Chapter 15 LeasesBRIEF Exercises

Brief ––1

Because none of the four classification criteria is met, this is an operating lease. Accordingly,
LTT will record rent expense for each of the four $25,000 payments, reducing its earnings by
$100,000 each year.

Brief Exercise 15–2

Because none of the four classification criteria is met, this is an operating lease. Accordingly,
Lakeside will record rent revenue for each of the four $25,000 payments, increasing its earnings by
$100,000 each year. In addition Lakeside, as owner of the asset, will record depreciation. Assuming
straight-line depreciation of the $2 million cost over the 25-year life, that’s $80,000 depreciation
expense each year. So, earnings are increased by a net $20,000 ($100,000 – 80,000).

Brief Exercise 15–3

Because this is an operating lease, Ward will record rent expense for each of the $5,000
payments. The advance payment also represents rent, recorded initially as prepaid rent and allocated
equally over the 10 years of the lease. As a result, Ward’s rent expense for the year reduces its
earnings by $70,000 each year.
$5,000 x 12 = $60,000
$100,000 ÷ 10 = 10,000
$70,000

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Solutions Manual, Vol.2, Chapter 15 15–
Brief Exercise 15–4

The lease is a capital lease to Athens because the present value of the minimum lease payments
($20.4 million) is greater than 90% of the fair value of the asset (90% x $22.4 million = $20.16
million). None of the other three classification criteria is met.

Brief Exercise 15–5

The present value of the minimum lease payments ($20.4 million) is greater than 90% of the fair
value of the asset (90% x $22.4 million = $20.16 million). Since the additional lessor conditions
also are met, it is a capital lease to Corinth. Furthermore, it is a sales-type lease because the present
value of the minimum lease payments exceeds the lessor’s cost ($16 million).

Brief Exercise 15–6

In direct financing leases, the lessor records a receivable for the present value of the lease
payments to be received ($1,486,000 for Sonic). The difference between the total of the lease
payments ($1,982,000 for Sonic) and the present value of the lease payments to be received over the
term of the lease represents interest. Over the term of the leases, Sonic will report this amount
($1,982,000 – 1,486,000 = $496,000) as interest revenue, determined as the effective interest rate
times the outstanding balance (net investment) each period.

Brief Exercise 15–7

The amount of interest expense the lessee would record in conjunction with the second
quarterly payment at October 1 is $2,892:

Initial balance, July 1 (given)................................................. $150,000

Reduction for first payment, January 1.................................. (5,376)

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15– Intermediate Accounting, 7e
Balance................................................................................... $144,624

Interest expense October 1: 2% x $144,624 = $2,892

Journal entries (not required):

July 1
Leased asset (given)......................................................... 150,000
Lease payable.............................................................. 150,000

Lease payable .................................................................. 5,376

Cash (lease payment).................................................. 5,376

Oct. 1
Interest expense (2% x [$150,000 – 5,376]).................... 2,892
Lease payable (difference)............................................... 2,484
Cash (lease payment).................................................. 5,376

The amount of interest revenue the lessor would record in conjunction with the second

quarterly payment at October 1 also is $2,892, determined in the same manner.

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Solutions Manual, Vol.2, Chapter 15 15–
Brief Exercise 15–8

The lease liability in the balance sheet will be $113,731:

Initial balance, January 1 (calculated below)......................... $140,000

Reduction for first payment, January 1.................................. (26,269)
December 31, net liability...................................................... $113,731

$26,269 x 5.32948 =
$140,000
(rounded)
 Present value of an annuity due of $1: n = 6, i = 5%

The liability for interest on the lease liability in the balance sheet will be $5,687:

Interest expense (5% x [$140,000 – 26,269])........................... 5,687

Interest payable.................................................................. 5,687

Brief Exercise 15–9

Pretax earnings will be reduced by $29,020 as calculated below:

January 1 interest expense..................................................... $ 0

Dec. 31, interest expense (5% x [$140,000* – 26,269]).... 5,687
Interest expense for the year.................................................. $ 5,687

Depreciation expense ($140,000* ÷ 6 years)......................... 23,333

Total expenses...................................................................... $29,020

*$26,269 x 5.32948 $140,000=

(rounded)
Present value of an annuity due of $1: n = 6, i = 5%

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15– Intermediate Accounting, 7e
Brief Exercise 15–10

The price at which the lessor is “selling” the asset being leased is the present value of the lease
payments:

*$26,269 x 5.32948 $140,000 =

(rounded)
Present value of an annuity due of $1: n = 6, i = 5%

Pretax earnings will be increased by $20,687 as calculated below:

January 1, interest revenue..................................................... $ 0

Dec. 31, interest revenue (5% x [$140,000* – 26,269]).... 5,687
Interest revenue for the year.................................................. $ 5,687

Sales revenue*.......................................................................... 140,000

Cost of goods sold..................................................................... (125,000)
Income effect......................................................................... $ 20,687

Journal entry (not required):

Lease receivable (present value).................................................... 140,000
Cost of goods sold (lessor’s cost).................................................. 125,000
Sales revenue (present value).................................................... 140,000
Inventory of equipment (lessor’s cost)..................................... 125,000

Brief Exercise 15–11

$100,000 ÷ 16.67846 = $5,996
fair lease
value payments

 Present value of an annuity due of $1: n = 20, i = 2%

Brief Exercise 15–12

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Solutions Manual, Vol.2, Chapter 15 15–
Amount to be recovered (fair value) $600,000

Less: Present value of the BPO price ($100,000 x .74726*) (74,726)

Amount to be recovered through periodic lease payments $525,274

_____________________
Lease payments at the beginning 
of each of the next 5 years: ($525,274 ÷ 4.46511**) $117,640
* Present value of $1: n = 5, i = 6%
** Present value of an annuity due of $1: n = 5, i = 6%

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15– Intermediate Accounting, 7e
Brief Exercise 15–13

Amount to be recovered (fair value) $700,000

Less: Present value of the residual value ($100,000 x .82270*) (82,270)

Amount to be recovered through periodic lease payments $617,730

_______________________
Lease payments at the end 
of each of the next 4 years: ($617,730 ÷ 3.54595**) $174,207
* Present value of $1: n = 4, i = 5%
** Present value of an ordinary annuity of $1: n = 4, i = 5%

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Solutions Manual, Vol.2, Chapter 15 15–
Brief Exercise 15–14

Under U.S. GAAP, this would not be a capital lease because none of the four classification
criteria is met. The lease term is less than 75% of the economic life of the asset, and the present
value of the minimum lease payments is less than 90% of the asset’s fair value. We don’t have these
“bright line” rules under IFRS. If the term of the lease constitutes a “major portion” of the useful
life of an asset a finance lease normally is indicated. Is 73% (8/11) a major portion? Perhaps so.
This is a matter of professional judgment, which may differ depending on the presence or absence of
other indicators that the risks and rewards of ownership have been transferred to the lessee.
Another situation that normally indicates a finance lease is if the present value of the minimum
lease payments is equal to or greater than substantially all of the fair value of the asset. Is 89%
(40/45) a major portion? Perhaps so. This also is a matter of professional judgment. When we
consider this and the previous indicator in combination, it’s very likely the conclusion would be that
the risks and rewards of ownership have been transferred to the lessee and this would be considered
a finance (capital) lease.

Exercises

Exercise 15–1

(a) Nath-Langstrom Services, Inc. (Lessee)

June 30, 2013

Rent expense............................................ 10,000
Cash .................................................... 10,000

December 31, 2013

Rent expense............................................ 10,000
Cash .................................................... 10,000

(b) ComputerWorld Corporation (Lessor)

June 30, 2013

Cash.......................................................... 10,000
Rent revenue........................................ 10,000

December 31, 2013

Cash.......................................................... 10,000
Rent revenue........................................ 10,000

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15– Intermediate Accounting, 7e
Depreciation expense ($90,000 ÷ 6 years) 15,000
Accumulated depreciation................... 15,000

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Solutions Manual, Vol.2, Chapter 15 15–
Exercise 15–3

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15– Intermediate Accounting, 7e
Present Value of Minimum Lease Payments:

($15,000 x 7.47199*) = $112,080

lease present
payments value
* Present value of an annuity due of $1: n = 8, i = 2%
[i = 2% (8% ÷ 4) because the lease
calls for quarterly payments]

Lease Amortization Schedule

Lease Effective Decrease Outstanding
Payments Interest in Balance Balance
2% x Outstanding Balance
112,080
1 15,000 15,000 97,080
2 15,000 .02 (97,080) = 1,942 13,058 84,022
3 15,000 .02 (84,022) = 1,680 13,320 70,702
4 15,000 .02 (70,702) = 1,414 13,586 57,116
5 15,000 .02 (57,116) = 1,142 13,858 43,258
6 15,000 .02 (43,258) = 865 14,135 29,123
7 15,000 .02 (29,123) = 582 14,418 14,705
8 15,000 .02 (14,705) = 295* 14,705 0
120,000 7,920 112,080

* Adjusted for rounding of other numbers in the schedule.

January 1, 2013
Leased equipment (calculated above).............................. 112,080
Lease payable (calculated above)................................ 112,080

Lease payable .................................................................. 15,000

Cash (lease payment).................................................. 15,000

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Solutions Manual, Vol.2, Chapter 15 15–
Exercise 15–3 (concluded)

April 1, 2013
Interest expense (2% x [$112,080 – 15,000]).................. 1,942
Lease payable (difference)............................................... 13,058
Cash (lease payment).................................................. 15,000

July 1, 2013
Interest expense (2% x $84,022: from schedule)............. 1,680
Lease payable (difference)............................................... 13,320
Cash (lease payment).................................................. 15,000

October 1, 2013
Interest expense (2% x $70,702: from schedule)............. 1,414
Lease payable (difference)............................................... 13,586
Cash (lease payment).................................................. 15,000

December 31, 2013

Interest expense (2% x $57,116: from schedule)............. 1,142
Interest payable .......................................................... 1,142

Depreciation expense ($112,080 ÷ 2 years)..................... 56,040

Accumulated depreciation........................................... 56,040

January 1, 2014
Interest payable (from adjusting entry)............................ 1,142
Lease payable (difference)............................................... 13,858
Cash (lease payment).................................................. 15,000

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15– Intermediate Accounting, 7e
Exercise 15–7

Requirement 1 January 1, 2013

Leased assets.................................................................... 4,000,000
Lease payable.............................................................. 4,000,000

Requirement 2

$4,000,000 ÷ 3.16987** = $1,261,881

present lease
value payment

** Present value of an ordinary annuity of $1: n = 4, i = 10%

Lease Amortization Schedule

Lease Effective Decrease Outstanding
Payments Interest in Balance Balance
10% x Outstanding Balance
4,000,000
2013 1,261,881 .10 (4,000,000) = 400,000 861,881 3,138,119
2014 1,261,881 .10 (3,138,119) = 313,812 948,069 2,190,050
2015 1,261,881 .10 (2,190,050) = 219,005 1,042,876 1,147,174
2016 1,261,881 .10 (1,147,174) = 114,707* 1,147,174 0
5,047,524 1,047,5244,000,000

* Adjusted for rounding of other numbers in the schedule.

Requirement 3 December 31, 2013

Interest expense (10% x outstanding balance)................. 400,000

Lease payable (difference)............................................... 861,881
Cash (payment determined above).............................. 1,261,881

Requirement 4 December 31, 2015

Interest expense (10% x outstanding balance)................. 219,005

Lease payable (difference)............................................... 1,042,876
Cash (payment determined above).............................. 1,261,881

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Solutions Manual, Vol.2, Chapter 15 15–
Exercise 15–10

1. Calculation of the present value of lease payments (“selling price”)

$562,907 x 5.32948 =
$3,000,000
(rounded)
 Present value of an annuity due of $1: n = 6, i = 5%

2. Receivable at December 31, 2013

Receivable
Initial balance, June 30, 2013....................... $3,000,000
June 30, 2013, reduction............................... (562,907)*
Dec. 31, 2013, reduction.............................. (441,052)**
December 31, 2013, receivable.................... $1,996,041

The receivable replaces the $2,500,000 machine on the balance sheet.

3. Income effect for year ended December 31, 2013

June 30, 2013, interest revenue.............................................. $ 0*

Dec. 31, 2013, interest revenue.............................................. 121,855
Interest revenue for 2013....................................................... $ 121,855

Sales revenue*.......................................................................... 3,000,000

Cost of goods sold*................................................................... (2,500,000)
Income effect......................................................................... $ 621,855

Calculations:

June 30, 2013*

Lease receivable (present value calculated above)........................ 3,000,000
Cost of goods sold (lessor’s cost).................................................. 2,500,000
Sales revenue (present value calculated above)........................ 3,000,000
Inventory of equipment (lessor’s cost)..................................... 2,500,000

Cash (lease payment)..................................................................... 562,907

Lease receivable........................................................................ 562,907
December 31, 2013**
Cash (lease payment)..................................................................... 562,907
Lease receivable (difference).................................................... 441,052
Interest revenue (5% x [$3,000,000 – 562,907])...................... 121,855

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15– Intermediate Accounting, 7e
Exercise 15–11

Requirement 1
a. Transfer of ownership is one of four criteria, any of which is sufficient to qualify this as a
capital lease.
b. A bargain purchase option is one of four criteria, any of which is sufficient to qualify this as a
capital lease because, by definition, ownership is expected to transfer.
c. Whether the term of the lease constitutes 75% of the useful life of an asset is one of four
criteria, any of which is sufficient to qualify this as a capital lease. 70% (14/20) does not meet
this criterion.
d. Whether the present value of the minimum lease payments is equal to or greater than 90% of
the fair value of the asset is one of four criteria, any of which is sufficient to qualify this as a
capital lease. 89% (8.9 ÷ 10) does not meet this criterion.
e. If the leased asset is of a specialized nature such that only the lessee can use it without major
modifications being made, that normally would suggest that one of the four classification
criteria might be met. But, this, by itself, is not a specified criterion under U.S. GAAP for a
lease to be classified as a capital lease.

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Solutions Manual, Vol.2, Chapter 15 15–
Exercise 15–11 (concluded)

Requirement 2
a. Transfer of ownership normally is an indicator of a finance lease.
b. A bargain purchase option normally is an indicator of a finance lease because, by definition,
ownership is expected to transfer.
c. If the term of the lease constitutes a “major portion” of the useful life of an asset a finance
lease normally is indicated. Is 70% (14 ÷ 20) a major portion? Perhaps so. This is a matter of
professional judgment, which may differ depending on the presence or absence of other
indicators that the risks and rewards of ownership have been transferred to the lessee.
d. One situation that normally indicates a finance lease is if the present value of the minimum
lease payments is equal to or greater than substantially all of the fair value of the asset. Is 89%
(8.9 ÷ 10) a major portion? Perhaps so. This is a matter of professional judgment, which may
differ depending on the presence or absence of other indicators that the risks and rewards of
ownership have been transferred to the lessee.
e. One situation that normally indicates a finance lease is if the leased asset is of a specialized
nature such that only the lessee can use it without major modifications being made. Could
another airline use the aircraft without modification or with nonmajor modification? That
information is not specified. With additional information, this is a matter of professional
judgment, which may differ depending on the presence or absence of other indicators that the
risks and rewards of ownership have been transferred to the lessee.

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15– Intermediate Accounting, 7e
Exercise 15–12
Situation 1
(a) $600,000 ÷ 6.53705** = $91,785
fair lease
value payments
** Present value of an annuity due of $1: n = 10, i = 11%

(b) $91,785 x 6.53705** = $600,000 (rounded)

lease leased asset/
payments lease liability
** Present value of an annuity due of $1: n = 10, i = 11%

Situation 2
(a) $980,000 ÷ 9.95011** = $98,491
fair lease
value payments
** Present value of an annuity due of $1: n = 20, i = 9%

(b) $98,491 x 9.95011** = $980,000 (rounded)

lease leased asset/
payments lease liability
** Present value of an annuity due of $1: n = 20, i = 9%

Situation 3
(a) $185,000 ÷ 3.40183** = $54,382
fair lease
value payments
** Present value of an annuity due of $1: n = 4, i = 12%

(b) $54,382 x 3.44371** = $187,276

lease leased asset/
payments lease liability
** Present value of an annuity due of $1: n = 4, i = 11%

But since this amount exceeds the asset’s fair value, the lessee
must capitalize the $185,000 fair value instead.

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Solutions Manual, Vol.2, Chapter 15 15–
Exercise 15–23

1. January 1, 2013
Lease receivable (fair value / present value)................................. 500,000
Inventory of equipment (lessor’s cost)..................................... 500,000

Lease receivable............................................................................ 4,242

Cash (initial direct costs).......................................................... 4,242

Cash (lease payment)..................................................................... 184,330

Lease receivable........................................................................ 184,330

2. Effective rate of interest revenue:

The initial direct costs increase the net investment: $500,000 + 4,242. The new effective
rate is the discount rate that equates the net investment and the future lease payments:

$504,242 ÷ ? **
$184,330
lessor’s lease
net investment payments
** Present value of an annuity due of $1: n = 3, i = ?%

Rearranging algebraically: $504,242 ÷ $184,330= 2.73554.

When you consult the present value table for an annuity due, you search row 3 (n = 3) for
this value and find it in the 10% column. So, the effective interest rate is 10%. The net
investment is amortized at the new rate.

3. December 31, 2013

Interest receivable.......................................................................... 31,991

Interest revenue (10% x [$500,000 + 4,242 – 184,330]).......... 31,991

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15– Intermediate Accounting, 7e
Exercise 15–24

Requirement 1

Inception of the lease, January 1, 2013

Lease receivable (fair value).......................................................... 300,000
Cost of goods sold (lessor’s cost).................................................. 265,000
Sales revenue (fair value).......................................................... 300,000
Inventory of equipment (lessor’s cost)..................................... 265,000

Selling expense.............................................................................. 7,500

Cash (initial direct costs).......................................................... 7,500

Cash (lease payment)..................................................................... 69,571

Lease receivable........................................................................ 69,571

Requirement 2

December 31, 2013

Interest receivable.......................................................................... 18,434
Interest revenue (8% x [$300,000 – 69,571)............................. 18,434

Problems Problem 15–2

1. NIC’s lease liability at the inception of the lease

$172,501: [$192,501 – 20,000] (present value of minimum lease payments or initial lease
balance minus first payment)

2. Leased asset

$192,501 (present value of minimum lease payments; initial lease balance)

3. Lease term in years

20 years

4. Asset’s residual value expected at the end of the lease term

$35,000

5. Residual value guaranteed by the lessee

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$35,000 (would not be part of lessee’s minimum lease payments unless lessee-guaranteed)

6. Effective annual interest rate

10%: ($17,250 ÷ $172,501)

7. Total of minimum lease payments

$435,000: [$20,000 x 20 years] + $35,000

8. Total effective interest expense over the term of the lease

$242,499: [$435,000 – 192,501]

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15– Intermediate Accounting, 7e
Problem 15–3

Requirement 1

Capital lease to lessee; direct financing lease to lessor.

Since the present value of minimum lease payments (same for both the lessor and the lessee) is
greater than 90% of the fair value of the asset, the 90% recovery criterion is met.

Calculation of the Present Value of Minimum Lease Payments

Present value of periodic lease payments

$130,516 x 15.32380** = $2,000,000
(rounded)
** Present value of an annuity due of $1: n = 20, i = 3%

The 75% of useful life criterion is met also. Both additional lessor conditions are met for a
capital lease. There is no dealer’s profit because the fair value equals the lessor’s cost.

Requirement 2

Mid-South Urologists Group (Lessee)

January 1, 2013
Leased equipment (calculated above)............................................ 2,000,000
Lease payable (calculated above)............................................. 2,000,000

Lease payable ............................................................................... 130,516

Cash (lease payment)................................................................ 130,516

April 1, 2013
Interest expense (3% x [$2 million – 130,516])............................ 56,085
Lease payable (difference)............................................................. 74,431
Cash (lease payment)................................................................ 130,516

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Solutions Manual, Vol.2, Chapter 15 15–
Problem 15–3 (concluded)

Physicians’ Leasing (Lessor)

January 1, 2013
Lease receivable (present value calculated above)................ 2,000,000
Inventory of equipment (lessor’s cost).............................. 2,000,000

Cash (lease payment)............................................................. 130,516

Lease receivable ............................................................... 130,516

April 1, 2013
Cash (lease payment)............................................................. 130,516
Lease receivable (difference)............................................ 74,431
Interest revenue (3% x [$2 million – 130,516])................ 56,085

Requirement 3

Rand Medical (Lessor)

January 1, 2013
Lease receivable (present value calculated above)................ 2,000,000
Cost of goods sold (lessor’s cost).................................................. 1,700,000
Sales revenue (present value calculated above)........................ 2,000,000
Inventory of equipment (lessor’s cost)..................................... 1,700,000

Cash (lease payment)..................................................................... 130,516

Lease receivable ....................................................................... 130,516

April 1, 2013
Cash (lease payment)..................................................................... 130,516
Lease receivable (difference).................................................... 74,431
Interest revenue (3% x [$2 million – 130,516])........................ 56,085

Problem 15–12
Situation
1 2 3 4
A. The lessor’s:
1. Minimum lease payments1 $40,000 $44,000 $44,000 $40,000

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15– Intermediate Accounting, 7e
2. Gross investment in the lease2 40,000 44,000 44,000 44,000
3. Net investment in the lease3 34,437 37,072 37,072 37,072
B. The lessee’s:
4. Minimum lease payments4 40,000 44,000 40,000 40,000
5. Leased asset5 34,437 37,072 34,437 34,437
6. Lease liability6 34,437 37,072 34,437 34,437

1 ($10,000 x number of payments) + residual value guaranteed by lessee and/or by third party.
2 Minimum lease payments plus unguaranteed residual value.
3 Present value of gross investment.
4 ($10,000 x number of payments) + residual value guaranteed by lessee.
5 Present value of minimum lease payments; should not exceed fair value.
6 Present value of minimum lease payments; should not exceed fair value.

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Solutions Manual, Vol.2, Chapter 15 15–