Brief Exercise 15-14

Under U.S. GAAP, this would not be a capital lease because none of the four classification criteria is met. The lease term is less than 75% of the economic life of the asset, and the present value of the minimum lease payments is less than 90% of the asset’s fair value. We don’t have these “bright line” rules under IFRS. If the term of the lease constitutes a “major portion” of the useful life of an asset a finance lease normally is indicated. Is 73% (8/11) a major portion? Perhaps so. This is a matter of professional judgment which may differ depending on the presence or absence of other indicators that the risks and rewards of ownership have been transferred to the lessee.

Another situation that normally indicates a finance lease is if the present value of the minimum lease payments is equal to or greater than substantially all of the fair value of the asset. Is 89% (40/45) a major portion? Perhaps so. This also is a matter of professional judgment. When we consider this and the previous indicator in combination, it’s very likely the conclusion would be that the risks and rewards of ownership have been transferred to the lessee and this would be considered a finance (capital) lease.

EXERCISES

Exercise 15-1

(a) Nath-Langstrom Services, Inc. (Lessee)

June 30, 2011

Rent expense 10,000 Cash 10,000

December 31, 2011

Rent expense 10,000 Cash 10,000

(b) ComputerWorld Corporation (Lessor)

June 30, 2011

Cash 10,000 Rent revenue 10,000

December 31, 2011

Cash 10,000 Rent revenue 10,000

Depreciation expense ($90,000 ÷ 6 years) 15,000 Accumulated depreciation 15,000

Exercise 15-2

January 1, 2011

Prepaid rent (advance payment) 96,000 Cash 96,000

Prepaid rent (annual rent payment) 80,000 Cash 80,000

Leasehold improvements 180,000 Cash 180,000

December 31, 2011

Rent expense (annual rent) 80,000 Prepaid rent 80,000 Rent expense (advance payment allocation) 32,000 Prepaid rent ($96,000 ÷ 3) 32,000

Depreciation expense($180,000 ÷ 3 years) 60,000 Accumulated depreciation 60,000

Exercise 15-3

Present Value of Minimum Lease Payments:

($15,000 x 7.47199^*) = $112,080

lease present payments value

^* present value of an annuity due of $1: n=8, i=2%

[i = 2% (8% ÷ 4) because the lease

calls for quarterly payments]

Lease Amortization Schedule

Lease Effective Decrease Outstanding Payments Interest in Balance Balance 2% x Outstanding Balance

112,080

1 15,000 15,000 97,080

2 15,000 .02 (97,080) = 1,942 13,058 84,022

3 15,000 .02 (84,022) = 1,680 13,320 70,702

4 15,000 .02 (70,702) = 1,414 13,586 57,116

5 15,000 .02 (57,116) = 1,142 13,858 43,258

6 15,000 .02 (43,258) = 865 14,135 29,123

7 15,000 .02 (29,123) = 582 14,418 14,705

8 15,000 .02 (14,705) = 295* 14,705 0

120,000 7,920 112,080

* adjusted for rounding of other numbers in the schedule

January 1, 2011

Leased equipment (calculated above) 112,080 Lease payable (calculated above) 112,080 Lease payable 15,000 Cash(lease payment) 15,000

Exercise 15-3 (concluded)

April 1, 2011

Interest expense(2% x [$112,080 – 15,000]) 1,942 Lease payable (difference) 13,058 Cash(lease payment) 15,000

July 1, 2011

Interest expense(2% x $84,022: from schedule) 1,680 Lease payable (difference) 13,320 Cash(lease payment) 15,000

October 1, 2011

Interest expense(2% x $70,702: from schedule) 1,414 Lease payable (difference) 13,586 Cash(lease payment) 15,000

December 31, 2011

Interest expense(2% x $57,116: from schedule) 1,142 Interest payable 1,142 Depreciation expense($112,080 ÷ 2 years) 56,040 Accumulated depreciation 56,040

January 1, 2012

Interest payable (from adjusting entry) 1,142 Lease payable (difference) 13,858 Cash(lease payment) 15,000

Exercise 15-4