1. January 1, 2011

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, 2011

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

Exercise 15-24

Requirement 1

Inception of the Lease, January 1, 2011

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, 2011

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

Exercise 15-25

List A List B

j_ 1. Effective rate times balance. a. PV of BPO price.

k_ 2. Realization principle. b. Lessor’s net investment.

c_ 3. Minimum lease payments plus c. Lessor’s gross investment.

unguaranteed residual value. d. Operating lease.

l_ 4. Periodic lease payments plus e. Depreciable assets.

lessee-guaranteed residual value. f. Loss to lessee.

b_ 5. PV of minimum lease payments plus g. Executory costs. PV of unguaranteed residual value. h. Depreciation longer than lease term.

n_ 6. Initial direct costs. i. Disclosure only.

d_ 7. Rent revenue. j. Interest expense.

m_ 8. Bargain purchase option. k. Additional lessor conditions.

e_ 9. Leasehold improvements. l. Lessee’s minimum lease payments

f_ 10. Cash to satisfy residual value m. Purchase price less than fair guarantee. value.

g_ 11. Capital lease expense. n. Sales-type lease selling expense.

a_ 12. Deducted in lessor’s computation o. Lessor’s minimum lease payments.

of lease payments.

h_ 13. Title transfers to lessee.

i_ 14. Contingent rentals.

o_ 15. Lease payments plus lessee-guaranteed

and 3rd-party-guaranteed residual value.

Exercise 15-26

Requirement 1

Present value of periodic lease payments* ($102,771 x 7.49236^**) $770,000*

^* rounded

^** present value of an annuity due of $1: n=13, i=11%

The lease meets at least one (actually 3 of 4 in this case) criteria for classification as a capital lease.

January 1, 2011

Cash(given) 770,000 Airplanes (carrying value) 620,000 Deferred gain on sale-leaseback (difference) 150,000 Leased airplane(present value of lease payments) 770,000 Lease payable (present value of lease payments) 770,000 Lease payable 102,771 Cash 102,771

Requirement 2

December 31, 2011

Interest expense(11% x [$770,000 – 102,771]) 73,395 Interest payable 73,395

Depreciation expense ($770,000 ÷ 15 years*) 51,333 Accumulated depreciation 51,333 Deferred gain on sale-leaseback ($150,000 ÷ 15 years) 10,000 Depreciation expense 10,000

* The airplane is depreciated over its remaining useful life rather than the lease term because title transfers to the lessee.

Exercise 15-27

When the leaseback is a finance (capital) lease, the gain is recognized over the useful life of the asset under U.S. GAAP as shown in the previous exercise. But, under IAS No. 17, the gain is recognized over the lease term as shown below (13 years rather than 15 years).

Present value of periodic lease payments* ($102,771 x 7.49236^**) $770,000*

^* rounded

^** present value of an annuity due of $1: n=13, i=11%

The lease meets at least one (actually 3 of 4 in this case) criteria for classification as a capital lease.

January 1, 2011

Cash(given) 770,000 Airplanes (carrying value) 620,000 Deferred gain on sale-leaseback (difference) 150,000 Leased airplane(present value of lease payments) 770,000 Lease payable (present value of lease payments) 770,000 Lease payable 102,771 Cash 102,771

December 31, 2011

Interest expense(11% x [$770,000 – 102,771]) 73,395 Interest payable 73,395

Depreciation expense ($770,000 ÷ 15 years*) 51,333 Accumulated depreciation 51,333 Deferred gain on sale-leaseback ($150,000 ÷13 years) 11,538 Depreciation expense 11,538

* The airplane is depreciated over its remaining useful life rather than the lease term because title transfers to the lessee.

Exercise 15-28

Requirement 1

January 1, 2011

Cash(given) 800,000 Accumulated depreciation (cost – carrying amount) 350,000 Building (original cost) 1,000,000 Deferred gain on sale-leaseback (difference) 150,000

Requirement 2

December 31, 2011

Rent expense 100,000 Cash(lease payment) 100,000 Deferred gain on sale-leaseback ($150,000 ÷ 12 years) 12,500 Rent expense 12,500