Question 15-23

The IASB and FASB are collaborating on a joint project with the intent of revising accounting standards for leases. As of 2009, the Boards have agreed on a “right of use” model. Under this approach, the lessee recognizes an asset representing the right to use the leased asset for the lease term and also recognizes a corresponding liability for the lease rentals, whatever the term of the lease. The new standard might result in most, if not all, leases being recorded as an intangible asset for the right of use and a liability for the present value of the lease payments. It may eliminate operating leases. The impact of any changes will be significant; U.S. companies alone have over $1.25 trillion in operating lease obligations.

BRIEF EXERCISES

Brief Exercise 15-1

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 ten 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

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).