ASC 840 / IAS 17 Capital Lease Example

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Let’s take as an example a copier lease, under the ASC 840 or IAS 17 accounting standards. The copier costs $3,500 to purchase new; the lessor is willing to lease it to you for 3 years, starting in 2015, at a price of $115 per month, paid at the beginning of each month. Of that, $16 is identified as the cost of maintenance. If you borrowed money for three years to finance the purchase of the same copier, you would have to pay 8.5% interest. If you bought the copier, you would normally depreciate it over 5 years. There is an option to buy the copier at the end of the lease for $500, which is estimated to be its fair market value at that time.

First, we check the four capital/finance vs. operating tests. There is no automatic ownership transfer as part of the lease agreement, so criterion #1 is not met. The purchase option is not a “bargain” as defined by ASC 840, so criterion #2 is not met. The lease term of 3 years is less than 75% of the economic life of 5 years, so criterion #3 is not met.

FASB 13/IAS 17 - Capital lease example: Buy vs. lease copier

Determining the present value of the rents takes a few more steps. First, we exclude the maintenance cost; that is considered an “executory cost,” and therefore excluded from this calculation. Thus, the net rent is $99 per month. At your incremental borrowing rate of 8.5%, the present value of the rent is $3,158.35, which is more than 90% of the fair value of the asset. Thus, criterion #4 is met and the lease is capital.

The first month, you set up an asset and an obligation, make the first rental payment, then accrue interest and amortization:

Sample capital lease journal entries, first month:

Debit Credit
Initial booking
Current liability
Long-term liability
Monthly rent payment
Long-term liability
Current liability
Obligation reclass, long-term to current
Long-term obligation
Current liability
Interest accrual for first month
Interest expense
Accrued interest
Amortization for first month
Amortization expense
Accumulated amortization

Note: The first rental payment, since it is made on the first day of the lease, goes entirely into obligation reduction. In following months, the interest accrued during the month is paid off by the rental payment, with the excess of rent over accrued interest going to obligation reduction. (In certain leases with scheduled rent increases, the rent paid may be less than the accrued interest. This results in an increase to the outstanding obligation, known as negative principal amortization.)


(Example continued below)

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For this lease, the journal entries for month #2’s rent payment would be:

Debit Credit
Current liability
Accrued interest
Executory expense

Each month, the rent payment is booked in the manner shown above, amortization and interest are accrued and expensed, and obligation is reclassified from long-term to current. When the lease expires (or if it is terminated before its scheduled expiration date), the asset and obligation are removed from the books, with a gain or loss recognized if the net asset and remaining obligation are unequal. This is almost always the case if the lease is terminated early.

So as of the end of year 1, your disclosure would be:

The following is a schedule by years of minimum future rentals on noncancelable capital leases as of December 31, 2015:

Year ending December 31
Total minimum payments required
Less executory costs
Net minimum lease payments
Less amount representing interest
Present value of net minimum lease payments

Note: This description applies to the rules set out in FASB 13 for U.S. accounting.

To enter this lease in EZLease, follow these steps* :

*Assumes default system settings of an Implementation Date of 1/1/2019 for IFRS and 1/1/2022 for FASB and a 12/31 Year End.

FASB 13 / IAS 17 - Capital lease example

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