864 SECTION 3 Financial Instruments and Liabilities Additional Consideration Some lessors use what’s called the “gross method” to record the receivable in a capital lease. By this method, the lessor debits lease receivable for the gross sum of the lease payments and credits deferred interest revenue for the difference between the total of the payments and the present value of the payments since that’s the amount that eventually will be recorded as interest revenue over the term of the lease. In Illustration 15–6 , the lessor’s entry by the gross method at the inception of the lease would be: Lease receivable ($100,000 3 6) ............................................... 600,000 Deferred interest revenue (difference) ............................... 120,921 Inventory of equipment (lessor’s cost) ............................... 479,079 The same ultimate result is achieved either way. We use the net method in our illustrations to more easily demonstrate the lessee’s entries and the lessor’s entries being “two sides of the same coin.” Whichever method is used, both the lessee and the lessor must report in the disclosure notes both the net and gross amounts of the lease. The amortization schedule in Illustration 15–6B shows how the lease balance and the effective interest change over the six-year lease term. Each rental payment after the first includes both an amount that represents interest and an amount that represents a reduction of principal. The periodic reduction of principal is sufficient that, at the end of the lease term, the outstanding balance is zero. An interesting aspect of the amortization schedule that you may want to note at this point relates to a disclosure requirement that we discuss at the end of the chapter. Among other things, the lessee and lessor must report separately the current and noncurrent portions of the outstanding lease balance. Both amounts are provided by the amortization schedule. For example, if we want the amounts to report on the 2016 balance sheet, refer to the next row of the schedule. The portion of the 2017 payment that represents principal ($68,301) is the current (as of December 31, 2016) balance. The noncurrent amount is the balance outstanding after the 2017 reduction ($248,686). These amounts are the current and noncurrent lease liability for the lessee and the current and noncurrent net investment for the lessor. Depreciation Depreciation is recorded for leased assets in a manner consistent with the lessee’s usual policy for depreciating its depreciable assets. The first rental payment includes no interest. The total of the cash payments ($600,000) provides for: 1. Payment for the equipment ($479,079). 2. Interest ($120,921) at an effective rate of 10%. Payments Effective Interest Decrease in Balance Outstanding Balance (10% 3 Outstanding balance) 1/1/16 479,079 1/1/16 100,000 100,000 379,079 12/31/16 100,000 .10 (379,079) 5 37,908 62,092 316,987 12/31/17 100,000 .10 (316,987) 5 31,699 68,301 248,686 12/31/18 100,000 .10 (248,686) 5 24,869 75,131 173,555 12/31/19 100,000 .10 (173,555) 5 17,355 82,645 90,910 12/31/20 100,000 .10 (90,910) 5 9,090* 90,910 0 600,000 120,921* 479,079 *Adjusted for rounding of other numbers in the schedule. Illustration 15–6B Lease Amortization Schedule
Spiceland_Inter_Accounting8e_Ch15
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