Accounting Iii: Presentation Question On Leases Project Team 2, Seminar Group 7 (Seminar 7)

ACCOUNTING III
Presentation Question on Leases

Project Team 2 , Seminar Group 7
(Seminar 7)
CHUA HAN YANG . MARIANNE LIM LING LI . TAN SIOK MIN RACHEAL . LEE ZHI-AN . YEO WENQING SHERRY
Part I
(1) Objections have been raised against operating leases as it is a form of off-balance sheet financing for lessors.
TRUE / FALSE
Review
Under FRS 17.49
Lessors shall present assets subject to operating leases in their balance sheets according to the nature of the asset.
Under FRS 17.33
Lease payments under an operating lease shall be recognised as an expense on a straight-line basis over the lease
term unless another systematic basis is more representative of the time pattern of the users benefit.
Part I
Illustration for Lessor
Operating Lease
Lease Receivable Unearned Interest Income
Finance Lease
Balance Sheet
Balance Sheet
Asset: 300
Liabilities: 200
Asset: 300
Liabilities: 200
Equity: 100
- 100 (Asset) + 100(Net Lease Receivable)
Equity: 100
300
300
300
300
D/E Ratio = 200/100 = 2
D/E Ratio = 200/100 = 2
Only Incurring Rental Income
Incurring Unearned Interest, Principal Payments & Recognizing Asset

Dr Lease Receivable
120
Cr Unearned Interest Income
20
Cr PPE
100
Conclusion: If a lessor enters into an operating lease Indifferent between Operating & Finance Lease
*Credit: A/P Low Kin Yew
Reference: David.M Katz. (March 1, 2014.). The path of Lease Resistance. Retrieved August 29, 2015, from http://ww2.cfo.com/accounting-tax/2014/03/path-lease-resistance/
Part I
Illustration for Lessee
Operating Lease
Finance Lease
Balance Sheet
Balance Sheet
Asset: 300
Liabilities: 200
Asset: 300
Liabilities: 200 +100
Equity: 100
+100 (Asset)
Equity: 100
300
300
D/E Ratio = 200/100 = 2
400
400
D/E Ratio = 300/100 = 3 (Lesser having a higher ratio!!!!!)
Incurring Interest, Principal Payments & Recognizing Asset

Dr Leased PPE
100
Cr Lease Payable
80
Cr Cash/Payable*
20
*Lessees initial direct costs
Conclusion: If a lessee enters into an operating lease No liabilities incurred!!!!!! Off-B/S Financing
Only Incurring Rental Expense

Reference: David.M Katz. (March 1, 2014.). The path of Lease Resistance. Retrieved August 29, 2015, from http://ww2.cfo.com/accounting-tax/2014/03/path-lease-resistance/
Problems in FRS 17
1. Undue Complexity in Classification Hard to determine Operating/Finance lease
2. Does not faithfully represent lease transactions
i. Lack of comparability between Finance & Operating
ii. Rights & Obligations of Operating leases omitted Off B/S Financing
iii. Lessors residual interest in leased asset not separately measured or disclosed
3. Fails to meet users needs (User try to capitalize operating leases to enhance comparability)
Solutions
New lease standards to be issued in 2nd half of 2015

Reference: FASB. (May 19, 2015.). Leases Joint Project. Retrieved August 29, 2015, from http://www.fasb.org/jsp/FASB/FASBContent_C/ProjectUpdatePage&cid=900000011123
Part I
(2) In lease accounting, the lessor never has to compute PV(MLP), it only applies to the lessee.
TRUE / FALSE
Reason 1
MLP =
+ /
*GRV/BPO may be different between Lessee & Lessor May have different PV(MLP), both needs to compute
Reason 2
Under FRS 17.20
At the commencement of the lease term, lessees shall recognise finance leases as assets and liabilities in their
balance sheets at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum
lease payments, each determined at the inception of the lease. The discount rate to be used in calculating the present
value of the minimum lease payments is the interest rate implicit in the lease, if this is practicable to determine; if not,
the lessees incremental borrowing rate shall be used. Any initial direct costs of the lessee are added to the amount
recognised as an asset.
Interest rate may be different Depending on whether lessee knows about the implicit interest rate
Part I
(2) In lease accounting, the lessor never has to compute PV(MLP), it only applies to the lessee.
TRUE / FALSE
Reason 3
Guidelines It determines the lease classification for lessor
Tests
Is there a transfer of Ownership?
Is there a Bargain Purchase Option?
Is lease term > 75% of useful life?
Is PV of MLP at least substantially all of assets FV?
Is leased asset of specialized nature?
MLP may be substantial for Lessee but may not be

for Lessor, thus accounting for it differently
Part I
(3) In computing its MLP, the lessee has to include contingent rent that is payable during the lease term.
TRUE / FALSE
Under FRS 17.4
Contingent rent is that portion of the lease payments that is not fixed in amount but is based on the future amount of a factor
that changes other than with the passage of time (e.g. percentage of future sales, amount of future use, future price indices,
future market rates of interest).
Under FRS 17.25
Subsequent Measurement
Minimum lease payments shall be apportioned between the finance charge and the reduction of the outstanding liability.
The finance charge shall be allocated to each period during the lease term so as to produce a constant periodic rate of
interest on the remaining balance of the liability. Contingent rents shall be charged as expenses in the periods in which
they are incurred.
Part II
Darrent Inc sells its equipment to Darryl Inc at a price of $20 million and immediately leases it back on an operating
lease (with future rentals that are anticipated to be lower than market rentals). The carrying amount of the equipment
in Darrent Incs books at the time of the sale was $18 million while the fair value of the equipment was determined by a
professional valuer to be $23 million. At the point of the sale and leaseback, Darrent Inc should recognize:
From the Question, we know...
Sale and Leaseback Transactions
Operating Lease
FV(23) > SP(20) > CA(18)
Future rentals anticipated to be lower than market rentals
Book GL = SP CA = 2m
Arr GL = SP FV = (3m)
Mkt GL = FV CA = 5m
(E) A gain of $2 million

ALP computed by Lessor (King)

Part III
Alpha Precision Pte Ltd (Alpha) leases a piece of standard equipment from King Leasing Pte Ltd (King) on 1st January
2015. The fair value of the equipment is $229,343 and it is leased for its entire useful life of 5 years. The annual lease
payment computed by King is $55,000 and the first payment is payable on the signing of the lease on 1st January
2015. Subsequent payments are due on each anniversary of the signing of the agreement. Alphas incremental
borrowing rate is 12% and it is aware of the implicit interest rate of the lease. Alpha uses the straight-line method to
compute depreciation and its financial year-end is 31 December.
Annuity Due
Use Lessors IRR

a. Determine the implicit interest rate of the lease.
i%
55,000
PV=229,343
55,000
55,000
55,000
55,000
ALP computed by Lessor (King)

Part III
Use Lessors IRR
a. Determine the implicit interest rate of the lease.
ALP = (Fair Value at start PV of est. Residual Value)/PV of annuity factor
55,000 =
229,343 0
1
1
+ +
0
1 + %
1 + %
By Calculator:
PV = 229,343
PMT = 55,000
Mode: Beginning
N=5
i% = 9.9999% 10% (Ans)
Annuity Due
b. In compliance with FRS17 Leases, prepare the journal entries to record the lease arrangement in the books of
Alpha (Lessee) for the financial years ended 31 December 2015 and 2016.
What kind of lease? Operating? Finance?
Tests
Alpha
Is there a transfer of Ownership?
No Information
Is there a Bargain Purchase Option?
No information
Is lease term > 75% of useful life?
Yes, 100% leased for its entire useful life of 5

years
Is PV of MLP at least substantially all of assets FV?
Yes, 100%, FV=229,343
Is leased asset of specialized nature?
No
Conclusion: Finance Lease!!!!
Since Lessee is aware of the implicit interest rate,
Interest Rate = 10%
PV(MLP) = 229,343 ( Since there is no residual value) = FV of Equipment
ALP = 55,000 (Given)
Lease Term = 5 Years
Amount of Interest Expense to be amortized over lease term

= (ALP * No. of years) PV(MLP) = (55,000*5) 229,343
= 45,657
Annual Depreciation = Lower of FV or PV(MLP)/No. of years
= 229,343/5
= 45,869
Amortization schedule
Year
ALP
Interest (10%)
Principal
Liability Balance
01/01/15
229,343
01/01/15
55,000
55,000
174,343
01/01/16
55,000
174,343*10%= 17,434
55,000-17,434= 37,566
174,343 37,566=
136,777
01/01/17
55,000
13,678
41,322
95,455
01/01/18
55,000
9,545
45,455
50,000
01/01/19
55,000
5,000
50,000
Accrual of
Interest from 31
Dec 15
Checksum = 0
(No residual
Value)
Date
01/01/15
31/12/15
Accounts
Dr Lease Equipment
Dr
Cr
229,343
Cr Lease Payable
174,343
Cr Cash
55,000
Dr Interest Expense
17,434
Cr Accrued Interest Payable
Dr Depreciation Expense
Cr Accumulated Depreciation
17,434
45,869
45,869
Accounting for the

Lease & Payment
at the start
Interest Incurred
@ Financial Yr
end 31 Dec
Dep. Incurred as
Lessee of
Financial Lease
Date
01/01/16
Accounts
Dr
Dr Accrued Interest Payable
17,434
Dr Lease Payable
37,566
Cr Cash
31/12/16
Dr Interest Expense
55,000
13,678
Cr Accrued Interest Payable
Dr Depreciation Expense
Cr Accumulated Depreciation
Cr
13,678
45,869
45,869
Payment of
Interest & Principal
Balance
Interest Incurred
@ Financial Yr
end 31 Dec
Dep. Incurred as
Lessee of
Financial Lease
Part IV
Use the same information as in Part III, except now assume that King (Lessor) is a retailer of the standard equipment
and has sold and provided financing to Alpha. The cost of the standard equipment is $150,000. The market interest
rate is 12%. A 1% variance in interest rate is considered significant. Kings financial year-end is 31 December.
IRR used by Lessor = 10%
FRS 17.45 requires sales to be recorded at MLP discounted at fair rate
Mkt Interest Rate = 12% (Use this)
N = 5 Years
Mode: Beginning
FV = 229,343
ALP = 55,000
Cost = 150,000
Part IV
a. Compute the gross profit of King arising from the sales transaction.
Gross Investment (GI) = MLP + URV
Arrangement
w/o FRS 17.45
FRS 17.45
= (55,000 * 5) + 0 = 275,000
Per FRS 17.45, using Market fair rate (12%)
Net Investment (NI) = Fair Value = PV(GI)
,
,
=55,000+ . + + .^
= 222,054
Gross Profit (GP) = NI Cost
= 222,054 150,000 = 72,054
Interest Income = GI NI
= 275,000 222,054 = 52,946
Discount Rate%
10%
12%
Sales Price
229,343
222,054
Gross Profit Reported
79,343
72,054
Interest Income Deferred
45,657
52,946
Less Revenue
Recognized
b. Prepare the journal entries to account for the sale-type lease in the books of King for the financial year ended
31 December 2015.
Amortization schedule
Year
ALP
Interest (12%)
Principal
Liability Balance
01/01/15
222,054
01/01/15
55,000
55,000
167,054
01/01/16
55,000
20,046
34,954
132,100
01/01/17
55,000
15,852
39,148
92,952
01/01/18
55,000
11,153
43,847
49,107
01/01/19
55,000
5,893
49,107
Accrual of
Interest from 31
Dec 15
Checksum = 0
(No residual
Value)
b. Prepare the journal entries to account for the sale-type lease in the books of King for the financial year ended
31 December 2015.
Date
01/01/15
Accounts
Dr Lease Receivable
Dr
275,000
Cr Sales
222,054
Cr Unearned Interest
52,946
Dr COGS
150,000
Cr Inventory
Dr Cash
150,000
55,000
Cr Lease Receivable
31/12/15
Cr
Dr Unearned Interest
Cr Interest Income
55,000
20,046
20,046
Recording of Saletype lease
Sale of Machine
1st ALP @
Beginning
Interest Earned @
Financial Yr end
31 Dec
Instructions
Correct answer Bid multiplied by 2
Wrong Answer Bid Forfeited
Why Wait? Place your Bid!!!
Pop Quiz!!!!!
Question 1 out of 3
Under an annuity due, payments must be made at the end of each period.
1) True
2) False
An annuity due requires lease payments be made at the beginning of each period. An ordinary annuity
requires payments be made at the end of each period.
Time
10
123567849
Up!!!
Pop Quiz!!!!!
Question 2 out of 3
The lessor records sales revenue and the cost of goods sold in the initial journal
entries for a sales-type lease assuming lease meets the requirements for a salestype lease.
1) False
2) True (E.g Part lV b)
If the lease meets the requirements for a sales-type lease, then the initial entry would be recorded similar to
a normal sales transaction with a credit to sales revenue and a debit to cost of goods sold.
Dr Lease Receivable
275,000
Cr Sales
222,054
Time
165748923
11
13
15
14
10
12
Cr Unearned Interest
52,946
Up!!!
Dr COGS
150,000
Cr Inventory
150,000
Pop Quiz!!!!!
Question 3 out of 3
Cost of goods sold and sales revenue are recorded at the inception of a direct
financing lease.
1) True
2) False
(E.g Part lll b)
A direct financing lease is a method of financing and not sales. At the inception of this transaction the
asset is removed from the books of the lessor at cost, but no sales revenue is recorded. Revenue
on this type of lease is in the form of interest revenue over the term of the lease.
Dr Lease Equipment
229,343
Cr Lease Payable
174,343
Cr Cash
55,000
Time
165748923
11
13
15
14
10
12
Up!!!
Have you had enough????
Pop Quiz!!!!!
Bonus Qn
If a leased asset is not recorded as an asset and liability by the lessee,

1)
2)
3)
4)
Time
165748923
11
13
15
14
10
12
Up!!!
the current ratio and rate of return are generally lowered

Comparability between companies is improved
The borrowing power of the lessee may be increased
Financial ratios are generally unaffected as compared to recording the asset
and liabilities.
1) Incorrect because the current ratio and rate of return are usually lowered if the item appears on the balance sheet
2) Incorrect because comparability between companies is impacted if two or more companies record similar
transactions differently
3) Correct because the lessee have lower liabilities, lower D/E Ratio and thus lower risk in borrowing
4) Incorrect because when you change the composition of assets and liabilities, financial ratios will be affected.
References
1. David.M Katz. (March 1, 2014.). The path of Lease Resistance. Retrieved August 29, 2015, from
http://ww2.cfo.com/accounting-tax/2014/03/path-lease-resistance/
2. FASB. (May 19, 2015.). Leases Joint Project. Retrieved August 29, 2015, from
http://www.fasb.org/jsp/FASB/FASBContent_C/ProjectUpdatePage&cid=900000011123
3. ACCA. (August 10, 2015). Lease Operating or Finance?. Retrieved August 29, 2015, from
http://www.accaglobal.com/sg/en/student/exam-support-resources/fundamentals-exams-studyresources/f7/technical-articles/lease.html
4. Cengage. (n.d.). Chapter 21, Accounting for Leases. Retrieved August 29, 2015, from
http://www.cengage.com/resource_uploads/downloads/053846805X_228065.pdf
5. A/P Low Kin Yew Seminar 4,5,6 Slides

Accounting Iii: Presentation Question On Leases Project Team 2, Seminar Group 7 (Seminar 7)

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ACCOUNTING III

Presentation Question on Leases

Lease Receivable Unearned Interest Income

- 100 (Asset) + 100(Net Lease Receivable)

D/E Ratio = 200/100 = 2

D/E Ratio = 200/100 = 2

Only Incurring Rental Income

Incurring Unearned Interest, Principal Payments & Recognizing Asset

Liabilities: 200 +100

D/E Ratio = 200/100 = 2

D/E Ratio = 300/100 = 3 (Lesser having a higher ratio!!!!!)

Incurring Interest, Principal Payments & Recognizing Asset

Only Incurring Rental Expense

*Credit: A/P Low Kin Yew

*Credit: A/P Low Kin Yew

MLP may be substantial for Lessee but may not be

(E) A gain of $2 million

ALP computed by Lessor (King)

Use Lessors IRR

ALP computed by Lessor (King)

Is there a transfer of Ownership?

Is there a Bargain Purchase Option?

Is lease term > 75% of useful life?

Yes, 100% leased for its entire useful life of 5

Is PV of MLP at least substantially all of assets FV?

Yes, 100%, FV=229,343

Is leased asset of specialized nature?

Amount of Interest Expense to be amortized over lease term

Cr Accrued Interest Payable

Accounting for the

Dr Accrued Interest Payable

Cr Accrued Interest Payable

Gross Profit Reported

Interest Income Deferred

Recording of Saletype lease

Why Wait? Place your Bid!!!

(E.g Part lll b)

Have you had enough????

If a leased asset is not recorded as an asset and liability by the lessee,

the current ratio and rate of return are generally lowered

5. A/P Low Kin Yew Seminar 4,5,6 Slides

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