Prepared by

Coby Harmon
University of California, Santa Barbara
Westmont College
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 CHAPTER 21
Accounting for Leases
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the environment 3. Explain the accounting for
related to leasing transactions. leases by lessors.
2. Explain the accounting for 4. Discuss the accounting and
leases by lessees. reporting for special features
of lease arrangements.

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 PREVIEW OF CHAPTER 21

Intermediate Accounting
IFRS 3rd Edition
Kieso ● Weygandt ● Warfield
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 LEARNING OBJECTIVE 1
The Leasing Environment Describe the environment
related to leasing transactions.

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

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ILLUSTRATION 21.2
What Do Companies
Lease?

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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.

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 The Leasing Environment

A Look at the Lessor

Captive
Banks Independents Leasing
Companies
► Credit Suisse ► CNH Capital
(CHE) (NLD) (for CNH
► Chase (USA) Global),
► Barclays (GBR) ► BMW Financial
Services (DEU)
► Deutsche Bank
(for BMW)
(DEU)
14% ► IBM Global
Financing (USA)
(for IBM)

55% Market Share 31%

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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.

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 LEARNING OBJECTIVE 2
Lease Accounting Explain the accounting for
leases by lessees.

Conveys the right to control the use of identified property,

plant or equipment (an identified asset) for a period of time
in exchange for consideration.”

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 non-

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performance is substantial.
 Lease Accounting

IASB requires lessees to capitalize all leases.

Only exceptions:
 leases covering a term of less than one year or
 lease of property with a value less than $5,000.

Right to use property under the lease is an

 asset, and
 lessee’s obligation to make payments is a liability.

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 Lease Accounting

The lessee
 recognizes interest expense on the lease liability using
the effective-interest method and
 records depreciation expense on the right-of-use asset.

This accounting (finance lease) is applied whether the lease

is effectively
 a purchase of the asset or
 when the lessee only controls the use of the asset.

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 Measurement of the Lease Liability and
Lease Asset

Lease Term
 The fixed, non-cancelable 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.

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 Lease Term

Illustration: Carrefour (FRA) leases Lenovo (CHN) 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.

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 Measurement of the Lease Liability and
Lease Asset

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.

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 Measurement of the Lease Liability and
Lease Asset

Discount Rate
Lessee should compute the present value of the lease
payments using the implicit interest rate.
► This rate, at commencement of the lease, which causes
the aggregate present value of the lease payments and
unguaranteed residual value to be equal to the fair value
of the leased asset.

In the event that it is impracticable to determine the implicit

rate, the lessee uses its incremental borrowing rate.
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 Subsequent Lease Accounting

To illustrate the accounting for a lease using the finance

lease method, assume that CNH Capital (NLD) (a subsidiary
of CNH Global) and Ivanhoe Mines Ltd. (CAN) sign a lease
agreement dated January 1, 2019, that calls for CNH to
lease a backhoe to Ivanhoe beginning January 1, 2019.

The terms and provisions of the lease agreement and other

pertinent data are as follows.

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 Terms and provisions of the lease agreement:
• The term of the lease is five years. The lease agreement is non-
cancelable, requiring equal rental payments of €20,711.11 at the
beginning of each year (annuity-due basis).
• The backhoe has a fair value at the commencement of the lease of
€100,000, an estimated economic life of five years, and a
guaranteed residual value of €5,000. (Ivanhoe expects that it is
probable that the expected value of the residual value at the end of
the lease will be greater than the guaranteed amount of €5,000.)
• The lease contains no renewal options. The backhoe reverts to
CNH Capital at the termination of the lease.
• Ivanhoe’s incremental borrowing rate is 5 percent per year.
• Ivanhoe depreciates its equipment on a straight-line basis.
• CNH sets the annual rental rate to earn a rate of return of 4 percent
per year; Ivanhoe is aware of this rate.
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 Lessee Accounting: Example 1

Ivanhoe computes the lease liability and the amount capitalized

as a right-of-use asset as follows:

Payment € 20,711.11
Present value factor (i=4%,n=5) x 4.62990
PV of lease payments €95,890.35 *

Ivanhoe uses CNH's implicit interest rate of 4 percent instead of its

incremental borrowing rate of 5 percent because it is known to
Ivanhoe.

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 Lessee Accounting: Example 1

Ivanhoe records the finance lease on its books on January 1, 2019,

as:

Right-of-Use Asset 95,890.35

Lease Liability 95,890.35

Ivanhoe records the first lease payment on January 1, 2019, as

follows.

Lease Liability 20,711.11

Cash 20,711.11

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 ILLUSTRATION 21.7
Lease Amortization Schedule—Lessee

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 ILLUSTRATION 21.7

Prepare the entry to record accrued interest at Dec. 31, 2019.

Interest Expense 3,007.17

Lease Liability 3,007.14

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 Lessee Accounting: Example 1

Depreciation of the right-of-use asset over the five-year lease

term, applying Ivanhoe’s normal depreciation policy (straight-line
method), results in the following entry at December 31, 2019.

Depreciation Expense 19,178.07

Right-of-Use Asset (€95,890.35 ÷ 5 years)
19,178.07

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 Lessee Accounting: Example 1

The statement of financial position as it relates to lease

transactions at December 31, 2019.
ILLUSTRATION 21.8
Statement of Financial
Position Presentation

On its December 31, 2019, income statement, Ivanhoe reports,

ILLUSTRATION 21.9
Income Statement
presentation

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 ILLUSTRATION 21.7

Ivanhoe records the second lease payment as follows.

Lease Liability (€3,007.17 + €17,703.95) 20,711.11

Cash 20,711.11

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 ILLUSTRATION 21.7

If Ivanhoe purchases the equipment from CNH at the termination of

the lease at a price of €5,000 and the estimated remaining life of the
equipment is two years, it makes the following entry.

Equipment 5,000
Cash 5,000
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