Intermediate accounting 17e by kieso ch21

Intermediate Accounting
Seventeenth Edition
Kieso ● Weygandt ● Warfield

Chapter 21
Accounting for Leases


Learning Objectives
After studying this chapter, you should be able to:
1. Describe the environment related to leasing
transactions.
2. Explain the accounting for finance leases.
3. Explain the accounting for operating leases.
4. Discuss the accounting and reporting for special
features of lease arrangements.

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Preview of Chapter 21 (1 of 3)
Accounting for Leases
The Leasing Environment
• Lessees
• Lessee lease advantages
• Lessors
• Lessor lease advantages
• Conceptual nature of a lease
• Finance and operating leases

• Lease classification
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Preview of Chapter 21 (2 of 3)
Finance Leases
• Lessee accounting
• Finance lease example
• Lessor accounting
• Sales-type lease example
Operating Leases
• Lessee accounting
• Lessor accounting

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Preview of Chapter 21 (3 of 3)
Special Lease Accounting Problems
• Residual values
• Other lease adjustments
• Bargain purchase options
• Short-term leases
• Presentation, disclosure, and analysis

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Learning Objective 1
Describe the Environment Related to
Leasing Transactions

LO 1

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The Leasing Environment (1 of 4)
A 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.
Largest group of leased equipment involves:
• Information technology equipment
• Transportation (trucks, aircraft, rail)
• Construction
• Agriculture
LO 1

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The Leasing Environment (2 of 4)
Company (Ticker)
Gap (GPS)
ExxonMobil Corp. (XOM)
JPMorgan Chase (JPM)

Maytag Corp. (MYG)

LO 1

Description
"We lease most of our store premises and some of our
headquarters facilities and distribution centers."
"Minimum commitments for operating leases, shown
on an undiscounted basis, cover drilling equipment,
tankers, service stations, and other properties."
"JPMorgan Chase and its subsidiaries were obligated
under a number of noncancelable operating leases for
premises and equipment used primarily for banking
purposes."
"The Company leases real estate, machinery,
equipment, and automobiles under operating leases,
some of which have renewal options."

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The Leasing Environment (3 of 4)
Company (Ticker)
McDonald's Corp. (MCD)

Starbucks Corp. (SBUX)
TXU Corp. (TXU)

LO 1

Description
"The Company was the lessee at 15,235 restaurant
locations through ground leases (the Company leases
the land and the Company or franchisee owns the
building) and through improved leases (the Company
leases land and buildings)."
"Starbucks leases retail stores, roasting and distribution
facilities, and office space under operating leases."
"TXU Energy Holdings and TXU Electric Delivery have
entered into operating leases covering various facilities
and properties including generation plant facilities,
combustion turbines, transportation equipment, mining
equipment, data processing equipment, and office
space."

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The Leasing Environment (4 of 4)
Company (Ticker)
Viacom Inc. (VIA.B)

Blank

LO 1

Description
"The Company has long-term non-cancelable operating lease
commitments for office space and equipment, transponders,
studio facilities, and vehicles. The Company also enters into
capital leases for satellite transponders."
Source: Company 10-K filings.

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The Leasing Environment
Advantages of Leasing—Lessees

1. 100% financing at fixed rates.
2. Protection against obsolescence.
3. Flexibility.
4. Less costly financing.

LO 1

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The Leasing Environment
A Look at the Lessor
Banks
•
•
•
•

LO 1

Wells Fargo
Chase
Citigroup
PNC

Independents
• International
Lease Finance
Corp.

Captive Leasing
Companies
• Caterpillar Financial
Services Corp.
• Ford Motor Credit

(Ford)
• IBM Global Financing

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The Leasing Environment
Advantages of Leasing - Lessor

1. Often provides profitable interest margins.
2. It can stimulate sales of a lessor’s product.
3. It often provides tax benefits to various parties in the
lease.
4. It can provide a high residual value to the lessor.
Global View
Some companies "double dip" on the international level too. The
leasing rules of the lessor's and lessee's countries may differ,
permitting both parties to own the asset. Thus, both lessor and
lessee receive the tax benefits related to depreciation.
LO 1

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What Do the Numbers Mean?: Residual Value Regret
(1 of 2)

As 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. The problems for
G
came
back
at the
end
LO M
1 started when the Volts
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©2019
John Wiley
& Sons,
Inc. of
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What Do the Numbers Mean?: Residual Value Regret

(2 of 2)

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 plummeted.
As a result, rather than reaping residual value profits, G M sustained
losses for the Volt lease returns that sold for less than the original
expected residual values. It’s a double whammy for G M as the already
low sales numbers for new Volts will be further hurt by the supply of lowpriced Volts on the used car lot. Although it appears that G M 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,” nlpc.org
LO 1

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The Leasing Environment
Conceptual Nature of a Lease

A lease conveys the use of an asset from one party (the
lessor) to another (the lessee) without transferring
ownership.
The various views on capitalization of leases are as follows.
1. Do not capitalize any leased assets.
2. Capitalize leases that are similar to installment purchases.

3. Capitalize all long-term leases.
4. Capitalize firm leases where the penalty for
nonperformance is substantial.
LO 1

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Finance and Operating Leases (Lessee) (1 of 2)
Companies classify lease arrangements as either finance
or operating. In either case, companies capitalize all
leased assets and liabilities.
For a finance lease,
• The lessee recognizes interest expense on the lease
liability over the life of the lease using the effectiveinterest method and
• records amortization expense on the right-of-use asset
generally on a straight-line basis.
LO 1

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Finance and Operating Leases (Lessee) (2 of 2)
For a operating lease,
• The lessee also measures interest expense using the
effective-interest method. However, the lessee

amortizes the right-of-use asset such that the total
lease expense is the same from period to period.
• Only a single lease expense (comprised of interest on
the liability and amortization of the right-of-use asset)
is recognized on the income statement.

LO 1

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Lease Classification (1 of 5)
From the lessee’s perspective, a lessee should classify a
lease based on whether the arrangement is effectively a
purchase of the underlying asset.
If the lease transfers control (or ownership) of the
underlying asset to a lessee, then the lease is classified
as a finance lease.
• The lessee takes ownership or consumes the
substantial portion of the underlying asset over the
term.
Alllease
leases
that do not meet any of the finance lease tests
are classified as operating leases.
LO 1

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Lease Classification (2 of 5)
For a finance lease,
• must be noncancelable and
• meet at least one of
the five tests.

LO 1

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Lease Classification (3 of 5)
Transfer of Ownership Test
• If the lease transfers ownership of the asset to the
lessee, it is a finance lease.
Purchase Option Test
• The lease purchase option allows the lessee to
purchase the property for a price that is significantly
lower than the underlying asset’s expected fair value at
the date the option becomes exercisable (bargain
purchase option).
LO 1

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Lease Classification (4 of 5)
Lease Term Test
• If the lease term is 75 percent or greater of the economic
life of the leased asset, the lease meets the lease term test
and finance lease treatment is appropriate (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 commencement 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 certain.
LO 1

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Accounting by the Lessee (1 of 2)
Illustration: 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 ____ years.

LO 1

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Accounting by the Lessee (2 of 2)
Illustration: 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 1

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Lease Classification (5 of 5)
Present Value Test
Lease Payments:
• Fixed payments.
• Variable payments that are based on an index or a rate.
• Guaranteed residual value.
• Payments related to purchase or termination options
that the lessee is reasonably certain to exercise.

LO 1

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