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Intermediate Accounting (Kieso)
Found in: Page 1245

Short Answer

Lessee-Lessor Entries, Sales-Type Lease) Glaus Leasing Company agrees to lease machinery to Jensen Corporation on January 1, 2017. The following information relates to the lease agreement.

  1. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.
  2. The cost of the machinery is $525,000, and the fair value of the asset on January 1, 2017, is $700,000.
  3. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $100,000. Jensen depreciates all of its equipment on a straight-line basis.
  4. The lease agreement requires equal annual rental payments, beginning on January 1, 2017.
  5. The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. 6. Glaus desires a 10% rate of return on its investments. Jensen’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown.


(Assume the accounting period ends on December 31.)

  1. Discuss the nature of this lease for both the lessee and the lessor.


Both Jensen Corporation and Glaus Leasing Company have the capital lease.

See the step by step solution

Step by Step Solution

Step 1: Meaning of Sales-type lease

In a sales-type lease, the lessor is assumed to be selling a product to the lessee, which necessitates the reporting of a profit or loss on the sale. As a result, at the lease's start date, the following accounting is applied: (a) Recognize assets. (b)Recognize net investment.

Step 2: Explaining the nature of the lease for both lessee and the lessor

Jensen has a capital lease since the lease period exceeds 75% of the economic life of the leased asset. The lease period is 78 percent of the economic life of the asset.

This is a capital lease to Glaus because the lease payments are generally predictable, there are no significant uncertainties regarding the lessor's future expenses, and the lease period exceeds 75 percent of the asset's economic life. The lease is a sales-type lease since the market value of the equipment ($700,000) exceeds the lessor's cost ($525,000).

Most popular questions for Business-studies Textbooks

Question: (Balance Sheet and Income Statement Disclosure—Lessee) The following facts pertain to a noncancelable lease agreement between Alschuler Leasing Company and McKee Electronics, a lessee, for a computer system.

Inception date

October 1, 2017

Lease term

6 years

Economic life of leased equipment

6 years

Fair value of asset at October 1, 2017


Residual value at end of lease term


Lessor’s implicit rate


Lessee’s incremental borrowing rate


Annual lease payment due at the beginning of each year, beginning with October 1, 2017


The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by the lessor. The lessee assumes responsibility for all executory costs, which amount to $5,500 per year and are to be paid each October 1, beginning October 1, 2017. (This $5,500 is not included in the rental payment of $62,700.) The asset will revert to the lessor at the end of the lease term. The straight-line depreciation method is used for all equipment.

The following amortization schedule has been prepared correctly for use by both the lessor and the lessee in accounting for this lease. The lease is to be accounted for properly as a capital lease by the lessee and as a direct-financing lease by the lessor.


Annual lease payments/Receipt

Interest (10%)

On Unpaid liability/Receivable

Reduction of Lease Liability?


Balance of Lease Liability/Receivable



































*Rounding error is $1.

(b) Assuming the lessee’s accounting period ends on December 31, answer the following questions with respect to this lease agreement.

(4) What items and amounts will appear on the lessee’s balance sheet at December 31, 2018?


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