There is another type of lease, which is called sale or leaseback.

The entries for this lease is as follows: -

Transaction In the books of Lessee In the books of Lessor

1 (a) When lessee sale the asset to lessor. a- (I) Cash Debit b-(I) Asset Debit
Asset Credit Cash Credit
Unclaimed Profit on sale or Credit
leaseback
(ii) Leased Asset Debit (ii) Leased Receivable Debit
Leased Liability Credit Asset Credit

(b) When lessor purchase the asset from lessee

2 For Payment of executory Cost Executory Cost Debit

Cash/ Accounts Payable Credit

3 For interest expense/For interest receivable Interest Expense Debit Interest Receivable Debit
Interest Payable Credit Interest Revenue Credit

4 For lease rent payment/For interest receivable Interest Payable Debit Cash Debit
Lease Liability Debit Lease Receivable Credit
Cash Credit Interest Receivable Credit

5 For depreciation charge Depreciation expense Debit

Accumulated Depreciation Credit
6 For amortization of profit on sales-leaseback Unearned profit on sale-leaseback Debit
Depreciation Credit
expense/Sales Revenue
Some terms of lease system: -
a) Minimum Lease Payments: Minimum Lease payments are payments the lessee is
obliged to make or can be expected to make in connection with the leased property.
Minimum Lease Payments for the lessee includes-
Minimum rental payments, guaranteed residual value, penalty for failure to renew or
extend the lease, Bargain Purchase Option.
b) Executory Cost: Like most assets, leased tangible assets require the incurrence of
insurance, maintenance and tax expenses-called executory costs during their
economic life. Executory costs are not included in the lessees computation of the
present value of the minimum lease payments.
c) Discount Rate: These should be considering two different discount rates to determine
the present value of Minimum lease payments; which are- (I) Incremental borrowing
rate and (ii) Implicit interest rate.
The stated rate of a lease used for comparative purposes, that a lessee would be
required to pay on a loan to acquire the same property that is being leased is called
incremental rate.
Generally, an implicit interest rate is one that is not explicit, in other words, the rate
is not stated. In lease, the interest rate implicit is the discount rate that at the
inception of the lease, causes the aggregate present value of the minimum lease
payments and the unguaranteed residual value to be equal to the sum of the fair value
of the leased asset and any initial direct costs of the lessor.
Lessor use the implicit rate to calculate the present value of minimum lease payment,
but lessee use the lower rate of the two-discount rate. If lessee does not know the
implicit interest rate then use incremental borrowing rate.
d) Initial Direct Costs: Costs that are directly attribute to negotiating and arranging a
lease that would not have been incurred had the lease transaction not been made.
Examples: the cost of an outside credit check of the lessee, a brokers fee for finding
the lessee, evaluating the prospective lessees financial condition, preparing and
processing leasing document, closing the transaction etc.
Accounting for Initial Direct Cost
Type of Lease Accounting Treatment of Cost
Operating Recorded as an asset and amortized over lease term
Direct Recorded as an asset and amortized over lease term with unearned
Financing interest so as to produce a constant rate of return on the net
investment in the lease.
Sales Type Immediately recognized as reduction in manufacturers or dealers
profit.

e) Residual Value: The residual value is the estimated fair value of the leased asset at
the end of the lease term. The residual value may be guaranteed or unguaranteed by
the lessee.
 If the lessee agrees to make up any deficiency below a stated amount that the lessor
realizes in residual value at the end of the lease term, that stated amount is the
guaranteed residual value.
Unguaranteed residual value refers to the worth of a lease property at the end of the
agreements term that is not the responsibility of the lessee.
Lease Accounting for residual value: - Whether the estimated residual value is
guaranteed or unguaranteed has both economic and accounting consequence to the
lessee. The accounting difference is that the minimum lease payments, the basis for
capitalization, includes the guaranteed residual value but excludes the unguaranteed
residual value.

Lessor Accounting for residual value: - The accounting treatment is the same whether
the residual value is guaranteed or unguaranteed as the net investment to be
recorded by the lessor. The lessor works on the assumption that the residual value will
be realized at the end of the lease term whether guaranteed or unguaranteed.

f) Lease Receivable: In direct financing method of lease, the lessor records a lease
receivable instated of a leased asset. The lease receivable is the present value of the
minimum lease payments, plus the present value of the unguaranteed residual value.
Recall that minimum lease payments includes:
Rental Payment (excluding executory Costs); Bargain Purchase Option (if any);
Guaranteed residual value (if any); Penalty for failure to renew (if any).
The lease receivable is often reported in the balance sheet as Net Investment in
capital leases. It is classified either as current or non-current, depending upon when
the net investment is to be recorded.

g) Sales price of the asset: In sales-type lease, sales price of the asset is the present value
of the minimum lease payments.
(i) Cost of goods sold: - In sales-type lease, the cost of the asset to the lessor, less the
present value of any unguaranteed residual value.

The primary difference between a direct financing lease and a sales type lease is the
manufacturers or dealers gross profit (or sales). A diagram shows these relationships: -

Direct-financing Lease

Cost of Asset Total Payments

(Equals fair market value) (Interest and Principal)
 Sales-type lease

Cost of Asset Sales price of asset Total Payments

(Does not equal fair (Interest and Principal)

market value)

Gross Profit Interest Revenue

Lease Amortization Schedule

Lessor Company
Date Annual Executory Interest on Lease Lease
Lease Cost Lease Receivable Receivable
Payment Receivable Recovery
Lessee Company
Date Annual Executory Interest on Reduction Lease
Lease Cost Lease of Lease Liability
Payment Liability Liability
7. Indiana Jones Corporation enters into a 6-year Lease of equipment on January 1, 2015 from
Lost ARK Company-Lessor, which requires 6 annual payments of Tk. 30,000 each, beginning
January 1, 2015. In addition, Jones guarantees the lessor a residual value of Tk. 20,000 at lease
end. The equipment has a useful life of 6 years. Collectability of the rental is reasonably
assumed and there are no important uncertainties covering costs and the carrying amount of
the machinery is Tk. 1,55,013.
Prepare Journal entries for January 1, 2015: -
(a) For Indiana Jones 9assuming interest rate of 10%)
(b) For Lost ARK
8. Ovi leasing company agrees to lease machinery to Jubaer Corporation on January 1, 2015.
The following relates to the lease agreement:
- The term of lease is 4 years with no renewal option, non-cancellable and the machinery has
some estimated economic life 5 years.
- The cost of the machinery is Tk. 2,80,000 and the fair value of the asset on January 1, 2015
is Tk. 3,10,000.
- At the end of the lease term the asset returns to the lessor. At the end of the lease term the
asset is expected to have a guaranteed residual value of Tk. 25,000. Jubaer depreciates all of
its equipment on a straight-line basis.
- The lease agreement requires equal rental payments, beginning on January 1, 2015.
- The lessees incremental borrowing rate is 11%. The lessors implicit rate is 10%. And it is
unknown to the lessee.
Instructions:
a) Calculate the amount to be recovered through lease payments by lessor.
b) Calculate the amount of lease payment.
c) Calculate the present value of the lease.
d) Calculate the annual depreciation.
9. Ovi leasing company agrees to lease machinery to Jubaer Corporation on January 1, 2015.
The following relates to the lease agreement:
- The term of lease is 7 years with no renewal option, non-cancellable and the machinery has
some estimated economic life 9 years.
- The cost of the machinery is Tk. 2,60,000 and the fair value of the asset on January 1, 2015
is Tk. 3,00,000.
- At the end of the lease term the asset returns to the lessor. At the end of the lease term the
asset is expected to have a non-guaranteed residual value of Tk. 20,000. Jubaer depreciates
all of its equipment on a straight-line basis.
- The lease agreement requires equal rental payments, beginning on January 1, 2015.
- The lessees incremental borrowing rate is 11%. The lessors implicit rate is 10%. And it is
unknown to the lessee.
Instructions:
e) Calculate the amount to be recovered through lease payments by lessor.
f) Calculate the amount of lease payment.
g) Calculate the present value of the lease.
h) Calculate the annual depreciation.
10. IDLC and Square Textile sign a lease agreement dated January 1, 2013. The terms and
provisions of the lease agreement and other pertinent data are as follows:
- The term of the lease is five years. The lease agreement is non-cancellable, requiring equal
rental payment of Tk. 51,963.24 at the beginning of each year (annuity-due basis).
- The machine has a fair value at the inception of the lease of Tk. 2,00,000; an estimated
economic life of five years and no required value.
- Square Textile pays all of the executory costs directly to third parties except for the property
taxes of Tk. 4,0000 per year, which is included of its annual payments to IDLC.
- The lease contains no required options. The machine returns to IDLC at the termination of
the lease.
- Collocability is reasonably assumed and IDLC incurs no additional costs.
- Square Textile depreciates on a straight-line basis.
- IDLC sets annual rental to earn a rate of return on its investment of 10%. Square Textile
knows this fact.
Prepare Lease Amortization Schedule for both Lessee and Lessor.
11. Mukul Company manufactures a Check-in Kiosk with an estimated economic life of 125
years and leases it to GMG Airlines for a period of 10 years. The normal selling price of the
equipment is Tk. 2,78,072 and its unguaranteed residual value at the end of the lease term is
estimated to be Tk. 20,000. GMG will pay annual payments of Tk. 40,000 at the beginning of
each period and all maintenance, insurance and taxes. Mukul incurred costs of Tk. 1,80,000
in manufacturing the equipment and Tk. 4,000 in negotiating and closing the lease. Mukul has
determined that the collectability of the lease payment is reasonably predictable, that no
additional cost will be incurred and that the implicit interest rate is 10% and GMG Airlines
having an incremental borrowing rate of 10%.
Instructions:
a) Discuss the nature of this lease in relation to the lessee and compute the amount of
the initial obligation under capital lease.
b) Prepare 10-year lease amortization schedule
 c) Prepare all of the lessees journal entries for the first year.
12. The Friel Company leased a machine on July 1, 2016 under a ten-year lease. The economic
life of the machine is estimated to be 15 years. Title to the machine passes to Friel Company
at the expiration of the lease and thus the lease is a capital lease. The lease payment is Tk.
40,500 per year including executory cost of Tk. 3,000 per year, all payable in advance annually.
The incremental borrowing rate of the company is 10% and lessors implicit rate is unknown.
The Friel Company uses the straight-line method of depreciation and use the calendar year as
its fiscal year.
Give all entries on the books of the lessee relating to the lease for 2016.
13. Ovi leasing company agrees to lease machinery to Jubar Corporation on January 1, 2015.
The following relates to the lease agreement:
- The term of lease is 7 years with no renewal option, non-cancellable and the machinery has
some estimated economic life 9 years.
- The cost of the machinery is Tk. 4,20,000 and the fair value of the asset on January 1, 2015
is Tk. 5,60,000.
- At the end of the lease term the asset returns to the lessor. At the end of the lease term the
asset is expected to have a guaranteed residual value of Tk. 80,000. Jubaer depreciates all of
its equipment on a straight-line basis.
- The lease agreement requires equal rental payments, beginning on January 1, 2015.
- The lessees incremental borrowing rate is 11%. The lessors implicit rate is 10%. And it is
unknown to the lessee.
Instructions:
i) Calculate the amount of annual rental payment.
j) Calculate the present value of the minimum lease payment.
k) Prepare journal entries for Jubaer Corporation through January 1, 2016.

14. The following facts pertain to a non-cancellable lease agreement between Mike Mooney
Leasing Company and Denise Rade Company, a lessee.

Inception Date May 1, 2012

Annual lease payment due at the beginning Tk. 21,227.65
of each years, beginning with May 1, 2012
Beginning purchase option price at the end Tk. 4,000.00
of lease term
Lease Term 10 years
Economic life of leased equipment 10 years
Lessorss cost Tk. 65,000.00
Fair value of asset at May 1, 2012 Tk. 91,000
Lessors implicit rate 10%
 Lesses incremental borrowing rate 10%

The collectability of the lease payment is reasonably predicable and there are no important
uncertainties surrounding then costs yet to be incurred by the lessor. The lessee assumes
responsibility for all executory costs.
Incrustations:
(a) Prepare a lease amortization schedule for Rode Company for the 5-year lease term.
(b) Prepare the journal entries on the lessees book to reflect the signing of the lease
agreement and to record the payments and expenses related to this lease for the year
2012 and 2013. Rodes annual accounting period ends on December 31. Reversing
entries are used by Rode.
15. Assume that on January 1, 2015 Jui Corporation signs a 5-year non-cancellable lease
agreement to a lease storage building from Chameli Storage Company. The following
information pertains to this lease agreement:
- The agreement requires equal rental payments of Tk. 21,103.82 beginning of December 31,
2015.
- The fair value of the building on January 1, 2015 is Tk. 85,000.
- The lease is non-cancellable. At the termination of the lease, the building returns to the
lessor.
- Juis incremental borrowing rate is 10%. The lessors implicit rate is not known by Jui.
Instructions:
(a) Calculate the present value of lease.
(b) Calculation of interest expense for lease term
(c) Make journal entry for 2015 in the books of lessee.

15. Financing leasing Company leases a new machine that has a cost and fair value of Tk.
1,25,000 to Riad Inc. on a 3-year non-cancellable lease. Riad agrees to assume all risks of
normal ownership including such costs as insurance, taxes and maintenance. The machine
has a 3-year useful life and no residual value. The lease was signed on January 1, 2013. Finance
leasing company expects to earn 10% rate of return on its investment. The annual rentals are