Chapter 20 Selected Solutions

EXERCISE 20-3 (30-40 minutes)

(a) Initial Measurement of Right-of-Use Asset and Lease Liability

Contractual Rights and Obligations under Lease,
July 1, 2017

Excel formula =PV(rate,nper,pmt,fv,type)

Using a financial calculator:
PV $ ?
Yields $ 88,000
I 9%
N 5
PMT $ (20,066.26)
FV $ (4,500)
Type 1

(b) The lease would be set up as a right-of-use asset and lease

liability under IFRS 16 as it would not qualify for a short-term or
low-value exemption.
EXERCISE 20-3 (CONTINUED)

(c) The lease agreement has a purchase option that is reasonably

certain to be exercised. The collectability of the lease payments
is reasonably predictable, and there are no important
uncertainties surrounding the costs yet to be incurred by the
lessor. The present value of the minimum lease payments
exceeds 90% of the fair value of the equipment. The initial
amount of net investment (which in this case equals the present
value of the minimum lease payments, $88,000) exceeds the
lessor’s cost ($60,000), the lease is a manufacturer or dealer
lease to the lessor.

(d)
Russell Corporation (Lessee)
Lease Amortization Schedule

Annual
Lease Interest (9%) Reduction Balance
Payment on Unpaid of Lease Lease
Date Plus BPO Liability Liability Liability

7/1/17 $88,000.00
7/1/17 $ 20,066.26 $20,066.26  67,933.74
7/1/18   20,066.26 *$ 6,114.04*  13,952.22  53,981.52
7/1/19   20,066.26 *  4,858.34*  15,207.92  38,773.59
7/1/20   20,066.26 *  3,489.62*  16,576.64  22,196.96
7/1/21   20,066.26 *  1,997.73*  18,068.53   4,128.42
6/30/21    4,500.00 *    371.58*   4,128.42       0.00
$104,831.30 *$16,831.30* $88,000.00

*Rounding error is $.02 cents.

EXERCISE 20-3 (CONTINUED)

(e)
7/1/17 Right-of-Use Asset.......................... 88,000.00
Lease Liability........................ 88,000.00

Lease Liability.................................. 20,066.26

Cash....................................... 20,066.26

12/31/17 Interest Expense............................  3,057.02

Lease Liability.......................  3,057.02
  ($6,114.04 X 6/12 = ($3,057.02)

Depreciation Expense.....................  4,400.00

Accumulated Depreciation
  —Right-of-Use Asset........  4,400.00
  ($88,000.00 ÷ 10 =
  ($8,800.00; $8,800.00 X 6/12 = $4,400)

7/1/18 Interest Expense*.......................... 3,057.02

Lease Liability................................ 17,009.24
Cash...................................... 20,066.26
* ($6,114.04 – $3,057.02)
** ($20,066.26 – $3,057.02)

12/31/18 Interest Expense............................  2,429.17

Lease Liability......................  2,429.17
 ($4,858.34 X 6/12 = ($2,429.17)

12/31/18 Depreciation Expense....................  8,800.00

 Accumulated Depreciation
  —Right-of-Use Asset...  8,800.00
($88,000.00 ÷ 10 years = ($8,800.00)

EXERCISE 20-4 (30-40 minutes)

(a) Note as determined in Exercise 20-3, part (c):

The lease agreement has a purchase option that is reasonably
certain to be exercised. The collectability of the lease payments
is reasonably predictable, and there are no important
uncertainties surrounding the costs yet to be incurred by the
lessor. The present value of the minimum lease payments
exceeds 90% of the fair value of the equipment. The initial
amount of net investment (which in this case equals the present
value of the minimum lease payments, $88,000) exceeds the
lessor’s cost ($60,000), the lease is a Manufacturer’s lease to the
lessor.

(b) Gross investment = Minimum lease payments + any

unguaranteed residual value or purchase option
The minimum lease payments associated with this lease are the
periodic annual rents plus the proceeds from the exercise of the
purchase option. There is no residual value relevant to the
lessor’s accounting in this lease.
Calculation: 5 X $20,066.26 =$100,331.30
+ 4,500.00
Gross investment at inception $104,831.30 
 
(c) The net investment equals the present value of the components
of the gross investment calculation.
Net investment calculation:
$20,066.26 Annual rental payment
X 4.23972 PV of annuity due of 1 for n = 5, i = 9%
$85,075.32 PV of periodic rental payments
$ 4,500.00Proceeds on exercise of purchase option
X .64993 PV of 1 for n = 5, i = 9%
$ 2,924.69PV of purchase option
$85,075.32 PV of periodic rental payments
+ 2,924.69 PV of purchase option
$88,000.01 Net investment at inception
EXERCISE 20-4 (CONTINUED)

(c) (continued)

Excel formula =PV(rate,nper,pmt,fv,type)

Using a financial calculator:
PV $ ?
Yields $88,000
I 9%
N 5
PMT $ 20,066.26
FV $ 4,500
Type 1
(d)
Herbert Leasing Corporation (Lessor)
Lease Amortization Schedule

Annual
Lease Interest (9%) Net Balance
Payment on Net Investment Net
Date Plus PO Investment Recovery Investment

7/1/17 $88,000.00
7/1/17 $ 20,066.26 $20,066.26  67,933.74
7/1/18   20,066.26 *$ 6,114.04*  13,952.22  53,981.52
7/1/19   20,066.26 *  4,858.34*  15,207.92  38,773.59
7/1/20   20,066.26 *  3,489.62*  16,576.64  22,196.96
7/1/21   20,066.26 *  1,997.73*  18,068.53   4,128.42
6/30/21    4,500.00 *    371.58*   4,128.42       0.00
$104,831.30 *$16,831.30* $88,000.00
*Rounding error is $.02 cents.

EXERCISE 20-4 (CONTINUED)

(e)
7/1/17 Lease Receivable........................... 104,831.30
Cost of Goods Sold........................  60,000.00
Sales Revenue....................... 88,000.00
Unearned Interest Income.... 16,831.30
Inventory................................ 60,000.00

7/1/17 Cash ................................................  20,066.26

Lease Receivable.................. 20,066.26

12/31/17 Unearned Interest Income.............   3,057.02

Interest Income.....................  3,057.02
  ($6,114.04 X 6/12 = $3,057.02)

7/1/18 Cash ................................................  20,066.26

Lease Receivable.................. 20,066.26

7/1/18 Unearned Interest Income.............  3,057.02

Interest Income.....................  3,057.02
  ($6,114.04 – $3,057.02)

12/31/18 Unearned Interest Income.............  2,429.17

Interest Income.....................  2,429.17
  ($4,858.34 X 6/12 = ($2,429.17)

7/1/19 Cash ................................................ 20,066.26

Lease Receivable.................. 20,066.26

Unearned Interest Income.............  2,429.17

Interest Income.....................  2,429.17
  ($4,858.34 – $2,429.17)
12/31/19 Unearned Interest Income.............  1,744.81
Interest Income.....................  1,744.81
  ($3,489.62 X 6/12 = $1,744.81)
EXERCISE 20-7 (30-40 minutes)

(a) The lease would be set up by Flynn as a right-of-use asset under

IFRS 16 as the lease does not qualify for a short-term or low-
value exemption.

This lease is a capital lease to the lessor because the lease term
(six years) exceeds 75% of the economic life of the asset (seven
years) although no ownership transfer is included in the lease.
Also, the present value of the minimum lease payments exceeds
90% of the fair value of the asset (144,000/144,000 = 100%).

This is a sales-type lease to Lavery since the lease is

a capital lease to Flynn, the lessee, and because the collectability
of the lease payments is reasonably predictable, there are no
important uncertainties surrounding the unreimbursable costs
yet to be incurred by the lessor and the fair value of the
equipment ($144,000) exceeds the lessor’s cost ($111,000).

(b) Calculation of annual rental payment:

Excel formula =PMT(rate,nper,pv,fv,type)

Using a financial calculator:
PV $ (144,000)
I 9%
N 6
PMT $ ?
Yields $28,718
FV $ 6,000
Type 1
 The Lessee will use 10% rather than the Lessor’s 9% as the
implicit lease rate is unknown to the Lessee.

(c)
1/1/17 Right-of-Use Asset............................... 137,582
Lease Liability............................. 137,582

Lease Liability......................................  28,718

Cash.............................................  28,718

***Present value of an annuity due at 10% for 6 periods.

Excel formula =PV(rate,nper,pmt,fv,type)

Using a financial calculator:
PV $ ?
Yields $137,582
I 10%
N 6
PMT $ (28,718)
FV $ 0
Type 1
(c) (continued)

12/31/17 Depreciation Expense.........................  22,930

Accumulated Depreciation
– Right-of-Use Asset......  22,930
  ($137,582 ÷ 6 years)

Interest Expense.................................  10,886

Lease Liability...........................  10,886
[($137,582 – $28,718) X .10]

(d)
1/1/17 Lease Receivable............................ 178,308*
Cost of Goods Sold......................... 107,422
Sales Revenue....................... 140,422
Inventory................................ 111,000
Unearned Interest Income.... 34,308**

*($28,718 X 6) + $6,000
**$178,308 – $144,000

Since the residual value is not guaranteed, the present value of

the residual value of $6,000 is excluded from both sales and cost
of goods sold.

Sales Revenue $144,000

Less present value of residual value 3,578*
$140,422

Cost of Goods Sold $111,000

Less present value of residual value 3,578*
$107,422
 *($6,000 X .59627**)
**Present value of $1 at 9% for 6 periods.

(d) (continued)
1/1/17 Cash ................................................  28,718
Lease Receivable.................  28,718

12/31/17 Unearned Interest Income.............  10,375

Interest Income.....................  10,375
 [($144,000 – $28,718) X .09]

(e) For Flynn Corporation—(the lessor):

Under IFRS 16, the lease would receive the same treatment as
under ASPE except the criteria need not include the two revenue
recognition-based tests concerning collectability and estimating
unreimbursable costs. Instead of being referred to as a sales-type
lease, the lease would be referred to as a manufacturer or dealer
lease.

EXERCISE 20-10 (30-40 minutes)

(a) The lessor sets the annual rental payment as follows:

Fair value of leased asset to lessor $28,500.00*

Less: Present value of bargain purchase
option $5,000 X .62026
(present value of 1 at 1% for 48 periods)   3,101.30
Amount to be recovered through lease payments $25,398.70
Forty-eight periodic lease payments
$25,398.70 ÷ 38.3538** $662.22

* Fair value of $29,500.00 less down payment of $1,000.00

**Present value of annuity due of 1 for 48 periods at 1%.

Excel formula =PMT(rate,nper,pv,fv,type)

 Using a financial calculator:
PV $ (28,500)
I 1%
N 48
PMT $ ?
Yields $662.22
FV $ 5,000
Type 1

(b) The lease agreement has a bargain purchase option.

The lease, therefore, qualifies as a capital lease from the
viewpoint of the lessee. The collectability of the lease payments
is reasonably predictable, and there are no important
uncertainties surrounding the costs yet to be incurred by the
lessor. Due to the fact that the initial amount of net investment
(which in this case equals the present value of the minimum
lease payments, ($28,500 + the down payment of $1,000) exceeds
the lessor’s cost ($21,200), the lease is a sales-type lease to the
lessor.
EXERCISE 20-10 (CONTINUED)

(c)
EXERCISE 20-10 (CONTINUED)

(c) (continued)

* rounding by $.18
EXERCISE 20-10 (CONTINUED)

(d) A journal entry would be required on December 31, 2017 by

Yogendran Corp. to accrue the interest in the amount of $254.76
related to payment no. 8, which is due January 1, 2018.

Unearned Interest Income ........................  254.76

Interest Income ...................................  254.76

(e) The income to be reported on the statement of income of

Yogendran Corp. for the fiscal year ending December 31, 2017
concerning this lease will be as follows:

Sales revenue $29,500

Cost of goods sold 21,200
Gross profit 8,300
Interest income - lease 1,867
(Interest income represents the sum of the interest for the
first 7 payments from the table above and an accrual of
interest for the 8th payment)

(f) At December 31, 2017, the statement of financial position would

have reported as a current asset, the amount of the principal
reduction that will be obtained in the next twelve months. Based
on the table above the sum of the principal reduction for monthly
payment 8 through 19 total $5,168. The remaining amount of the
balance of the investment at December 31, 2017 ($25,476 less the
current portion of $5,168) of $20,308 will be reported as a long-
term lease receivable.
EXERCISE 20-11 (25-35 minutes)

(a) Calculation of annual payments

Cost (fair value) of leased asset

to lessor $135,000.00
Less: Present value of residual value
$13,000 X .82645
(Present value of 1 at 10% for 2 periods)   (10,743.85)
Amount to be recovered through lease payments $124,256.15

Two periodic lease payments

$124,256.15 ÷ 1.73554* $71,595.09
*Present value of an ordinary annuity of 1 for 2 periods at 10%

Excel formula =PMT(rate,nper,pv,fv,type)

Using a financial calculator:
PV $ (135,000)
I 10%
N 2
PMT $? Yields $71,595
FV $ 13,000
Type 0

Calculation of lease receivable

Annual payments ($71,595 X 2) $143,190
Residual value   13,000
Lease receivable $156,190

Calculation of unearned interest income

Gross investment by lessee $156,190
Asset cost (fair value)  135,000
Unearned interest income $ 21,190
EXERCISE 20-11 (CONTINUED)

(b) Castle Leasing Corporation should classify the lease as a direct

finance lease because it is not a manufacturer or dealer. Wai
Corporation, the lessee, will treat the leased equipment as right-
to-use assets.

(c) For ASPE, quantitative criteria such as any one of the following
are used:
1. the term of the lease exceeding 75% of the remaining
economic life of the asset,
2. the present value of the minimum lease payments exceeding
90% of the fair value of the asset, or
3. the transfer of title to the asset, perhaps represented by the
presence of a bargain purchase option.

For Castle Leasing, the lessor, the lease would receive the
same treatment as under IFRS, as long as the two revenue
recognition-based tests concerning collectability and estimating
unreimbursable costs are passed.

(d)
CASTLE LEASING CORPORATION (Lessor)
Lease Amortization Schedule

Annual Pmt. Interest Net

Excl. Ins. on Net Investment Net
Date Costs Investment Recovery Investment

1/1/17 $135,000
12/31/17 $71,595 *$13,500 $58,095   76,905
12/31/18  71,595 *  7,690  63,905   13,000
*$21,190
EXERCISE 20-11 (CONTINUED)

(e)
1/1/17 Lease Receivable......................... 156,190
(71,595 x 2 + 13,000)
Equipment Acquired for Lessee 135,000
Unearned Interest Income....  21,190

12/31/17 Cash ($71,595.09 + $5,000)..........  76,595

Insurance Expense...............    5,000
Lease Receivable..................  71,595

Unearned Interest Income...........  13,500

Interest Income.....................  13,500

12/31/18 Cash..............................................  76,595

Insurance Expense...............    5,000
Lease Receivable..................  71,595

Unearned Interest Income...........   7,690

Interest Income.....................   7,690

(f)
12/31/18 Cash..............................................  13,000
Lease Receivable.................  13,000

(g) Upon signing the lease, Wai Corporation, the lessee, should
record a right-of-use asset and lease liability at the present value
of the lease payments in the amount of $71,595 including the
present value of the option to purchase the equipment for
$13,000 and therefore the same amount used by the lessor or
$135,000. The lessee includes the option payment, as it is
reasonably certain to be exercised.
EXERCISE 20-14 (15-20 minutes)

(a) (1) Calculation of gross investment:

$24,736 X 6 = $148,416

(2) Calculation of unearned interest income:

Gross investment $148,416
Less: Fair value of machine  123,500*
Unearned interest income $ 24,916

*$24,736 X 4.99271 (PV factor of annuity due at 8% for

6 periods)

Excel formula =PV(rate,nper,pmt,fv,type)

Using a financial calculator:
PV $ ?
Yields $123,499.68
I 8%
N 6
PMT $ 24,736
FV $ 0
Type 1

(3) Net investment in lease:

Lease receivable $148,416
Less: Unearned interest income 24,916
$123,500
EXERCISE 20-14 (CONTINUED)

(b)
1/1/17 Lease Receivable.................................148,416
Cost of Goods Sold............................. 99,000
Sales Revenue............................ 123,500
Inventory...................................... 99,000
Unearned Interest Income..........  24,916

1/1/17 Cash ..................................................... 24,736

Lease Receivable.......................  24,736

12/31/17 Unearned Interest Income...................  7,901

Interest Income..........................  7,901
 [($123,500 – $24,736) X .08]
 PROBLEM 20-1

(a) Option No. 1 - Precision Inc.

Calculation of present value of minimum lease payments: The $5,000
option to buy the software at the end of the lease of five years is not
considered a bargain purchase option in view of the $200 price
offered by Graphic Inc. in Option No. 2.

The lease payments are in the amount of $3,500 as the $1,000 annual
licensing fee is an executory cost.

$3,500 X 3.79079* = $13,268

*Present value of an ordinary annuity of 1 for 5 periods at 10%.

Excel formula =PV(rate,nper,pmt,fv,type)

Using a financial calculator:
PV $ ? Yields $13,268
I 10%
N 5
PMT $ (3,500)
FV $ 0
Type 0

Total lease payments:

At inception of lease – January 1, 2017 $12,000

Present value of minimum lease payments 13,268
Total $25,268
PROBLEM 20-1 (CONTINUED)

(a) (continued)

This is an operating lease to Interior Design Inc. since the lease term
(5 years) is less than 75% of the economic life (8 years) of the leased
asset. The lease term is 62.5% (5 ÷ 8) of the asset’s economic life.
There is no bargain purchase option and the present value of
minimum lease payments of $25,268 represent 84% of the $30,000
fair value at January 1, 2014, falling short of the criteria of 90% to treat
the lease as a capital lease under ASPE.

Option No. 2 – Graphic Inc.

Calculation of present value of minimum lease payments:

The minimum lease payments in the case include the bargain
purchase option of $200. The present value therefore is:

PV of monthly payment *............................................... $27,104

PV of bargain purchase option of $200 **.....................     124
Present value of minimum lease payments.................. $27,228

* Present value of an annuity due of 1 for 5 periods at 10%.

$6,500 X 4.16986 = $27,104
**Present value of a single payment of 1 for 5 periods at 10%
$200 X .62092 = $124

Excel formula =PV(rate,nper,pmt,fv,type)

Using a financial calculator:
PV $ ? Yields $27,228
I 10%
N 5
PMT $ (6,500)
FV $ (200)
Type 1
PROBLEM 20-1 (CONTINUED)

(a) (continued)

To Interior Design Inc., this lease is a capital lease because the terms
satisfy the following criteria:

1. Although as in Option No. 1, the lease term is not greater than

75% of the economic life of the leased asset; that is, the lease
term is 62.5% (5/8) of the economic life, there is a bargain
purchase option.

2. The present value of the minimum lease payments is greater than

90% of the fair value of the leased asset; that is, the present value
of $27,228 is 91% of the fair value of the leased asset of $30,000:
($27,228 / $30,000 = 90.76%)

(b)
January 1, 2018
Prepaid Rent.................................................  12,000
Cash.................................................... 12,000

The first payment will be amortized straight-line over the term of the
lease.
December 31, 2018
Rent Expense (Software)..............................  3,500
Operating Expenses.....................................  1,000
Cash....................................................  4,500

December 31, 2018

Rent Expense (Software)..............................  2,400
Prepaid Rent..........................................  2,400
($12,000 / 5 = $2,400)
PROBLEM 20-1 (CONTINUED)

(c)
Interior Design Inc.
Lease Amortization Schedule with Graphic Inc.

Interest (10%) Reduction

Annual on Unpaid of Lease Balance
Date Lease Obligation Obligation of Lease
Payment Obligation

1/1/18 $27,228
1/1/18 $6,500 $6,500 20,728
1/1/19  6,500 *$2,073 4,427 16,301 
1/1/20 6,500 *  1,630  4,870 11,431 
1/1/21 6,500 *  1,143  5,357 6,074
1/1/22 6,500 607  5,893 181
1/1/23   200 18   182      0
$32,700 *$5,471 $27,229
(d)
January 1, 2018
Software under Lease....................................  27,228
Obligations under Lease........................  27,228

January 1, 2018
Obligations under Lease................................ 6,500
Cash...................................................... 6,500

December 31, 2018

Interest Expense.......................................  2,073
Interest Payable................................  2,073

PROBLEM 20-1 (CONTINUED)

(d) (continued)

December 31, 2018

Depreciation Expense.................................... 3,404
Accumulated Depreciation—
Software under Lease..................... 3,404
  ($27,228 ÷ 8 years = $3,404)
Use 8 years, as option to purchase will be exercised as it is a
bargain price.

January 1, 2019
Interest Payable........................................  2,073
Obligations under Lease........................... 4,427
Cash...................................... 6,500

(e)
Option No. 1 Option No. 2
 Operating Capital
Income statement effects: Lease Lease
Rent expense
$3,500
Operating expenses 1,000

Interest expense $2,073

Depreciation expense _____ 3,404
Total expenses $4,500 $5,477

PROBLEM 20-1 (CONTINUED)

(e) (continued)
Asset and liability balances Dec. 31, 2018
Current assets:
Prepaid rent $9,600

Non-current assets:
Software under lease $27,228
Less: accumulated depreciation (3,404)
$23,824
Current liabilities:
Interest payable 2,073
Current portion of obligations under lease 4,427

Non-current liabilities:
Obligations under lease 20,728
Less current portion (4,427)
16,301
Total liabilities: $22,801

Total cash outflows during 2018 ($16,500) ($6,500)

(f) Among Interior’s paramount concerns will be ensuring that it
continues to meet its debt to equity covenant. Since all financing is
done with the bank, Interior Design Inc. may be perceived to be of
high risk by the bank. Entering into the Precision Inc. lease (Option
No. 1) would provide off balance sheet financing, keeping the
obligations under capital leases off the balance sheet. Equity would be
reduced by the lease payments expensed each period.

In contrast the Graphic Inc. (Option No. 2) lease would increase

Interior’s liabilities by the present value of the minimum lease
payments. Interest expense each period and depreciation of the
leased asset will decrease net income and therefore equity each
period.

To maintain their debt to equity covenant, Interior would probably

choose to enter into the Precision lease (operating lease Option No.
1) to minimize debt on their statement of financial position.

The bank officials would be satisfied but nevertheless aware of the

accounting treatment used to lead to required result. Consequently,
although Interior is in compliance with the covenant, the bank might
apply other more stringent conditions to make up for the off-balance
sheet financing or include the lease as a debt for their long-term
assessment ratio calculations.

(g) In the long term, Option No. 2 presents the better option. The
software will be owned and used by Interior over the eight-year useful
life of the asset, instead of the five-year term of lease under the
operating lease, Option No. 1. The other immediate disadvantage to
the operating lease option No. 1 is the large immediate (January 1,
2017) cash outflow required by the prepayment clause under the
operating lease of $12,000. This payment could create an important
liquidity problem over the term of the lease, especially in the first year.
PROBLEM 20-1 (CONTINUED)

(g) (continued)

The conclusion to be drawn from this study is that choices are often
made by private businesses for reasons outside what makes
economic sense overall. IFRS 16 removes the distinction between
operating and capital leases except for low-value asset leases or
leases with terms of less than 12 months. This treatment, used by
public companies and those companies following IFRS, eliminates the
option to select leases in order to reduce or eliminate the presence of
liabilities on the statement of financial position.
PROBLEM 20-3
(a) The lease would be set up by Hunter Ltd. as a right-of-use asset and
lease liability under IFRS 16 as the lease does not qualify for a short-
term or low-value exemption lease.

For Situ Ltd., The PV of the lease payments are 100% of FMV is
recovered, providing evidence that the present value of the minimum
lease payments approximates the fair value of the leased asset.
Although the 3/5 years of lease may not provide “the substantial
portion of the economic benefit” and although there is no transfer of
ownership, the finance lease criteria have been met. Specifically,
since the lessor Situ Ltd. is not a manufacturer or dealer (FMV =
Carrying Value) the lease is a direct finance lease.

(b) Calculation of annual rental payment:

(Hint when using a financial calculator: ensure that the compounding
is done monthly, P/Y = 1)

Excel formula =PMT(rate,nper,pv,fv,type)

Using a financial calculator:
PV $ 20,691
I 1%
N 36
PMT $ ?
Yields ($600)
FV $ (3,500)
Type 1
 This confirms that the interest rate used to calculate the lease
payment was 12% or 1% per month. Alternatively, the RATE function
could have been used directly. (The lease payments include the
executory costs of $20 per month and are therefore in the net amount
of $600.)

PROBLEM 20-3 (CONTINUED)

(b) (continued)
PROBLEM 20-3 (CONTINUED)

(c)
Lease Amortization Schedule

Monthly
Lease Interest (1%) Reduction Balance
Payment on Unpaid of Lease Lease
Date Plus RVG Liability Liability Liability
$20,691
Jan. 1 2017 $ 600 $600 20,091
Feb. 1 2017 600 $ 201 399 19,692
Mar. 1 2017 600 403 19,289
197
Apr. 1 2017 600 193 407 18,882
May 1 2017 600 189 411 18,471
June 1 2017 600 185 415 18,055
July 1 2017 600 181 419 17,636
Aug. 1 2017 600 176 424 17,212
Sep. 1 2017 600 172 428 16,784
Oct. 1 2017 600 168 432 16,352
Nov. 1 2017 600 164 436 15,916
Dec. 1 2017 600 159 441 15,475
Jan. 1 2018 600 155 445 15,030
Feb. 1 2018 600 150 450 14,580
Mar. 1 2018 600 146 454 14,126
Apr. 1 2018 600 141 459 13,667
May 1 2018 600 137 463 13,204
Jun. 1 2018 600 132 468 12,736
July 1 2018 600 127 473 12,263
Aug. 1 2018 600 123 477 11,786
Sep. 1 2018 600 118 482 11,303
Oct. 1 2018 600 113 487 10,816
Nov. 1 2018 600 108 10,325
492
Dec. 1 2018 600 103 497 9,828
PROBLEM 20-3 (CONTINUED)

(c) (continued)

Lease Amortization Schedule

Monthly
Lease Interest (1%) Reduction Balance
Payment on Unpaid of Lease Lease
Date Plus RVG Liability Liability Liability
Jan. 1 2019 $600 $98 $502 $9,326
Feb. 1 2019 600 93 507 8,819
Mar. 1 2019 600 88 512 8,308
Apr. 1 2019 600 83 517 7,791
May 1 2019 600 78 522 7,269
Jun. 1 2019 600 73 527 6,741
July 1 2019 600 67 533 6,209
Aug. 1 2019 600 62 538 5,671
Sep. 1 2019 600 57 543 5,127
Oct. 1 2019 600 51 549 4,579
Nov. 1 2019 600 46 554 4,025
Dec. 1 2019 600 40 560 3,465
Dec. 31 2019 3,500 36* 3,464 0
$25,100 $4,409 $ 20,691
* Rounding $1
RVG = Residual value guarantee

(d)
January 1, 2017
Right-of-Use Asset............................................ 20,691
Lease Liability............................................ 20,691

Lease Liability....................................................  600

Insurance Expense............................................   20
Cash..........................................................  620
PROBLEM 20-3 (CONTINUED)

(d) (continued)

December 31, 2017

Interest Expense................................................  155
Lease Liability............................................  155

Depreciation Expense.......................................  5,730

Accumulated Depreciation—Right-
of-Use Asset.......................................  5,730
[$20,691 - $3,500] ÷ 3)

January 1, 2018
Lease Liability....................................................  600
Insurance Expense............................................   20
Cash..........................................................  620

(e) Hunter Ltd.

Statement of Financial Position
December 31,
2018 2017
Non-current assets
Property plant and equipment
Right-of-Use Asset $20,691 $20,691
Less accumulated depreciation 11,460 5,730
9,231 14,961
Current liabilities
Lease Liability. 9,926 5,704
Non-current liabilities
Lease Liability (Note X)..* 9,626

[($15,030** + $600) – ($9,326** + $600) = $5,704]

** from table
PROBLEM 20-3 (CONTINUED)

(e) (continued)

(Note X): The following is a schedule of future payments under lease

liability expiring December 31, 2019.

2018 2017
Amounts due in 2018 $7,440
Amounts due in 2019 $10,940 10,940
10,940 18,380
Amount representing executory costs (240) (480)
Amount representing interest (774) (2,270)
Balance of liability $9,926 $15,630

From lease amortization schedule:

Balance at December 31 $9,828 $15,475
Add accrued interest 98 155
Balance $9,926 $15,630

Hunter Ltd.
Statement of Income
For the Year Ended December 31,

2018 2017
Administrative expense
Depreciation expense $5,730 $5,730
Insurance expense 240 240
Other expenses
Interest expense* 1,497 2,139

* from lease amortization schedule part (c)

PROBLEM 20-3 (CONTINUED)

(f)
December 21, 2019
Interest Expense................................................  36
Lease Liability.................................................... 3,465*
Accumulated Depreciation—Right-
of-Use Asset.............................................. 17,190
Loss on Lease...................................................  300
Right-of-Use Asset..................................... 20,691
Cash..........................................................  300
* rounding $1

(g)
Hunter Ltd.
Statement of Cash Flows
For the Year Ended December 31,

2018 2017
Indirect Format:
Cash flows from operating activities
Depreciation expense $5,730 $5,730
Increase (decrease) in lease liability
for accrued interest (57)* 155

Financing Activities:
Lease payment ** (5,646) (5,216)
* ($155 – $98)
** from lease amortization schedule part (c)

In the notes to the financial statements:

Non-cash Investing and Financing Activities:
Purchase of Right-of-Use Asset $20,691

Direct Format:
Cash flows from operating activities
Cash paid for interest ($1,554) ($1,984)
Cash paid for insurance (240) (240)
 PROBLEM 20-5

(a) The lease would be set up by Labonté Ltée. as a right-of-use asset

and lease liability under IFRS 16 as the lease is not eligible for a short-
term or low-value exemption.

For LePage, the collectibility of the lease payments is not reasonably

predictable, and there are important uncertainties surrounding the
costs yet to be incurred. Accordingly, the earnings process is not
considered complete and, in spite of the fact that the fair value
($560,000) of the equipment exceeds the lessor’s cost ($420,000), the
lease cannot be recorded as a sales-type lease by LePage and must
be recorded as an operating lease.

(b) Calculation of annual rental payment:

To calculate the amount of the payments using Tables:

$560,000 - ($80,000 X .37594 *)

= $110,759
4.78448 **

**Present value of $1 at 15% for 7 periods.

**Present value of an annuity due at 15% for 7 periods.

Excel formula =PMT(rate,nper,pv,fv,type)

Using a financial calculator:
PV $ (560,000.00)
I 15%
N 7
PMT $ ?
Yields $110,759
FV $ 80,000
Type 1
PROBLEM 20-5 (CONTINUED)

(c)
7/15/17 Right-of-Use Asset........................... 560,000
Lease Liability............................ 560,000

Lease Liability.................................  110,759

Cash..........................................  110,759

12/31/17 Depreciation Expense......................  31,429

Accumulated Depreciation
-Right-of-Use Asset..............  31,429
  ($560,000 - $80,000) ÷ 7 X 5.5/12

Interest Expense..............................  30,885

Lease Liability............................  30,885
 ($560,000 – $110,759) X .15 X 5.5/12

7/15/18 Lease Liability..................................  74,258

Interest Expense*.............................  36,501
Cash.....................................  110,759
  *($560,000 – $110,759) X .15 X 6.5/12

12/31/18 Depreciation Expense...................... 68,571

Accumulated Depreciation
-Right-of-Use Asset.............. 68,571
   ($560,000 - $80,000) ÷ 7

Interest Expense..............................  27,903

Lease Liability............................  27,903
[($560,000 – $110,759 – $43,373) X .15 X 5.5/12]
PROBLEM 20-5 (CONTINUED)

(e)
7/15/17 Rental Equipment ............................ 420,000
Inventory.................................... 420,000
Cash...............................................  110,759
Unearned Rent Revenue...........  110,759
Legal Expense*..............................  2,500
Cash..........................................  2,500

12/31/17 Unearned Rent Revenue................. 50,765

Rent Revenue...........................  50,765
   ($110,759 X 5.5/12)
Depreciation Expense......................  22,262
Accumulated Depreciation
-Rental Equipment..............  22,262
  ($420,000 - $80,000) ÷ 7 X 5.5/12

7/15/18 Unearned Rent Revenue................. 59,994

Rent Revenue...........................  59,994
   ($110,759 X 6.5/12)
Cash...............................................  110,759
Unearned Rent Revenue...........  110,759

12/31/18 Depreciation Expense...................... 48,571

Accumulated Depreciation
-Rental Equipment..............  48,571
   ($420,000 - $80,000) ÷ 7
12/31/18 Unearned Rent Revenue................. 50,765
Rent Revenue...........................  50,765
   ($110,759 X 5.5/12)

*If the amounts are significant, these costs might be capitalized and
amortized to expense to achieve better matching with revenues.
PROBLEM 20-5 (CONTINUED)

(d) (f)
Labonté LePage
Right-of- Operating
Use Lease
Statement of financial position:
Property Plant & Equipment:
Right-of-use asset $560,000
Rental equipment $ 420,000
Less: Accumulated depreciation (31,429) (22,262)
528,571 397,738
Current Liabilities:
Lease liability* 74,258
Unearned rent revenue 59,994

Long term liabilities:

Lease liability 449,241
Less: Current portion
(43,373)
405,868

Statement of income:
Rent revenue $ 50,765
Depreciation expense $ 31,429 22,262
Interest expense 30,885
Legal expense 2,500
* Includes interest accrued of $30,885
PROBLEM 20-5 (CONTINUED)

(g) Although it might seem odd that the same asset is reported on two
different statements of financial position, the collection risks under
which the lessor, LePage, is operating do not justify the recognition of
income under a sales type lease. There are too many uncertainties
surrounding the related costs and collections under the terms of its
lease with Labonté. Should Labonté default on the lease, LePage
might have to rent the used equipment to another lessee. It is also not
unreasonable to consider that the residual value “guarantee” by the
leasee, Labonté, should not be considered in the calculations (e.g. for
depreciation) as that company’s financial situation may make them
unable to “make good” on the guarantee.
 PROBLEM 20-9

(a) 1. Interest expense (See schedule) $10,216

Repairs and maintenance expense $2,500
Depreciation expense ($150,690 ÷ 6) $25,115

2 Property, plant, and equipment:

Property under lease $150,690
Accumulated depreciation ($25,115)
Net Property under lease $125,575

Current liabilities:
Obligations under lease $20,284
Interest payable $10,216

Long-term liabilities:
Obligations under lease $99,906

3. Interest expense (See schedule) $8,492

Repairs and maintenance expense $2,500
Depreciation expense ($150,690 ÷ 6) $25,115

4. Property, plant, and equipment:

Property under lease $150,690
Accumulated depreciation ($50,230)
Net Property under lease $100,460

Current liabilities:
Obligations under lease $22,008
Interest payable $8,492

Long-term liabilities:
Obligations under lease $77,898
PROBLEM 20-9 (CONTINUED)

(b) 1. Interest expense ($10,216 X 3/12) $2,554

Repairs and maintenance expense
($2,500 X 3/12) $625
Depreciation expense $6,279
  ($150,690 ÷ 6 = $25,115 X 3/12)

2. Current assets:
Prepaid expenses$1,875
($2,500 X 9/12 = $1,875)

Property, plant, and equipment:

Property under lease $150,690
Accumulated depreciation ($6,279)

Current liabilities:
Obligations under lease $20,284
Interest payable $2,554

Long-term liabilities:
Obligations under lease $99,906

3. Interest expense $9,785

[($10,216 – $2,554) + ($8,492 X 3/12) =
$7,662 + [$2,123 = $9,785]
Repairs and maintenance expense $2,500
Depreciation expense ($150,690 ÷ 6) $25,115
PROBLEM 20-9 (CONTINUED)

(b) (continued)

4. Current assets:
Prepaid expenses$1,875
($2,500 X 9/12 = $1,875)

Property, plant, and equipment:

Property under lease $150,690
Accumulated depreciation ($31,394)
($6,279 + $25,115 = $31,394)

Current liabilities:
Obligations under lease $22,008
Interest payable ($8,492 X 3/12) $2,123

Long-term liabilities:
Obligations under lease $77,898
 PROBLEM 20-11

(a) 1. Interest income $10,216

2. Current assets:
Lease receivable $30,500
Unearned interest income (0)
Net investment in lease $30,500

Noncurrent assets:
Lease receivable $122,000
($183,000 – $30,500 – $30,500)
Unearned interest income (22,094)
($32,310 – $10,216)
Net investment in lease $99,906

3. Interest income $8,492

4. Current assets:
Lease receivable $30,500
Unearned interest income (0)
Net investment in lease $30,500

Noncurrent assets:
Lease receivable $91,500
($183,000 – $30,500 – $30,500– $30,500)
Unearned interest income (13,602)
 ($32,310 – $10,216 – $8,492)
Net investment in lease $77,898

b) 1. Interest income ($10,216 X 3/12 = $2,554) $2,554

2. Current assets:
Lease receivable $30,500
Unearned interest income (7,662)
($10,216 – $2,554)
Net investment in lease $22,838

Noncurrent assets:
Lease receivable $122,000
($183,000 – $30,500 – $30,500)
Unearned interest income (22,094)
($32,310 – $10,216)
Net investment in lease $99,906

3. Interest income $9,785

[($10,216 – $2,554) + ($8,492 X 3/12) =
$7,662 +$2,123]

4. Current assets:
Lease receivable $30,500
Unearned interest income (6,369)
($8,492 – $2,123)
Net investment in lease $24,131

Noncurrent assets:
Lease receivable $91,500
($183,000 – $30,500 – $30,500 – 30,500)
Unearned interest income (13,602)
($32,310 – $10,216 – $8,492)
Net investment in lease $77,898

PROBLEM 20-13
(a) The lease should be treated as a capital lease by Lee Industries,
requiring the lessee to capitalize the leased asset. The lease qualifies
for capital lease accounting by the lessee because: (1) title to the
engines transfers to the lessee, and (2) the lease term is equal to the
estimated life of the asset. While no mention is made of the amount of
the fair value of the leased asset at January 1, 2017, it is reasonable
to assume that it would be above the cost to manufacture the engines.
Lor Inc. is in business to manufacture and sell its products, so Lor
would want to recover the sales price of the engines, not just their
cost. The present value of the minimum lease payments (see below) is
$4,500,000 and the assumption is that this is the selling price and fair
value of the engines. The transaction represents a purchase financed
by instalment payments over a 10-year period.

For Lor Inc. the transaction is a sales-type lease because a

manufacturer’s profit accrues to Lor Inc. This lease arrangement also
represents the manufacturer’s financing of the transaction over a
period of 10 years.

Lease Payment Receivable

Payment per period $  620,956
Periods    X    10
Lease receivable $6,209,560

Present Value of Lease Payments

$620,956 X 7.24689* $4,500,000

*Present value of an annuity due at 8% for 10 years.

PROBLEM 20-13 (CONTINUED)
(a) (continued)

Excel formula =PV(rate,nper,pmt,fv,type)

Using a financial calculator:
PV $ ?
Yields $4,499,999
I 8%
N 10
PMT $ (620,956)
FV $ 0
Type 1
 Unearned Interest Income
Lease receivable $6,209,560
Less: Present value of lease payments  4,500,000
Unearned interest income $1,709,560

Dealer Profit
Sales revenue
(present value of lease payments) $4,500,000
Less cost  3,900,000
Profit on sale $  600,000

(b) Equipment under Lease..............................4,500,000

Obligations under Lease..................... 4,500,000

Obligations under Lease...........................   620,956

Cash..................................................   620,956

(c) Lease Receivable..................................... 6,209,560

Cost of Goods Sold................................... 3,900,000
Sales Revenue.................................. 4,500,000
Inventory........................................... 3,900,000
Unearned Interest Income................ 1,709,560

Cash.........................................................   620,956
Lease Receivable.............................   620,956
PROBLEM 20-13 (CONTINUED)

(d) Lee Industries

Lor Inc.
Lease Amortization Schedule

Annual Interest Reduction

Lease Income/ in Present Present
Payment/ Expense Value of Value of
Date Receipt at 8% Lease Lease

1/1/17 4,500,000
1/1/17 620,956 620,956 3,879,044
1/1/18 620,956 310,324 310,632 3,568,412
1/1/19 620,956 285,473 335,483 3,232,929

Lessee (December 31, 2017)

Interest Expense.......................................   310,324
Interest Payable................................   310,324

Lessor (December 31, 2017)

Unearned Interest Income........................   310,324
Interest Income.................................   310,324

(e) LEE INDUSTRIES INC.

Statement of Financial Position
December 31, 2017

Property, plant, and equipment: Current liabilities:

Equipment under Interest payable $  310,324
   lease $4,500,000 Obligations under
Less accumulated    lease    310,632
  depreciation    450,000* ***
$4,050,000 Long-term liabilities:
Obligations under
   lease  3,568,412**

***$4,500,000 ÷ 10 = $450,000
*** taken from amortization schedule above
PROBLEM 20-13 (CONTINUED)

(e) (continued)
LOR INC.
Statement of Financial Position
December 31, 2017

Assets:
Current assets:
Net investment in leases $  310,632*

Noncurrent assets:
Net investment in leases $3,568,412*

* from amortization schedule

(f) The transaction securing the equipment using the capital lease would
not be reported on the statement of cash flows for the year ending
December 31, 2017 of Lee, the lessee. This is a non-cash financing
and investing transaction to Lee. These transactions would be
described in the notes to the respective financial statements. The only
cash transaction between the parties during 2017 is the January 1,
2017 lease payment in the amount of $620,956. This transaction is an
operating activity inflow to Lor and is a financing outflow to Lee. For
Lee, the annual depreciation for 2017 would be an adjustment to
determine cash flow from operations under the indirect approach. For
Lor, the operating cash flows would be included in the adjustments to
net income under the indirect approach and would be shown as part of
cash collected from customers under the direct approach.
PROBLEM 20-13 (CONTINUED)

(g) Note X: (on Lee’s financial statements:)

The following is a schedule of future minimum lease payments under
the capital lease expiring December 31, 2026 together with the
balance of the obligations under capital leases.

Year ending December 31

2018 $620,956
2019 620,956
2020 620,956
2021 620,956
2022 620,956
2023 and beyond 2,483,824
Total minimum lease payments 5,588,604
Less amount representing interest at 8% 1,709,560
Balance of the obligations $3,879,044

(h) Note Y: (on Lor’s financial statements:)

The company's future minimum lease payments receivable under the
sales-type lease and the net investment in lease are as follows:

Year ending December 31

2018 $620,956
2019 620,956
2020 620,956
2021 620,956
2022 620,956
2023 and beyond 2,483,824
Total minimum lease payments receivable $5,588,604
Unearned income 1,709,560
Net investment in lease $3,879,044