
Concept explainers
1)
Lease
Lease is a contractual agreement whereby the right to use an asset for a particular period of time is provided by the owner of the asset to the user of the asset. The owner, who possesses the asset, is termed as ‘Lessor’ and user, to whom the right is transferred to, is termed as ‘Lessee’.
The criteria for defining the lease as finance lease or operating lease
As per the notes issued by Financial Accounting Standard Board (FASB), the following are four criteria to determine is a lease is a capital lease or an operating lease:
- 1. Transfer of title: The asset is transferred to lessee at the end of the lease period concerned.
- 2. Purchase option: The purchase option is exercisable when the purchase price is sufficiently lower than expected fair value.
- 3. Economic life: The economic life of the lease period is 75% or more than the useful life of the asset.
- 4. Value recovery: Present value of lease payments is greater or equal to 90% of the fair value.
If a particular lease fulfils any one of the above four criteria, then it is considered as finance lease. If a lease does not fulfil any of the above four criteria, it would be considered as operating lease.
Sales-type lease/Finance lease
Sales type/Finance lease is a parallel type of direct financing whereby the owner (lessor) purchases the equipment to lease it and received the interest revenue over the period of lease for equipment, apart from the recognition of profit from sale of equipment.
Lessee guaranteed residual value
The lessee guaranteed residual value of leased asset is an estimation of the commercial value of the asset at the end of lease term. The present value is considered when determining the lease classification criteria (Criteria 4). Lessee guaranteed residual value is added to lease receivable and also added to sales revenue.
(1)
the appropriate classification of lease by lessee and state the reason.
1)

Explanation of Solution
The lease is a finance lease to the lessee.
The classification criteria for lessee are as follows:
S.No | Classification criteria | Does it satisfy? | |
1 | Does the lease agreement specify about ownership transfer? | No | |
2 | Does the lease agreement state about bargain purchase option? | No | |
3 | Is the lease value equal to 75% or more of the expected economic life of the asset? | Yes | Lease term = 4 years Useful life = 5 years |
4 | Is the present value of the minimum lease payments equal to or greater than 90% of the of the fair value of the asset? | No | Present value (1) = $39,564 Fair value = $45,114 |
Table (1)
Working note:
The present value of lease payments is calculated as below:
(2)
To Calculate: the amount YA Company (lessee) would record as right-of-use asset and lease liability.
(2)

Explanation of Solution
The present value of lease payments is recorded as leased asset, which is $39,564.
The present value of lease payments that would be recorded as leased asset, hence the amount as per the above calculation is used
Therefore, the present value of lessee’s periodic payments is $35,313.
(3)
the appropriate classification of lease by lessor and state the reason.
(3)

Explanation of Solution
The lease is a sales type lease to the lessee.
The classification criteria for lessor are as follows:
S.No | Classification criteria | Does it satisfy? | |
1 | Does the lease agreement specify about ownership transfer? | No | |
2 | Does the lease agreement state about bargain purchase option? | No | |
3 | Is the lease value equal to 75% or more of the expected economic life of the asset? | Yes | Lease term = 4 years Useful life = 5 years |
4 | Is the present value of the minimum lease payments equal to or greater than 90% of the of the fair value of the asset? | Yes | Present value (2) = $42,382 |
Table (2)
The present value of lease payments is calculated as below:
(4)
To Show: how the annual lease payments of $11,000 is being calculated.
(4)

Explanation of Solution
Amount ($) | |
Lease payments at the beginning of each of the next 4 years (5) | 10,000 |
Add: Maintenance cost | 1,000 |
Lease payments including maintenance costs | 11,000 |
Table (3)
Working notes:
Calculate present value of residual amount:
Calculate the amount to be recovered by periodic lease payments:
Amount ($) | |
Amount to be recovered (Fair value of truck) | 45,114 |
Less: Present value of residual value (3) | 10,245 |
Amount to be recovered by periodic lease payments | 34,869 |
(4)
Calculate lease payments at the beginning of each of the next 4 years:
(5)
To Calculate: the amount the company BM (Lessor) would record as sales revenue.
(5)

Explanation of Solution
Calculate the sales revenue for lessor as follows:
Amount ($) | |
Present value of periodic lease payments (4) | 35,313 |
Add: Present value of lessee guaranteed residual value (6) | 4,251 |
Sales revenue | 39,564 |
Table (4)
Working notes:
Calculate the present value of lessee guaranteed residual value
Hence, the sales revenue for lessor is $39,564.
(6)
To Prepare: appropriate journal entries for YA Company (Lessee) and Company BM (Lessor) on December 31, 2016.
(6)

Explanation of Solution
Prepare
Date | Accounts title and explanation | Post Ref. |
Debit ($) |
Credit ($) |
|
Leased asset (1) | $39,564 | ||||
Lease Payable | $39,564 | ||||
(To record the lease payable) |
Table (5)
- Right-of-use asset is an asset. There is an increase in asset. Therefore, debit right-of-use asset account by $39,564.
- Lease payable is a liability. There is an increase in liability. Therefore, credit lease liability by $39,564.
Transaction on December 31, 2016: Record the lease payments and prepaid maintenance expense.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) |
Prepaid maintenance expenses | 1,000 | |||
Lease payable (Difference) | 10,000 | |||
Cash | 11,000 | |||
(To record annual lease payment and maintenance expenses.) |
Table (6)
- Prepaid maintenance expense is an asset and increases. Therefore, debit prepaid maintenance expense by $1,000.
- Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $10,000.
- Cash is an asset. There is a decrease in asset. Therefore, credit cash account by $11,000.
Prepare journal entry for BM Company (Lessor) in the month of December 31, 2016
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | |
Lease Receivable | 45,114 | ||||
Cost of Goods Sold (7) | 37,268 | ||||
Sales Revenue (2) | 42,382 | ||||
Equipment | 40,000 | ||||
(To record lease inception) |
Table (7)
- Lease receivable is an asset. There is an increase in asset. Therefore, debit lease receivable by $45,114.
- Equipment is an asset. There is a decrease in asset. Therefore, credit inventory of equipment by $40,000.
- Cost of goods sold decreases
stockholders’ equity. Therefore, debit cost of goods sold by $37,268. - Sales revenue increases stockholders’ equity. Therefore, credit sales revenue by $42,382.
Working notes:
Calculate the cost of goods sold as follows:
Journalize the lease receivable: December 31, 2016
Date | Accounts Title and Explanation | Post Ref. |
Debit ($) |
Credit ($) |
|
Cash | 11,000 | ||||
Lease Receivable | 10,000 | ||||
Maintenance fee payable | 1,000 | ||||
(To record the lease received) |
Table (8)
- Cash is an asset. There is an increase in asset. Therefore, debit Cash Account by $11,000.
- Lease receivable is an asset. There is a decrease in asset. Therefore, credit Lease Receivable Account by $10,000.
- Maintenance fees payable is a liability and is increased. Therefore, credit maintenance fees payable by $1,000.
(7)
To prepare: an amortization schedule that describes the pattern of interest expense over the lease term for YA Company.
(7)

Explanation of Solution
Prepare an amortization schedule for the Lessee – YA Company.
Lease Amortization Schedule | ||||
A | B | C | D | E |
Year (Dec 31) | Lease Payment ($) | Effective Interest (9% × Outstanding balance) ($) | Payment Reduction ($) (B – C) |
Outstanding Balance ($) (E – D) |
39,564 | ||||
2016 | 10,000 | 10,000 | 29,564 | |
2017 | 10,000 | 2,661 | 7,339 | 22,225 |
2018 | 10,000 | 2,000 | 8,000 | 14,225 |
2019 | 10,000 | 1,280 | 8,720 | 5,505 |
2020 | 6,000 | 495 | 5505 | 0 |
40,000 | 6,436 | 39,564 |
Table (9)
The amortization table is prepared to present the pattern of interest expenses throughout the period. The schedule shows the lease balance and effective interest change over the 4 term period of lease using effective interest rate of 9%. Each lease payment after the first payment includes both the interest and amount that represents the reduction of outstanding balance. At the end of the lease period, the outstanding balance becomes zero.
(8)
To prepare: an amortization schedule that describes the pattern of interest expense over the lease term for BM Company.
(8)

Explanation of Solution
Prepare an amortization schedule for the Lessee – BM Company.
Lease Amortization Schedule | ||||
A | B | C | D | E |
Year (Dec 31) | Lease Payment ($) | Effective Interest (10% × Outstanding balance) ($) | Payment Reduction ($) (B – C) |
Outstanding Balance ($) (E – D) |
45,114 | ||||
2016 | 10,000 | 35,114 | ||
2017 | 15,000 | 3,511 | 6,489 | 28,625 |
2018 | 15,000 | 2,863 | 7,137 | 21,448 |
2019 | 15,000 | 2,149 | 7,851 | 13,637 |
2020 | 15,000 | 1,363 | 13,637 | 0 |
55,000 | 9,886 | 45,114 |
Table (10)
The amortization table is prepared to present the pattern of interest expenses throughout the period. The schedule shows the lease balance and interest change over the 4 term period of lease using effective interest rate of 10%. Each lease payment after the first payment includes both the interest and amount that represents the reduction of outstanding balance. At the end of the lease period, the outstanding balance becomes zero.
(9)
To Prepare: the appropriate entries for both YA Company and BM Company on December 31, 2017.
(9)

Explanation of Solution
Prepare entries in the books of YA Company.
Transaction on December 31, 2017: Record the maintenance expense.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) |
Maintenance expense | 1,000 | |||
Prepaid maintenance expenses | 1,000 | |||
(To record maintenance expenses.) |
Table (11)
- Maintenance expense decreases stockholders’ equity. Therefore, debit maintenance interest expense by $1,000.
- Prepaid maintenance expense is an asset and decreases. Therefore, credit prepaid maintenance expense by $1,000.
Transaction on December 31, 2017: Record the lease payment.
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | |
Interest expense (8) | 2,661 | ||||
Lease payable | 7,339 | ||||
Prepaid maintenance expense | 1,000 | ||||
Cash | 11,000 | ||||
(To record lease payment) |
Table (12)
- Interest expense decreases stockholders’ equity. Therefore, debit maintenance interest expense by $2,661.
- Prepaid maintenance expense is an asset and increases. Therefore, credit prepaid maintenance expense by $1,000.
- Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $7,339.
- Cash is an asset. There is a decrease in asset. Therefore, credit Cash Account by $11,000.
Working note:
Calculate the amount of interest expense for December 31, 2017 as follows:
Transaction on December 31, 2017: Record the amortization expense.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) |
Amortization expense (9) | 8,391 | |||
Right-of-use asset | 8,391 | |||
(To record amortization expense.) |
Table (13)
- Amortization expense decreases stockholders’ equity. Therefore, debit amortization expense by $8,391.
- Right-of-use asset is an asset. There is a decrease in asset. Therefore, credit right-of-use asset by $8,391.
Working note:
Calculate the amortization expense for December 31, 2017 as follows:
Prepare entries in the books of BM Company.
Journalize the lease receivable and interest revenue: December 31, 2017
Date | Accounts Title and Explanation | Post Ref. |
Debit ($) |
Credit ($) |
|
Cash | 11,000 | ||||
Lease Receivable (Difference) | 6,489 | ||||
Maintenance fee payable | 1,000 | ||||
Interest revenue (10) | 3,511 | ||||
(To record the lease received) |
Table (14)
- Cash is an asset. There is an increase in asset. Therefore, debit Cash Account by $11,000.
- Lease receivable is an asset. There is a decrease in asset. Therefore, credit Lease Receivable Account by $10,000.
- Maintenance fees payable is a liability and is increased. Therefore, credit maintenance fees payable by $1,000.
- Interest revenue increases stockholders’ equity. Therefore, credit interest revenue by $3,511.
Working note:
Calculate the amount of interest revenue for December 31, 2017 as follows:
(10)
To Prepare: the appropriate entries for both YA Company and BM Company on December 31, 2019.
(10)

Explanation of Solution
Prepare entries in the books of YA Company.
Transaction on December 31, 2019: Record the maintenance expense.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) |
Maintenance expense | 1,000 | |||
Prepaid maintenance expenses | 1,000 | |||
(To record maintenance expenses.) |
Table (15)
- Maintenance expense decreases stockholders’ equity. Therefore, debit maintenance interest expense by $1,000.
- Prepaid maintenance expense is an asset and decreases. Therefore, credit prepaid maintenance expense by $1,000.
Transaction on December 31, 2019: Record the final lease payment.
Date | Account Titles and Explanation | Post Ref. | Debit ($) | Credit ($) | |
Interest expense | 1,280 | ||||
Lease payable | 8,720 | ||||
Prepaid maintenance expense | 1,000 | ||||
Cash | 11,000 | ||||
(To record lease payment) |
Table (16)
- Interest expense decreases stockholders’ equity. Therefore, debit maintenance interest expense by $1,280.
- Prepaid maintenance expense is an asset and increases. Therefore, credit prepaid maintenance expense by $8,720.
- Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $9,174.
- Cash is an asset. There is a decrease in asset. Therefore, credit Cash Account by $11,000.
Transaction on December 31, 2017: Record the amortization expense.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) |
8,391 | ||||
Leased asset | 8,391 | |||
(To record depreciation expense.) |
Table (17)
- Depreciation expense decreases stockholders’ equity. Therefore, debit amortization expense by $8,828.
- Leased asset is an asset. There is a decrease in asset. Therefore, credit right-of-use asset by $8,828.
Prepare entries in the books of BM Company.
Journalize the lease receivable and interest revenue: December 31, 2019
Date | Accounts Title and Explanation | Post Ref. |
Debit ($) |
Credit ($) |
|
Cash | 11,000 | ||||
Lease Receivable (Difference) | 7,851 | ||||
Maintenance fee payable | 1,000 | ||||
Interest revenue | 2,149 | ||||
(To record the lease received) |
Table (18)
- Cash is an asset. There is an increase in asset. Therefore, debit Cash Account by $11,000.
- Lease receivable is an asset. There is a decrease in asset. Therefore, credit Lease Receivable Account by $7,851.
- Maintenance fees payable is a liability and is increased. Therefore, credit maintenance fees payable by $1,000.
- Interest revenue increases stockholders’ equity. Therefore, credit interest revenue by $2,149.
(11)
To Prepare: the appropriate entries for both YA Company and BM Company on December 31, 2020.
(11)

Explanation of Solution
Prepare entries in the books of YA Company.
Transaction on December 31, 2020: Record the maintenance expense.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) |
Maintenance expense | 1,000 | |||
Prepaid maintenance expenses | 1,000 | |||
(To record maintenance expenses.) |
Table (19)
- Maintenance expense decreases stockholders’ equity. Therefore, debit maintenance interest expense by $1,000.
- Prepaid maintenance expense is an asset and decreases. Therefore, credit prepaid maintenance expense by $1,000.
Transaction on December 31, 2020: Record the amortization expense.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) |
Depreciation expense (9) | 8,391 | |||
Leased asset | 8, 391 | |||
(To record depreciation expense.) |
Table (20)
- Depreciation expense decreases stockholders’ equity. Therefore, debit amortization expense by $8, 391.
- Leased asset is an asset. There is a decrease in asset. Therefore, credit right-of-use asset by $8, 391.
Transaction on December 31, 2020: Record the loss on residual value guarantee.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) |
Loss on residual value guarantee | 2,000 | |||
Cash ($6,000 – $4,000) | 2,000 | |||
(To record loss on residual value.) |
Table (21)
- Loss on residual value guarantee decreases stockholders’ equity. Therefore, debit amortization expense by $2,000.
- Cash is an asset. There is a decrease in asset. Therefore, credit cash account by $2,000.
Prepare entries in the books of BM Company.
Journalize the lease receivable and interest revenue: December 31, 2020
Date | Accounts Title and Explanation | Post Ref. |
Debit ($) |
Credit ($) |
|
Interest expense | 495 | ||||
Lease payable | 5,505 | ||||
33,564 | |||||
Leased equipment | 39,564 | ||||
(To record the lease received) |
Table (22)
- Interest expense decreases stockholders’ equity. Therefore, debit maintenance interest expense by $495.
- Accumulated depreciation expense is a contra asset, which reduces the asset. Therefore, debit accumulated depreciation expense by $33,564.
- Lease payable is a liability. There is a decrease in liability. Therefore, debit lease liability by $5,505.
- Leased equipment is an asset. There is a decrease in asset. Therefore, credit leased equipment by $39,564.
Prepare entries in the books of BM Company.
Journalize the lease receivable and interest revenue: December 31, 2020
Date | Accounts Title and Explanation | Post Ref. |
Debit ($) |
Credit ($) |
|
Cash | 4,000 | ||||
Inventory of equipment | 7,000 | ||||
Loss on leased assets | 4,000 | ||||
Lease Receivable | 13,637 | ||||
Interest revenue | 1,363 | ||||
(To record the lease received) |
Table (23)
- Cash is an asset. There is an increase in asset. Therefore, debit Cash Account by $4,000.
- Inventory of equipment is an asset. There is an increase in asset. Therefore, debit inventory of equipment by $7,000.
- Loss on leased assets is a loss and decreases the shareholder’s equity. Therefore, debit loss on leased assets by $4,000.
- Lease receivable is an asset. There is a decrease in asset. Therefore, credit Lease Receivable Account by $13,637.
- Interest revenue increases stockholders’ equity. Therefore, credit interest revenue by $1,363
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Chapter 15 Solutions
INTERMEDIATE ACCT.-CONNECT PLUS ACCESS
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