2. Introductory Lecture – Includes Flow Charts
Accounting for Leases
Chapter 21
Also includes slides from 11th edition prepared by Jep Robertson and Renae Clark - New Mexico State University
And has slides added by Teresa Gordon (University of Idaho)
Intermediate Accounting
12th Edition
Kieso, Weygandt, and Warfield
Prepared by Coby Harmon, University of California, Santa Barbara

3. Learning Objectives
Explain the nature, economic substance, and advantages of lease transactions.
Describe the accounting criteria and procedures for capitalizing leases by the lessee.
Contrast the operating and capitalization methods of recording leases.
Identify the classifications of leases for the lessor.
Describe the lessor’s accounting for direct-financing leases.
Identify special features of lease arrangements that cause unique accounting problems.
Describe the effect of residual values, guaranteed and unguaranteed, on lease accounting.
Describe the lessor’s accounting for sales-type leases.
List the disclosure requirements for leases.

4. Teresa’s Specific Objectives
Be able to classify a lease from the perspective of lessor and lessee
Be able to prepare journal entries for lessor and lessee – for both operating and capital-type leases
Be able to research FARS to resolve complications not mentioned in text

5. Special Accounting Problems
Accounting for Leases
Leasing Environment
Accounting by Lessee
Accounting by Lessor
Special Accounting Problems
Who are players?
Advantages of leasing
Conceptual nature of a lease
Capitalization criteria
Accounting differences
Capital lease method
Operating method
Comparison
Economics of leasing
Classification
Direct-financing method
Operating method
Residual values
Sales-type leases
Bargain purchase option
Initial direct costs
Current versus noncurrent
Disclosure
Unsolved problems

6. The lease gives the lessee the right to use specific property.
The lease is a contractual agreement between the lessor and the lessee.
The lease gives the lessee the right to use specific property.
The lease specifies the duration of the lease and rental payments.
The obligations for taxes, insurance, and maintenance may be assumed by the lessor or the lessee.
LEASE = A contract specifying the terms under which the owner of an asset agrees to transfer the right to use the asset to another party.
The “Parties” to a Lease
Lessee: The party granted the right to use the property under the terms of a lease.
Has possession and use of the asset
Lessor: The owner of the property that is rented (leased) to another party.
The legal owner of the asset

7. Cancellation Provision
Lease Contracts
Cancellation Provision
Specifies under what
circumstances the lease
may be canceled.
Rental payment required
over lease term – may include planned increases.
Lease Payment
Lease Term
Delineates the time period the lease is to be in force. May include renewal periods. 22 6

8. Lease Contracts Residual Value Purchase Option
Who is responsible for market value of leased
asset at end of lease term?
Purchase Option
Grants lessee the right to
purchase the asset at the end of the lease term. The option price may or may not be a bargain. 24 7

9. Other Terms You Will Learn
Contingent rentals
Bargain renewal option
Bargain purchase option
Nonrenewal penalty
Guaranteed residual value
Interest rate implicit in the lease
Unguaranteed residual value
Executory costs
Initial direct costs
Minimum lease payments
Incremental borrowing rate

10. The Leasing Environment
Advantages of Leasing
100% Financing at Fixed Rates.
Protection Against Obsolescence.
Flexibility.
Less Costly Financing.
Tax Advantages.
Off-Balance-Sheet Financing.

11. The Leasing Environment
Benefits to the Lessor
Interest Revenue.
Tax Incentives.
High Residual Value.
Making a sale that would otherwise go to a competitor that provides a leasing option

12. The Leasing Environment
The issue of how to report leases is the case of substance versus form. Although technically legal title may not pass, the benefits from the use of the property do.
Operating Lease
Capital Lease
Journal Entry:
Rent expense xxx
Cash xxx
Journal Entry:
Leased equipment xxx
Lease obligation xxx
Largest group of leased equipment involves:
Information technology, Transportation (trucks, aircraft, rail), Construction and Agriculture.
A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized (only noncancellable leases may be capitalized).
Statement of Financial Accounting Standard No. 13, “Accounting for Leases,” 1980
LO 1 Explain the nature, economic substance, and advantages of lease transactions.

13. Accounting by the Lessee
Leases that DO NOT meet any of the four criteria are accounted for as Operating Leases.
Lease Agreement
Operat ing
Lease
Transfer of
Ownership
Bargain
Purchase
Lease Term
>= 75%
PV of
Payments
>= 90% No No No No
Yes
Yes
Yes
Yes
Capital Lease

14. Accounting by Lessee Capital Lease Operating Lease Lease Agreement
Is there transfer
of ownership?
Yes
Is there a bargain
purchase option?
Yes No
Is lease term equal
to or greater than
75% of economic
life ?
Yes No
Is present value
of payments
equal to or more
than 90% FMV?
Yes No
My students in previous semesters found this slide particularly helpful
Operating
Lease
11th Ed Slide

15. Accounting by the Lessor
Classification of Leases by the Lessor
Illustration 21-11
A sales-type lease involves a manufacturer’s or dealer’s profit, and a direct-financing lease does not.

16. Accounting by the Lessor
Classification of Leases by the Lessor
Illustration 21-12
A lessor may classify a lease as an operating lease but the lessee may classify the same lease as a capital lease.

17. Accounting by Lessor Operating Lease Sales type Direct financing yes
Lease Agreement
Does lease meet
Group 1 criteria? No
Operating
Lease
Is collectibility of
payments assured? No
yes
Is lessor’s
performance
substantially
complete ? No
yes
My students in previous semesters found this slide particularly helpful No
Sales type
Direct
financing
yes
yes
Does asset FMV
equal lessor’s
book value?
11th Ed Slide

18. Later we’ll talk about International Financial Reporting Standards
IFRS Flowchart

19. From KPMG webcast Spring 2008
Additional indicators are things like:
Cancellation losses borne by lessee
Changes in fair value of residual borne by lessee
Bargain lease renewal option

20. Copyright
Copyright © 2007 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.