annual depreciation.Bargain Purchase Option (Lessee)LO 4SPECIAL LEASE ACCOUNTING PROBLEMSAccounting for initial direct costs: Operating leases, the lessor should defer initial direct costs.Sales-type leases, the lessor expenses the initial direct costs.Direct-financing lease, the lessor adds initial direct costs to the net investment.Initial Direct Costs (Lessor)LO 4SPECIAL LEASE ACCOUNTING PROBLEMSBoth the annuity-due and the ordinary-annuity situations report the reduction of principal for the next period as a current liability/current asset.Current versus NoncurrentLO 4SPECIAL LEASE ACCOUNTING PROBLEMSThe current portion of the lease liability/receivable as of December 31, 2017, would beCurrent versus NoncurrentLO 4$18,017.70.ILLUSTRATION 21-30Lease Amortization Schedule—Ordinary-Annuity BasisGeneral description of the nature of leasing arrangements.The nature, timing, and amount of cash inflows and outflows associated with leases, including payments to be paid or received for each of the five succeeding years.The amount of lease revenues and expenses reported in the income statement each period.Description and amounts of leased assets by major balance sheet classification and related liabilities.Amounts receivable and unearned revenues under lease agreements.Disclosing Lease DataLO 4SPECIAL LEASE ACCOUNTING PROBLEMSTo avoid leased asset capitalization, companies design, write, and interpret lease agreements to prevent satisfying any of the four capitalized lease criteria.The real challenge lies in disqualifying the lease as a capital lease to the lessee, while having the same lease qualify as a capital (sales or financing) lease to the lessor. Unlike lessees, lessors try to avoid having lease arrangements classified as operating leases.Unresolved Lease Accounting ProblemsLO 4LO 5 Describe the lessee’s accounting for sale-leaseback transactions.The term sale-leaseback describes a transaction in which the owner of the property (seller-lessee) sells the property to another and simultaneously leases it back from the new owner.Advantages:FinancingTaxesSALE-LEASEBACKSAPPENDIX 21ADETERMINING ASSET USETo the extent the seller-lessee continues to use the asset after the sale, the sale-leaseback is really a form of financing. Lessor should not recognize a gain or loss on the transaction. If the seller-lessee gives up the right to the use of the asset, the transaction is in substance a sale. Gain or loss recognition is appropriate.SALE-LEASEBACKSLO 5APPENDIX 21AIf the lease meets one of the four criteria for treatment as a capital lease, the seller-lessee should Account for the transaction as a sale and the lease as a capital lease. Defer any profit or loss it experiences from the sale of the assets that are leased back under a capital lease.Amortize profit over the lease term .LesseeSALE-LEASEBACKSLO 5APPENDIX 21AIf none of the capital lease criteria are satisfied, the seller-lessee accounts for the transaction as a sale and the lease as an operating lease. Lessee defers such profit or loss and amortizes it in proportion to the rental payments over the period when it expects to use the assets.LesseeSALE-LEASEBACKSLO 5APPENDIX 21AIf the lease meets one of the lease capitalization criteria in Group I and both in Group II, the purchaser-lessor records the transaction as a purchase and a direct-financing lease. If the lease does not meet the criteria, the purchaser-lessor records the transaction as a purchase and an operating lease.LessorSALE-LEASEBACKSLO 5APPENDIX 21AAmerican Airlines on January 1, 2017, sells a used Boeing 757 having a carrying amount on its books of $75,500,000 to CitiCapital for $80,000,000. American immediately leases the aircraft back under the following conditions:The term of the lease is 15 years, noncancelable, and requires equal rental payments of $10,487,443 at the beginning of each year.The aircraft has a fair value of $80,000,000 on January 1, 2017, and an estimated economic life of 15 years.American pays all executory costs.American depreciates similar aircraft that it owns on a straight-line basis over 15 years.The annual payments assure the lessor a 12 percent return. American’s incremental borrowing rate is 12 percent.SALE-LEASEBACK EXAMPLESALE-LEASEBACKSLO 5APPENDIX 21AThis lease is a capital lease to American because the lease term exceeds 75 percent of the estimated life of the aircraft and because the present value of the lease payments exceeds 90 percent of the fair value of the aircraft to CitiCapital.CitiCapital should classify this lease as a direct-financing lease.SALE-LEASEBACK EXAMPLESALE-LEASEBACKSLO 5APPENDIX 21AILLUSTRATION 21A-1Comparative Entries for Sale-Leaseback for Lessee and LessorLO 5RELEVANT FACTS - SimilaritiesBoth GAAP and IFRS share the same objective of recording leases by lessees and lessors according to their economic substance—that is, according to the definitions of assets and liabilities.Much of the terminology for lease accounting in IFRS and GAAP is the same.Under IFRS, lessees and lessors use the same general lease capitalization criteria to determine if the risks and rewards of ownership have been transferred in the lease.LO 6 Compare the accounting for leases under GAAP and IFRS.LO 5RELEVANT FACTS - DifferencesOne difference in lease terminology is that finance leases are referred to as capital leases in GAAP.GAAP for leases uses bright-line criteria to determine if a lease arrangement transfers the risks and rewards of ownership; IFRS is more general in its provisions. GAAP has additional lessor criteria: payments are collectible and there are no additional costs associated with a lease.IFRS requires that lessees use the implicit rate to record a lease unless it is impractical to determine the lessor’s implicit rate. GAAP requires use of the incremental rate unless the implicit rate is known by the lessee and the implicit rate is lower than the incremental rate.LO 6RELEVANT FACTS - DifferencesUnder GAAP, extensive disclosure of future non-cancelable lease payments is required for each of the next five years and the years thereafter. Although some international companies (e.g., Nokia) provide a year-by-year breakout of payments due in years 1 through 5. IFRS does not require it. The FASB standard for leases was originally issued in 1976. The standard (SFAS No. 13) has been the subject of more than 30 interpretations since its issuance. The IFRS leasing standard is IAS 17, first issued in 1982. This standard is the subject of only three interpretations. One reason for this small number of interpretations is that IFRS does not specifically address a number of leasing transactions that are covered by GAAP. Examples include lease agreements for natural resources, sale-leasebacks, real estate leases, and leveraged leases.LO 6ON THE HORIZONLease accounting is one of the areas identified in the IASB/FASB Memorandum of Understanding. The Boards have developed rules based on “right-of-use” (ROU) which require that all leases with terms longer than one year be recorded on the balance sheet. The IASB has decided on a single approach for lessee accounting. Under that approach, a lessee would account for all leases similar to the current approach for capital leases, recognizing amortization of the ROU asset separately from interest on the lease liability. The FASB reached a different conclusion on the expense recognition for operating-type leases. Under the FASB model, the income effects will reflect a straight-line expense pattern, reported as a single total lease expense. The Boards are generally converged with respect to lessor accounting. A final standard is expected in 2016. You can follow the lease project at either the FASB ( or IASB ( websites.LO 6Which of the following is not a criterion for a lease to be recorded as a finance lease?There is transfer of ownership.The lease is cancelable.The lease term is for the major part of the economic life of the asset.There is a bargain-purchase option.IFRS SELF-TEST QUESTIONLO 6Under IFRS, in computing the present value of the minimum lease payments, the lessee should:use its incremental borrowing rate in all cases.use either its incremental borrowing rate or the implicit rate of the lessor, whichever is higher, assuming that the implicit rate is known to the lessee. use either its incremental borrowing rate or the implicit rate of the lessor, whichever is lower, assuming that the implicit rate is known to the lessee. use the implicit rate of the lessor, unless it is impracticable to determine the implicit rate.IFRS SELF-TEST QUESTIONLO 6A lease that involves a manufacturer’s or dealer’s profit is a (an):direct financing lease.finance lease.operating lease.sales-type lease.IFRS SELF-TEST QUESTIONLO 6“Copyright © 2016 John Wiley & Sons, Inc. 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